Generally speaking, debts of a person’s estate are deductible for IHT purposes – though there are some circumstances where specific debts cannot be deducted such as where the deceased had previously made a gift to the person who made the loan. Following this year’s Finance Act, which became law on 17 July, there are several changes affecting deaths on or after that date.
The changes will affect deductions for debt in the following ways:
- Generally, a deduction will be denied unless the debt is repaid on or after death out of the estate. However, a deduction may still be permitted where the debt has been retained for sound commercial reasons, and gaining a tax advantage was not one of the main purposes for keeping it.
- Debts will not be taken into account as deductions for IHT purposes if they were taken out to purchase, maintain or enhance property excluded from IHT. If, however, the amount of the debt exceeds the value of the excluded property, and is not perceived to have a tax avoidance motive, then the balance may be allowed as a deduction. This will affect relatively few people.
- Debts taken out to acquire property which benefits from business property relief or agricultural property relief must first be deducted from the value of that property with only the balance being deductible from the chargeable estate. Previously, debts were deductible from the value of the property on which they were secured (which was usually chargeable) rather than from the property they were used to acquire, so this change means that such debts may no longer obtain the IHT savings they previously did. However, following a change to the original Finance Bill, this particular rule only applies to debts incurred on or after 6 April 2013 – so arrangements existing at that date remain effective. Even so, this change will affect many who are farmers or run their own businesses (whether as sole traders, partnerships or companies) and take out new finance or possibly reorganise existing finance.
These changes could have a significant impact on estate planning. We recommend that any individual who is relying on a debt reduction to minimise future IHT payments should seek advice.