Changes to Inheritance Tax (IHT) have come into effect as a result of the Finance Act 2013 – and they could catch out the unwary.
Inheritance Tax is charged on the net value of a deceased person’s estate after taking into account liabilities outstanding and after deducting any reliefs, exemptions and the nil-rate band for IHT.
Reliefs are available for certain assets such as business property and agricultural property, while property situated outside the UK and which belongs to, or was settled by, a non-UK domiciled individual is not chargeable to IHT at all.
It used to be the case that a mortgage over a property could be set against the value of that property for the purposes of IHT; it was thus possible to borrow against the family home and purchase another asset – agricultural land, for example. The value of the family home would be reduced by the debt while the value of the agricultural land would benefit from relief at 50% or even 100%. In this way a deduction in IHT could be achieved without a corresponding asset necessarily being taxed.
However, the Finance Act 2013 has brought in restrictions in the way that a deduction for liabilities is allowed. The permutations are quite complex, but they are important to understand if you are to minimise your exposure to Inheritance Tax.
Firstly: from now on no deduction will be allowed for a loan taken out directly or indirectly to acquire property which is excluded from the charge to IHT. In other words, if you borrow money against your UK home to buy a property outside the UK and you are a non-UK domiciled individual, you will no longer be able to offset that borrowing against the value of your home for the purposes of IHT.
Secondly: where borrowing has taken place to acquire assets on which a relief is due – such as a business property or agricultural land – the borrowing will from now on be taken to reduce the value of those assets that can qualify for relief. The deduction for the loan will be matched against the assets acquired and Inheritance Tax relief will only apply on the net value of the new assets, not the total value as before.
There’s something else to consider too: not only has the new legislation closed the previous planning opportunity, but it is not a symmetrical relief. If we reversed the above scenario, and borrowed against agricultural property to buy a second home, the loan would still be set off against the value of the agricultural land (which may well be fully relieved anyway) but the second home would be fully taxable. For the unwary, it is still quite possible to create a taxable asset without a corresponding deduction being recognised – but not the other way around!
Michael Cope is a Partner at the Skegness office of Duncan & Toplis.