Last week I looked in a little bit of detail at the new provisions in this year’s Finance Act in relation to the non deductibility of many loans made after 5 April 2013 to acquire, enhance or maintain property qualifying for IHT business property relief, agricultural property relief or woodlands relief.
These provisions were introduced in the Finance Act 2013 so as to prevent (officially) perceived unacceptable tax avoidance by persons borrowing funds to invest in property that is not chargeable to inheritance tax yet obtaining a deduction for inheritance tax purposes in respect of the borrowed funds by setting the debt against the value of otherwise chargeable assets.
As indicated last week, these new rules can also apply to funds borrowed to invest in excluded property.
Recent updates to HMRC’s Inheritance Tax Manual confirm that the new rules can indeed apply to restrict the ability to make a deduction for IHT where the borrowed funds are used to enhance or maintain excluded or relievable property – extending the scope of the provisions beyond simply buying such property. It is thought that, in practice, these provisions will primarily cover situations where money is borrowed to maintain or enhance buildings that qualify for relief. However, there is no such formal limitation.
I was interested in that part of the updates that provides detailed guidance on how the rules will operate in practice where borrowed funds are used to acquire excluded or relievable property. Having looked at BPR, APR and woodlands relief – qualifying property last week, it is worth noting that, in relation to excluded property, according to HMRC there are two common situations where borrowed money might be used to acquire excluded property:
- The trustees of an excluded property trust that owns assets in the UK borrow money and then look to set the debt against other assets that are chargeable to UK inheritance tax immediately before a ten-year anniversary. They invest the borrowed funds abroad so that they become excluded to avoid the ten-yearly charge; and
- A person who is not domiciled in the UK borrows money from a UK source, secured against their UK assets, and buys property abroad.
For example, the trustees of an excluded property trust, which includes UK property worth £1.5m, borrow £1m which they charge on the UK property. They use the funds to buy shares in an overseas company, which is excluded property. Although the liability is charged on UK property, the liability is disallowed by the new inheritance tax rules in the Finance Act 2013. According to HMRC this is because the liability has been incurred to directly finance the acquisition of excluded property.
HMRC has confirmed that the rules may also apply where a person domiciled in the UK acquires an interest in an excluded property trust depending on the nature of the interest acquired.
There are three exceptions to the new rule:
(a) Where the excluded property has been sold and the proceeds become chargeable assets in the deceased’s estate;
(b) The property is no longer “excluded property” or
(c) To the extent that the property has fallen in value
In these cases, any loan used to acquire the excluded property will be fully (or in the case of (c) partly) deductible for IHT purposes. Examples of how these exceptions could operate in practice are provided in the guidance which will eventually be incorporated into the Inheritance Tax Manual. The guidance also provides further detail on how the new rules will work where borrowed money is used to acquire, enhance or maintain property that qualifies for 100% relief from inheritance tax. This was covered in last week’s article.
While talking about non-doms, let’s not forget that offshore funds and offshore bonds are assets that will represent income tax, capital gains tax and IHT exemption from tax and so warrant some tax-motivated consideration.
If these assets are held inside a trust created by a settlor who, at the time the trust was created, was a true non-dom then the property will remain excluded property and be free, under the current rules at least, of inheritance tax. The clue’s in the name really.
Tony Wickenden is joint managing director of Technical Connection
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