Inheritance Tax Planning – The Rules Are Set To Change

11th September 2013

The 2013 Budget announced significant changes in the rules governing how debts are treated for Inheritance Tax purposes. Whilst the legislation is in draft form, it is likely to receive Royal Assent in July 2013.

Under current scheme rules, on the death of an individual the value of their estate is subject to Inheritance Tax at 40%, after taking into account an individual’s £325,000 nil rate band. When calculating the value of the deceased’s estate, any outstanding liabilities including secured and unsecured loans and debts, are deducted from the gross value of their estate, thus reducing the amount of inheritance tax payable.

Agricultural land should qualify for 100% Agricultural Property Relief (APR) if it has been owned and farmed ‘in hand’ for a period of 2 years or more and used primarily for agriculture, or if it has been owned for 7 years or more and leased out for the purposes of agriculture. In addition if agricultural land and assets have been owned by a partnership or sole trader and used as part of the agricultural business, then you may acquire 100% Business Property Relief (BPR).

If you take a typical mixed farming business or rural estate, then it is likely that the mix of assets held will incorporate both APR relievable assets (farmland) and non-relievable assets (residential investment property portfolio). In this instance, it has been common practice to secure any debts incurred in investing into the core business (e.g. buying farmland or fixed equipment) against non-relievable assets such as the residential portfolio which may not qualify for APR or BPR, thus reducing the burden of Inheritance tax.

Example

John’s gross estate is worth £3 million. His estate includes a mix of residential property worth £1 million and agricultural property, which qualifies for APR, worth £1 million.

John has a mortgage on a residential property of £500,000. John took out the mortgage on the residential property in order to acquire additional agricultural land.

On John’s death the outstanding mortgage is deducted from the value of the residential property. Therefore, the value of the residential property which is subject to IHT is £500,000 (£1 million less £500,000). The nil rate band is ignored for the purpose of this example.

The Proposed Changes

There will be much greater scrutiny on the purposes of the original loan to determine what assets the loan may be deducted against for IHT purposes.

If we consider the above example, where a loan was taken against non-relievable assets to acquire assets that might qualify for APR or BPR, then the loan will be deducted from the value of the agricultural property which is likely to qualify for some relief anyway and not from the value of the residential property.

This means that no IHT saving would be achieved in respect of this loan. Whilst the proposed changes are not thought to apply retrospectively, it may be worth reviewing existing arrangements, particularly in light of the closer scrutiny rural property and estates are under.

Another major change in the treatment of debt in reducing an estate’s inheritance Tax liability is that the draft legislation outlines that any debt must actually be repaid (on or after death) or there must be a real commercial reason for the loan not being repaid. This is designed to prevent an IHT saving being obtained where the loan is never repaid.

As an advisor to farmers and to estate owners, there are a number of areas to review with your other professional advisors that might lead to significant inheritance tax savings for the future. The starting point is to understand what you hold, its relative Market Value and how these assets might qualify for any APR or BPR relief so you can then put in place any desirable changes to mitigate a tax that might otherwise mean a sale of assets to pay tax, rather than a smooth transition to the next generation.

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