HMRC turns screw on IHT debt rules

The Finance Bill earlier this year contained a number of surprises, not least the introduction of some new rules relating to the deductibility of debts for the purposes of inheritance tax.

The new rules aim to tackle those arrangements which HM Revenue & Customs felt were entered into purely to secure a tax advantage. As has happened many times before, the words ‘sledge-hammer’ and ‘nut’ spring to mind.

No one has ever claimed the IHT rules are straightforward – far from it. The main principle, however, is simple. When someone dies IHT is charged on their estate using this formula:

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- Add up the value of the assets owned by the deceased

- Deduct the liabilities of the deceased

- Take account of any exemptions, allowances and reliefs

- Pay tax at 40 per cent on what is left.

The Finance Act this year has introduced three main restrictions. These limit the situations where a liability can be deducted when calculating the IHT charge, which arises on death or other chargeable events. The restrictions apply depending on whether the money borrowed is repaid from the estate and depending on what the borrowed monies are used for.

Unpaid loans: Under the new rules the basic premise is that a liability can only be deducted for IHT purposes if it is repaid out of the estate. If it is not repaid out of the estate, then it will only be deductible if, in the opinion of HMRC, there is a real commercial reason for the liability not to be discharged.

There are many cases where family trusts lend money to beneficiaries. When a beneficiary dies, the trustees do not intend to call in the loan but instead are happy for the loan to be ‘rolled over’ to the next generation, and for those beneficiaries to inherit all of the deceased’s assets.

Following the introduction of the new rules, such loans will need to be repaid from other monies within the estate to secure the IHT reduction.

What is not clear is how such arrangements are to be policed. When completing a set of probate papers the executors will include all the liabilities, whether or not they have been settled. In the vast majority of cases, none of the liabilities will have been settled at that stage because of the requirement to obtain the grant of probate to, in turn, obtain the funds needed to pay the liabilities.

This will include debts such as credit card bills and mortgages, as well as loans from family members or trustees. The present position of HMRC appears to be that the probate papers should be completed as normal and that if a liability is not repaid, then a corrective account will need to be completed by the executors.

Loans between family members and trusts are frequently ‘flexible’ and decisions as to whether to write them off or not can often take years. It will be interesting to see how the Revenue’s approach to such issues develops.