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This article looks at another of the practical effects of the new IHT provisions in Finance Bill 2013:
- restrictions on the deduction of liabilities for IHT
Throughout this article, references to spouses include civil partners; the term ‘partner’ means both a member of a married couple and a registered civil partnership.
Aside from artificial schemes, the new measures will affect ordinary UK businesses. It is common for business owners to obtain finance for their enterprise by mortgaging their home, since it may be the only asset deemed suitable as a security. The arrangement includes an inheritance tax advantage because of the requirement that an incumbrance on a property reduces the value of that property. So when the business owner dies, the business qualifies for BPR and, in addition, the chargeable value of the home is reduced by the mortgage.
The proposals in Finance Bill 2013 will require that the liability is detached from the home and re-attached to the business if it qualifies for BPR.
Commentators have questioned whether this was the real intention of the Chancellor. It is indeed a shock for business owners who will have assumed that the liabilities secured on their personal assets would reduce their exposure to inheritance tax. Whether intended or not, it is unlikely that the government will concede any exceptions on this point. The measure may have been unexpected but, objectively, it is difficult to see how it is unfair. Whilst the business owner's family will have to finance the tax on the home, and may even have to sell the home to do so, that dilemma is often presented to families faced with an inheritance tax bill: personal property, including the home, has to be sold to pay the tax.
In many cases, the purpose of charging a business loan on personal property was not to save inheritance tax. Offering the home as security may be the only way a business can obtain finance, in which case the arrangements will have to stand. However, if a business owner has a choice on whether to accept a charge on his home or a charge on business assets, he may now prefer not to put his home at risk since it offers no tax advantage.
Obtaining finance for a relievable business may be tied up with the owner's other personal and commercial interests and it will not always be clear which asset a loan is financing. The taxpayer will need to be able to demonstrate that a particular liability should be attached to the chargeable assets where there are other assets eligible for BPR and APR in the estate. Documentation and bank statements illustrating the sequence of events should be retained. Remember that the acquisition of property and the loan to finance it may have been instigated long before the chargeable occasion.
So, for the business owner, care should be taken to match liabilities with the non-business assets they finance and retain the evidence. Interestingly, the provision does not work in reverse, as illustrated by Example 5.
Tax planning now rendered ineffective by the new provisions may have taken place many years ago. Practitioners should review past arrangements in the light of the proposed changes so that they can warn clients of any additional exposure to IHT.
Gerald runs a successful small manufacturing business. He purchased the factory and yard with a legacy he received many years ago. He buys a plot of land and engages a builder to build a pair of houses, which he intends to let. The bank is reluctant to lend on property which has not yet been built but is quite willing to lend Gerald the money if he takes out a mortgage on his factory.
Gerald's liability to the bank is secured on the factory, although the purpose of the loan was to finance the acquisition of the rental property. When Gerald dies, the liability will not reduce the chargeable value of the estate because it is secured on non-chargeable property. This is the current position and it does not change when the new provisions are enacted.
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