On 20 March 2013, the then Chancellor, George Osborne, announced a significant change on how debts are allowed or relieved in an inheritance tax computation particularly when that estate includes property which qualifies for either Agricultural Property Relief or Business Property Relief.
Ten years on and with many farmers and landowners reviewing their long-term debt, it can be easy to forget that a change in the terms and conditions on that debt might affect your inheritance tax planning.
Inheritance tax is calculated on the net value of someone’s estate. In other words, you take the market value of the assets in the deceased’s estate and you deduct from that the deceased’s liabilities. Typical debts which are deducted in these circumstances include mortgages, overdrafts, credit cards and bills.
For secured loans such as mortgages, the amount outstanding is set against the value of the property the mortgage is secured against. Business debts should be deducted from business property.
Prior to 5 April 2013, a useful inheritance tax planning tactic in a farming context was to secure long-term debt against assets which did not qualify for Agricultural Property Relief or Business Property Relief such as residential let properties and to use the money loaned for the farming business. On the death of the farmer the assets qualifying for relief would pass without attracting inheritance tax and the assets which would attract inheritance tax are reduced in value because of the secured loan.
The change in the law
New anti-avoidance rules were introduced with effect from 6 April 2013 and apply to an estate which has a mortgage or loan and the funds borrowed were used to acquire, maintain or enhance property attracting agricultural property relief, business property relief or woodlands relief. If the borrowed funds have been used directly or indirectly for these purposes, the amount of debt outstanding at the date of death is deducted from the relievable property irrespective of whether the security of the debt is on other property.
So, for example, a landowner takes out a large mortgage on his London property and uses the money borrowed to buy commercial woodland in North Wales. If that happened prior to 5 April 2013 then the value of the mortgage at the date of his death in 2023 would be deducted from the London property and the woodland in North Wales would qualify fully for Business Property Relief. If the mortgage was taken out in 2014 then the value of the London Property is not reduced but the value of the mortgage is deducted from the value of the woodland in North Wales. In other words more inheritance tax would be payable.
Points to remember
It can be easy to forget when renegotiating mortgages the reason why the debt was secured on the property in the first place and the potential tax mitigation opportunities available. It is therefore useful to retain the documentation at the time the original mortgage was taken out and remind yourself before changing your security arrangements.
If the terms and conditions change then that can constitute a new loan which fall into the post 6 April 2013 rules even if the original security and legal charge doesn’t change.
If the borrowed funds are used for mixed purposes in other words partly for relievable property and partly for non-relievable property it is important to retain the supporting documentation for the use of the funds otherwise HMRC may argue that the whole amount of the loan should be deducted from the relievable property.
It is important to never let the tax tail wag the dog and there may be more advantages in your family’s circumstances to renegotiate the terms of that long term debt even if that affects the inheritance tax position, but if you do so, then it is worth reviewing your estate planning to see what can be done to mitigate any changes. The devil is aways in the detail and keeping good records of any changes to your security arrangements and what the funds were used for will definitely assist.