A nervous disposition
"He that dies pays all debts," says Shakespeare in the Tempest.
Indeed, debts are payable from a deceased’s estate on their passing - and not by their beneficiaries or family if the estate has insufficient assets to cover the liabilities. Debts also impact on Inheritance Tax (IHT) liability.
On death, IHT is chargeable on your “net” estate; essentially, what you own at your death less what you owe at your death.
The only post death expense that’s allowable for IHT is the funeral account plus a reasonable amount for mourning expenses, say a wake or post funeral reception.
The debt must be real and truly repayable; signing an IOU in favour of your son for £1million when he’s not actually loaned you any money won’t work. HMRC will look very carefully at debts owed to close friends and family and will need evidence of a written or verbal agreement to repay, and evidence that the deceased was, or would be, making repayments.
Similarly, a debt legally due, but, in truth, unlikely ever to be called in or repaid, won’t be allowable.
Otherwise, it’s the purpose for which the money was borrowed that’s important, rather than the property given as security for the loan. Your house might have been given as security for a bank loan, but the debt to the bank won’t be allowable for IHT if the money was spent on IHT-free assets (for example farmland or business assets or an AIM portfolio).
It remains possible to borrow money and to give that money away. If you survive the gift by seven years, the debt remains allowable for IHT purposes, and the borrowed money given away will have fallen out of account. Parents with valuable property but limited liquid assets often will take out a lifetime mortgage or equity release to realise a cash sum from their property and then gift the cash to their children or grandchildren. But do the maths. The compounding of interest on, say, an “equity release” loan will substantially reduce the overall saving. And if you die within seven years, such that the value given is retrospectively chargeable to IHT, there may be no saving at all.
Persons domiciled outside the UK pay IHT only on their UK assets. So if they own nothing in the UK apart from, say, a house, it's best they borrow as much of the purchase price as possible. The debt will reduce the value of the asset for IHT purposes. It matters not that they had sufficient resources to buy the house without recourse to borrowing.
With traditional, IHT-efficient structures for non- domiciled persons buying UK property (usually though an offshore company within an offshore trust) likely to be ineffective for IHT from April 2017 after legislative changes, many will fall back on the simple process of borrowing all, or a large part, of the purchase monies.
Remember, only monies borrowed by the non-domiciliary to buy the property will normally be allowable. Borrowing money secured on the property at a later date and investing the borrowed money in overseas assets, outside the IHT net, won’t work.
Of course, just as you might owe monies on your death, so too might you be owed monies. The amount of any debt due to you will be chargeable to IHT. But that doesn’t stop your executors arguing that all or part of the monies due should be discounted for IHT purposes if there’s little or no likelihood of repayment . The borrower may have gone bankrupt, say, or proved to be a “man of straw”, with no chance of ever being in a position to repay.
Shakespeare (again) concluded (in Hamlet):
"Neither a borrower nor a lender be, for loan oft loses both itself and friend" ….
….but you might see a tax saving in the end .
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