In calculating the value of an estate for the purposes of Inheritance Tax (‘IHT’), the general rule is that liabilities may be deducted, though anti-avoidance rules may operate to deny or restrict deduction. For example, special rules apply where you borrow in order to acquire property that does not bear a charge to IHT (such as property that qualifies for Business Property Relief or ‘excluded property’ owned by a person not domiciled in the UK).
Less well-known is the effect of Section 103 of the Finance Act 1986 (‘FA1986 s103’), on which this note focusses.
A liability is deductible for IHT only if and to the extent that it is incurred for a consideration in money or money’s worth (unless it is imposed by law, as for taxes, fines, penalties etc). Thus, no deduction is available for a mere promise to pay, even where that promise is made legally enforceable by being evidenced by a properly executed deed.
So: can you turn the trick by making a gift of money and immediately borrowing back the same amount from the donee?
No: this is what is countered by s103, presumably on the basis that the economic substance of such an arrangement (as distinct from its legal form) is that no consideration has been received in respect of the loan.
However, the scope of s103 is wider than that: it can apply in much less obvious circumstances.
Suppose, for example, I give my daughter an investment property, with the intention (on the part of both myself and my daughter) that the gift is to be an outright one with no strings attached. Ten years later I unexpectedly find myself short of cash to pay care home fees. My daughter unhesitatingly raises a mortgage on the property to fund a loan to me. S103 will deny any deduction from my estate for the amount of the debt. This is because the consideration she has given for the debt derives from the property gifted.
In fact, s103 goes even further than that. If I have made a gift to a person, no deduction may be made in computing my estate for any debt owed to that person if and to the extent that the loan could have been made out of the property gifted (even if it is plain that it was not) unless it can be demonstrated that the gift ‘was not made with reference to, or with a view to enabling or facilitating’ the making of the loan.
Thus, even if my daughter is able to, and does, fund the loan out of assets other than the property gifted (so that the loan is not in fact ‘derived from’ the gift), it is also necessary to show (if the loan is to be deductible from my estate) that there was at the time of the gift no plan that it would ‘free up’ other assets to finance a future loan back.
This may seem obscure, but it is not a ‘dead letter’: in its published guidance, HMRC enjoins officers to look out for s103 liability. So be aware.
For more information on IHT and estate planning, please get in touch with your usual BKL contact or use our enquiry form.