Mark McLaughlin highlights an anti-avoidance provision that could result in the unexpected denial of an IHT deduction for an outstanding debt on death.
The making of gifts and loans between family members, friends, etc. is a relatively common part of everyday life, and is not necessarily done for inheritance tax (IHT) planning purposes. However, an IHT anti-avoidance provision can potentially apply in such situations, regardless of an individual’s motives when the gifts and loans are made.
The anti-avoidance rule (in FA 1986, s 103) restricts debts (and ‘encumbrances’) incurred or created by the deceased (on or after 18 March 1986) in determining the value of his or her estate immediately before death, broadly to the extent that consideration given for the debt, etc. was either:
- originally derived from the deceased; or
- given by any person who was at any time entitled to, or whose resources at any time included, any property derived from the deceased (see below).
This provision is intended to prevent the avoidance of IHT through the ‘artificial’ creation of liabilities, which would normally be allowable deductions from the deceased’s estate.
However, the above restriction does not apply broadly if the original disposition by the deceased was not a transfer of value, and was not part of ‘associated operations’ which contained any element of direct or indirect bounty (s 103(4); see HMRC’s Inheritance Tax manual at IHTM28368).
If the debt is disallowable, lifetime repayments of the debt within seven years of death are treated as potentially exempt transfers (s 103(5)).
Cash gift and loan back
An example of a restriction resulting from the first bullet point above is where Joe gifted cash of £100,000 to his daughter Karen on 1 December 2008. Karen lent £100,000 back to Joe on 1 January 2009. Joe died on 1 April 2016, and Karen’s loan was still outstanding on his death. For IHT purposes, the lifetime gift of cash by Joe was a potentially exempt transfer (PET), which became an exempt transfer after seven years.
On the face of it, the loan of £100,000 is a deductible liability in Joe’s estate. However, the loan is ‘caught’ (by s 103(1)(a)), as the liability was derived from Joe’s gift of cash to Karen. Therefore, the liability cannot be deducted from Joe’s estate on death for IHT purposes (i.e. there is ‘abatement’ (as the legislation puts it) of an IHT deduction for the loan).
Gifted asset and loan back
An example of a restriction in the second bullet point above is where Lucy gives jewellery worth £50,000 to her son Martin on 4 April 2009. Martin kept the jewellery, but lent Lucy £50,000 on 30 May 2009. Lucy died on 30 September 2016. The arrangement is caught (by s 103(1)(b)), so the loan of £50,000 is not a deductible liability in Lucy’s estate.
In this case, Martin’s loan was not made out of property derived from Lucy, but Martin’s resources included Lucy’s gift of jewellery. However, in some circumstances where an arrangement is caught by this anti-avoidance rule part of the debt may be allowed, if certain conditions are satisfied (see s 103(2); see IHTM28369).
Double whammy?
The disallowance of a debt could potentially result in a double IHT charge. In the first example above, if Joe’s gift to Karen had been made within seven years of his death, the PET would become chargeable to IHT as a result. In addition, Joe’s estate includes the £100,000 lent back to him, but a deduction for the debt would be denied (under s 103).
However, relief is available in such circumstances (s 104(1)(c); SI 1987/1130, reg 6). The effect is broadly that either the debt is disallowed and the gift is correspondingly reduced, or the gift is taxed and the debt is allowed; whichever gives rise to the higher overall IHT liability remains chargeable.
Practical Tip:
The above examples have been simplified to illustrate some difficult and wide-ranging anti-avoidance legislation. Care is needed in circumstances such as where gifts and loans have been made between the same family members.
