Friday, 13 September 2013

HMRC Publishes Guidance on non deductible estate debts.

From STEP - The society for trust and estate practitioners

Thursday, 12 September, 2013


HMRC has published guidance on s176 of the Finance Act 2013, which prevents executors deducting certain liabilities of an estate from its taxable value.
The surprise measure was introduced in the Finance Bill 2013 without prior consultation. The liabilities affected are, briefly, debts incurred by the deceased in order to purchase inheritance tax (IHT)-exempt assets; and debts that his executors do not pay off on his death.
According to HMRC, the measure was necessary to counter certain IHT-avoidance schemes, but professional bodies have sharply criticised it because it may cause serious problems for existing arrangements that were not set up to avoid tax. They are also disappointed that there was no consultation before the legislation appeared, though HMRC claims the period between publication of the Finance Bill and its enactment into law was an adequate substitute for a formal consultation.
In a document issued last week, HMRC stated that the inheritance tax manual will be updated to take account of some of these objections; in the meantime interim guidance has been issued.
One of the main criticisms voiced noted that the legislation required that a liability can only be deducted from the taxable estate if it is discharged from the deceased’s estate. This could give rise to a situation in which a testator set up a life policy written in trust to pay off his mortgage on death, but HMRC refuses to allow the mortgage to be deducted from the estate because the estate funds are not used to repay it. This would hit those who have incurred liabilities on purely commercial terms just to buy a home, and with no IHT avoidance in mind.
HMRC’s reply to this is that the deduction for the mortgage would indeed not normally be allowable. However, it adds, there is no reason why the trustees could not refinance the debt so that the estate passes to the beneficiaries encumbered with a new liability.
Retrospection was a further widely expressed criticism, as the measures apply to pre-existing liabilities, affecting many businessmen and farmers who had borrowed in the past to expand their business and secured the loan against their personal property. HMRC disagrees that the provisions are retrospective, but says it recognises that borrowers who have done this may not be able to restructure the loan or unwind the arrangements quickly. Thus the commencement provisions have been amended so that they will not apply to liabilities incurred to acquire IHT-exempt (relievable) property before 6 April 2013 ‒ although the retrospective action continues to apply to the other types of liabilities.
The original text was also unclear about whether the status of the property (i.e. whether it was excluded as a liability) should be considered at the time of purchase, or when the tax charge occurs. Section 162A of the Act has now been rewritten to clarify that the status has to be considered when the liability is taken into account, and also to deal with situations where property ceases to be, or becomes, excluded property.
Other critics noted that it was not clear whether the term ‘estate’ meant just the free estate or whether it included the wider meaning of estate for IHT purposes, for example settled property, or lifetime gifts with reservation of benefit. Accordingly the Bill was amended to state that ‘estate’ has the wider meaning for the purposes of repaying the liability.
Another criticism was that the Bill did not state how a liability should be treated on submission of the IHT400 form ‒ that is, whether it should be allowed in the initial computation, to be disallowed if not discharged subsequently. There were also concerns that personal representatives would have to produce evidence that any liabilities were repaid in all cases. HMRC has now stated that its assumption will be that a liability will be repaid, and PRs will only need to provide evidence of repayment if HMRC enquires into the liability.