IHT and debt – important changes to the rules
Angus Hunter Smart of Wrigleys reviews new rules affecting how debts can be deducted for IHT - unwelcome news for many farmers and landowners.
The 2013 Budget changes to how debts can be set against assets to reduce their net value for inheritance tax (IHT) purposes have, rightly, been widely publicised. Now enacted, the new rules apply to all deaths and chargeable transfers (i.e. IHT charges involving trusts) after 17 July 2013. Despite some concessions before enactment, meaning that most pre-6 April 2013 borrowing will escape the new rules, it may be difficult to preserve pre-2013 status. Either way, many farmers and landowners will be affected and should review secured borrowing, particularly where there was an IHT planning aspect.
Case Study – Deceased Farmer
- £1m of farmland and £1m farmhouse (both qualifying for 100% APR)
- £2m of let cottages (no relief)
- £2m of borrowing (secured bank debt)
The basic rule is that a liability reduces the taxable value of the asset upon which it is charged. Until the recent changes, this allowed landowning clients to secure borrowing tax efficiently. In the case study, if the borrowing had been secured on the farmland and farmhouse alone, the 40% IHT on death would have been £800k (ignoring the nil-rate band) – the debt would have been 'wasted' because it was deductible against 'fully relievable' assets. On the other hand, if the borrowing had been secured on the cottages instead, their taxable value would have been reduced to zero by the debt. Since the remaining assets (the farmland and farmhouse) attracted 100% APR, the overall IHT would have been nil.
So where possible it made obvious sense to offer non-relievable assets as security for borrowing, rather than farmland. Arrangements already in place may still work, because the new rules apply to new borrowing only – but overdrafts and renewed or refinanced arrangements may be caught.
The 'new' rules
The new rules have a major impact. They will apply to all deaths or chargeable transfers from 17th July 2013, and, with the qualifications below, will apply to all borrowing taken out on or after 6 April 2013.
This will include where pre-existing borrowing is refinanced and where additional borrowing is taken out under pre-existing loan agreements. Probably, too, all borrowing on secured overdrafts will be caught (whether before or after 6 April 2013). In short, great care will have to be taken if existing debt is to remain tax effective for IHT.
The general principle of a debt being deductible against the asset upon which it is secured is now supplemented by a new set of rules. The most significant change is that, where a liability has been incurred to 'acquire, maintain or enhance' assets on which relief (such as APR or BPR) is available, the liability will be taken to reduce the value of those relievable assets – so negating the tax advantage – regardless of which assets the liability is actually secured against.
This represents a major change, and will stop new borrowing being secured tax efficiently for IHT. For instance, if the borrowing in the case study was taken out in May 2013, and the farmer died in August 2013, then even if the borrowing was secured entirely against the non-relievable assets, the IHT bill on death would be £800,000 (rather than nil under the old rules).
What will the impact of the new rules be?
All new borrowing will be caught, and the opportunity to secure such borrowing tax efficiently for IHT purposes has gone. Where landowners have pre-existing arrangements, these may still be tax efficient but any refinancing or renewing of term loans will bring the new rules into play.
Borrowing secured on non-relievable assets will only be non-deductible if it has been incurred to acquire, maintain or enhance a relievable asset. Funding of purchases of farmland should be easy to identify, but it is difficult to know where the line will be drawn as far as maintenance and enhancement are concerned. There will almost certainly be grey areas where 'general' borrowing (perhaps by way of an overdraft secured on let cottages) has been used in part to fund the capital requirements of a farming business, and in part to build an extension to the farmhouse and improve drainage across the farm.
Overall, the changes will affect most landowners who have taken out borrowing and secured that debt on non-relievable assets. Anyone in that position should review their arrangements urgently.
Angus Hunter Smart is a partner in the private client department of Wrigleys Solicitors LLP, specialising in tax advice for landowning clients. He can be contacted on 0113 204 5730 or firstname.lastname@example.org.