Section 176, Schedule 36: Treatment of Liabilities for Inheritance Tax Purposes
Summary
1.Section 176 introduces Schedule 36 which amends the inheritance tax (IHT) provisions relating to the treatment of liabilities. The schedule brings in restrictions and conditions that must be met before a liability is allowed as a deduction from the value of an estate so as to remove the tax advantage that is achieved by arrangements which exploit the current provisions.
Details of the Schedule
2.Paragraph 2 of the schedule amends section 162 of Inheritance Tax Act 1984 (IHTA) so that that a liability is first taken into account under the new provisions before the existing provisions of section 162 apply.
3.Paragraph 3 of the schedule inserts new sections 162A to C into IHTA.
4.New section 162A deals with liabilities incurred to finance excluded property. Property is ‘excluded property’ if it is situated outside the UK and the individual entitled to it is domiciled outside the UK, or if settled property is situated outside the UK and the settlor was domiciled outside the UK when the settlement was made.
5.New section 162A(1) provides that a deduction for a liability which has been incurred directly or indirectly to acquire, enhance or maintain excluded property is only allowable in so far as the conditions in sections 162A(2) to (4) are met. Otherwise the deduction will not be taken into account.
6.New section 162A(2) provides that where the excluded property has been disposed of, a deduction may be allowed to the extent that the consideration is subject to tax and has not been used to acquire, maintain or enhance further excluded property or to repay a liability that itself would not be allowable. The liability may be deducted only if the disposal is at full value and the proceeds form part of the estate so that they are chargeable to IHT.
7.New section 162A(3) is directed at cases where property ceases to be excluded property and becomes chargeable to IHT before the question of whether to take the liability into account arises. The deduction may be allowed to the extent that the property has not been disposed of and is subject to tax.
8.New section 162A(4) applies where the liability exceeds the value of the excluded property. A deduction for the excess liability may be made but only if that excess is not due to any of the reasons given in new section 162A(7). This subsection ensures that a deduction is not allowed where the excess liability has arisen by a deliberate manipulation of the value of the excluded property or the liability to obtain a tax advantage, as defined in new section 162A(8).
9.New sections 162A(5) and (6) are aimed at cases where the property financed by the liability becomes excluded property at some stage before deciding whether to take the liability into account. A deduction may only be allowed for the amount of any liability that exceeds the value of the excluded property, but only if that excess is not due to any of the reasons in new section 162A(7).
10.New section 162B deals with liabilities incurred to finance property which qualifies for certain reliefs (‘relievable property’).
11.New sections 162B(1) and (2) apply if the liability has been incurred to acquire, maintain or enhance property which qualifies for business property relief under section 104 IHTA. Section 162B(2) provides that the liability reduces the value of the relevant business property, so that only the net value of the property may then qualify for business property relief.
12.New sections 162B(3) and (4) apply if the liability has been incurred to acquire agricultural property which qualifies for agricultural property relief under section 116 IHTA, or to maintain or enhance its agricultural value. The liability reduces the agricultural value of the property, so that only the net agricultural value may then qualify for agricultural property relief.
13.New sections 162B(5) and (6) apply if the liability has been incurred to acquire land, trees or underwood which qualify for woodlands relief under section 125(2)(a) IHTA, to plant the trees or underwood, or to enhance or maintain the value of that woodland. The liability reduces the value of the trees or underwood, so that only the net value is left out of account.
14.New section 162B(7) provides that once a liability has been taken into account, it cannot be taken into account against another transfer by the same transferor.
15.New section 162B(8) disapplies subsection (7) for the purposes of a ten year anniversary (TYA) charge so that a liability can be taken into account again for subsequent TYA charges.
16.New section 162B(9) extends the provisions in subsections (1) to (4) and (7) to relevant property trust charges.
17.New section 162C gives details of supplementary provisions for the purposes of sections 162A and 162B.
18.New section 162C(1) explains that this section applies where a liability has been incurred to acquire, maintain or enhance the value of, a mixture of excluded property, relievable property and/or other property, and where the liability has been partially repaid before it has to be taken into account for the purposes of a deduction.
19.New section 162C(2) provides a priority rule for how the repayments should be applied to the liability. The repayment is first applied to any part of the liability that was not attributable to excluded property or relievable property, then to any part used to finance relievable property, and finally to any part used to finance excluded property. The result is that the part of the liability that might be allowable as a deduction is treated as paid off first.
20.Paragraph 4 of the schedule introduces a new section 175A into IHTA which deals with repayment of liabilities after death.
21.New section 175A(1) provides that, in arriving at the value of a deceased person’s estate, a deduction for a liability will only be allowable to the extent that the liability has been repaid on or after death out of assets in the estate or from excluded property that the deceased owned. The deduction must also not be disallowed by other provisions in IHTA.
22.New section 175A(2) sets out the conditions to be met before a deduction for a liability that has not been repaid may still be allowable. The unpaid part of the liability may be allowable if it is shown that there is a real commercial reason for not repaying the liability, and the main purpose of leaving any part of it unpaid is not to obtain a tax advantage as defined in new section 175A(5).
23.New section 175A(3) explains that a real commercial reason for a liability not being repaid is one where it is shown that the liability is to a person at arm’s length, or that an arm’s length creditor would not require the liability to be repaid.
24.New section 175A(4) specifies that for the purposes of the IHT exemption for transfers between spouses or between civil partners, where a liability is not repaid and is disallowed as a deduction, the increase in the value of deceased’s spouse’s or civil partner’s estate is treated as the full value without any deduction for the disallowed liability.
25.New section 175(7) applies where a liability is attributable to a mixture of excluded property, relievable property and/or other property and has only been partially repaid after death. It provides a priority rule for how the partial repayments should be applied to the liability. The part of the liability that is attributable to excluded property is taken to be repaid first, followed by any part attributable to relievable property, and finally any remaining part.
26.Paragraph 5 of the schedule explains when the provisions come into effect. They will apply to deaths and other chargeable transfers which occur on or after 17 July 2013. In addition, the provisions in new section 162B will only apply to liabilities incurred on or after 6 April 2013.
Background
27.IHT is normally charged on the net value of a deceased person’s estate after deducting liabilities outstanding at the date of death, reliefs, exemptions and the nil-rate band. The deduction for liabilities is given for the full value due to the creditors and is not limited to the amount actually repaid after death, or restricted if the liability has been incurred to acquire property which also qualifies for a relief or is not chargeable to IHT.
28.Reliefs are available for certain assets which are not chargeable to IHT in certain circumstances. These include business property relief, agricultural property relief and woodlands relief. Property which is situated outside the UK and which belongs to, or was settled by, a non-UK domiciled individual is ‘excluded property’. It does not form part of a person’s estate and is not chargeable to IHT.
29.IHTA includes limited provisions about when and how a liability should be taken into account. As a result, a tax advantage may arise where a liability is not repaid, or where the borrowed money is used to acquire property that is not liable to IHT.
30.The amendments made by this section will remove the tax advantage that arises from obtaining a deduction for a liability and either not repaying the liability after death, or acquiring an asset which is not chargeable to IHT. They will make certain arrangements unattractive because the estate will no longer gain the double benefit of a relief or exclusion and the deduction of a liability. They will also ensure that the treatment of liabilities used to acquire relievable property will be consistent for IHT purposes regardless of the nature of the assets acquired or how the loan has been secured.
