We now have the detail of the new provisions which will deny a deduction for certain debts in calculating the value of a person’s estate for inheritance tax purposes.
As expected, where a non-domiciled individual (or the trustees of his trust) borrow from a bank secured on a UK property and deposit the borrowed funds on a back to back basis (or use them for investing offshore) the debt will not be allowable on the individual’s death. This will increase the inheritance taxable estate. Nor will the debt be allowable in calculating inheritance tax charges in the trust.
Entrepreneurs who borrow to invest in their business but secure the borrowing on other assets will have the borrowing deducted from the business assets leaving their family with a bigger inheritance tax bill. This also applies where the borrowings are used in relation to agricultural property and woodlands.
Debts which are not repaid after an individual’s death, may also be disallowed. The time limit for repayment is not specified but the debt must be discharged “after death, out of the estate” which suggests that it must be repaid in the course of administration of the estate if it is to be allowable.
Debts are not disallowed where there is a “real commercial reason” for the debt not being repaid. This will be the case where there is an arm’s length borrowing or, if the borrowing is from someone other than a third party, a third party in the same circumstances would not require the debt to be paid.
In addition the liability must not be left unpaid as part of “arrangements where the main purpose, or one of the main purposes, is to secure a tax advantage”.
The definitions of “arrangements” and “tax advantage” are very wide. A tax advantage includes a delay in a charge to tax or even the avoidance of a possible assessment or determination in respect of tax as well as obtaining a relief or repayment or reduction in the tax. “Tax” is expressly defined to include income tax and capital gains tax.
Before the disguised remuneration provisions were introduced, it was common for Employee Benefit Trusts (EBTs) to make loans to beneficiaries which were left outstanding indefinitely and might be waived after the individual’s death.
These sorts of loans will, if not repaid by the estate after the ex-employee’s death, be disallowed in calculating inheritance tax.
This creates a catch-22 situation. The disguised remuneration rules provide that if the loan is waived after death, the individual’s estate or heirs will be subject to an income tax charge.
But if the loan remains outstanding, there is no deduction from the estate, potentially increasing the inheritance tax due.
If, of course, the loan is repaid then there will be no income tax charge and the debt will be allowed in the normal way, but many EBT beneficiaries will not have reckoned on having to find the money to repay the loan.