INHERITANCE TAX – PLANNING
Synopsis: Loans used to purchase property which qualifies for business property relief: Gift of the property subject to the relief: The position on the subsequent death of the donor.
Date posted: Thursday, October 31, 2013
New rules now apply to loans used to buy property that qualifies for special IHT treatment. Such loans must in future be primarily offset against the value of the qualifying property on death. But what happens when the property in question has been gifted before death?
Readers will be aware of the new provisions in the Finance Act 2013 to restrict the ability of persons to offset loans against assets in their taxable estate.
This operates, for example, in cases where an individual borrows money against the security of his house and uses the loan to invest in property (say shares) that qualifies for business property relief.
Prior to the introduction of the new provisions, once the individual had owned the shares for 2 years he would be in a position whereby on his death:-
– The shares would qualify for 100% business property relief, and so not give rise to any liability for IHT purposes, and
– The loan would be deductible against assets in his estate and so reduce the value of those assets for IHT purposes
In effect, a double saving in IHT could be achieved.
The new section 162B IHT Act 1984 changes all of this. This section provides that where a person borrows money to invest in property that qualifies for (inter alia) business property relief then, on death, the value of any outstanding loan is first deducted from the value of the property that qualifies for business property relief. This prevents double relief because business property relief will then only be available on the value of the property that exceeds the outstanding loan.
This is all very well but what is the position if a person borrows money to invest in property that qualifies for business property relief but subsequently gives that property away? How will the loan be treated in those circumstances on the individual’s death?
The answer to this is that the loan must be deducted from any chargeable transfer in respect of the qualifying property. A chargeable transfer will arise in respect of a lifetime gift if the individual
– Gifts the shares to a discretionary trust or
– Makes a gift of the shares that is a potentially exempt transfer (PET) and dies within 7 years of the gift so giving rise to a chargeable transfer
In both of these sets of circumstances, the outstanding loan will be deducted from the value of the property (the shares) which was transferred by the transfer of value – even though it qualified for business property relief. This will mean that unless the value of the property gifted has reduced since it was purchased, none of the loan will be offsettable against the other assets in the individual’s taxable estate on death.
On the other hand, if the individual makes a gift of the shares which is a PET and survives the PET by 7 years, the PET will never be a chargeable transfer. This will mean that the loan will be deductible against the other assets in the individual’s taxable estate on death.
Where an individual has borrowed money to buy property that qualifies for business property relief, if that individual is contemplating making a gift of that property, if at all possible it would be best to make a gift that is a PET. This is because, if he survives the PET by 7 years, the loan could then be offset against the other assets in his taxable estate on death.
Of course, in order to make a PET, the individual would need to be happy to make an outright gift other than one to, say, a discretionary trust. Either way, CGT hold-over relief should be available on the gift – if needed.