As it stands, if a debt is secured against an asset, only the net value is exposed to UK Inheritance Tax (IHT). For a non UK domiciled individual’s estate, or associated trust, any unsecured debt is set off against excluded property in priority to taxable property. Both of these have lead to a variety of tax planning opportunities over the years.
Draft rules in the Finance Bill 2013, however, if enacted, will compromise these principles and will give rise to results that do not reflect the commercial reality of an arrangement. This will not only increase IHT liabilities but may impact the amount lenders will be prepare to advance, even with security.
With the new legislation may come restrictions and conditions on the deduction of debts where, the loan is not repaid by the executors of the estate; the borrowed money has been invested in property that qualifies for relief from IHT, like business property, agricultural property or qualifying woodlands; the borrowed money has been used to acquire “excluded property” typically property situated outside the UK acquired by a not-UK domiciled taxpayer or their associated settlement but can include UK based authorised investment funds.
Generally, it will no longer be possible to offset the loans against fully taxable property, save if the debt exceeds the property it is now to be associated with under these proposed changes. This is also the case even where the debt is to a third party lender and is secured on the taxable property.
Although the proposed rules are mainly targeted at tax planning based on the general deductibility of debts and loan arrangements between family members where the prospects of repayment are remote, their actual effect will be considerably broader.
Lenders may even have to reconsider their own position given that their security will be ignored for IHT purposes and so may cause forced selling of the assets actually invested in