In ascertaining the value of the death estate for the purposes of inheritance tax (IHT), any liabilities or debts owed by the deceased at the date of death must be deducted.
Except.
Yes, except. Many years ago, my personal tax lecturer taught me something very true: there is no such thing as a straightforward tax rule. There is always an exception or three. Remember that, and you won't go wrong. Always look for the 'except'.
Back to the topic: you can deduct from the death estate debts or liabilities owed by the deceased at the time of his death. So if the deceased had a death estate of, say, £200,000, and was owing £5,000 in bills, etc, the death estate is £200,000 - £5,000 = £195,000.
However, this article is about a specific anti-avoidance measure aimed at catching out people who try to reduce the IHT payable by creating artificial debts, which can then be deducted from their death estate.
The scenario goes thus:
- Mr A owns several properties, including a house with a market value of £250,000.
- He gives away the house to his son, Mr B. (This is a potentially exempt transfer (PET), so that if Mr A survives seven years from the making of the gift, there is no IHT payable.)
- Mr B then mortgages the property for £250,000 which he lends to Mr A.
- Mr A dies eight years later, without having repaid the loan.
- The PET becomes fully exempt, as Mr A survived seven years from when he made the gift.
- Mr A's death estate is worth £850,000 at the date of his death. His personal representatives wish to deduct the outstanding loan of £250,000, thereby reducing the death estate to £600,000.
Can they?
The Finance Act 1986 section 103 says no. According to that section, there should be no deduction for a debt where the consideration for the debt consisted of 'property derived from the deceased'. The £250,000 lent to Mr A 'derived from' the land Mr A had given to Mr B, as it was through a mortgage that the sum was raised.
Even if the consideration was not so derived, the rule still applies if the consideration was supplied by anyone who was at any time entitled to any property derived from the deceased, or amongst whose resources such property had been included at any time. This provision would catch a scenario like that set out above, except where the money lent to Mr A was not derived from the mortgaged property, but from, say, Mr B's own investments.
And it is no use Mr A getting, say, his wife, to transfer the property to Mr B instead. The rules catch not only dispositions made by the deceased, but those made by him in concert with other people. I believe it will also catch a situation where he transferred the house to his wife, who then advanced some other kind of property, eg shares, to Mr B, who then loaned money to Mr A.
Where the transactions are caught by these anti-avoidance provisions, the debt is not deducted from the value of the death estate. In addition, if Mr A had made any repayments to Mr B in his lifetime, these are treated as PETs, and would only escape the IHT net if they were made more than seven years before Mr A's death. Obviously, tapering relief applies to PETs made more than three years before the death of the donor. A double charge can arise if Mr A died less than seven years from making the gift to Mr B, and in addition to that, deduction for the debt was disallowed. In such a case, double charges relief is available.
The above anti-avoidance provisions do not apply where the transfer of property by the deceased (in our example, the transfer from Mr A to Mr B) was not a transfer of value, and was not part of associated operations which included any element of bounty, whether direct or indirect. In addition, the provisions only apply to debts incurred on or after 18 March 1986.