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HMRC internal manual

Inheritance Tax Manual

Liabilities: restricted deductions: Excess liability over value of excluded property where money has been borrowed to acquire excluded property

Where the value of a liability that would not otherwise be taken into account, is greater than the value of the asset acquired with the loan and that asset:

  • has not been disposed of, and
  • remains excluded property

the excess liability may still be deducted against the chargeable estate, IHTA84/S162A(4). But only if the excess liability has not been brought about by one or more of the reasons listed in IHTA84/S162A(7), which are that:

  • the excess arises from arrangements, the main purpose, or one of the main purposes of which was to bring about a tax advantage,
  • the amount of the liability has been increased because interest has been added to the amount due or the amount to be repaid was to be worked out by reference to indexation, or some other formula,
  • the amount of the liability has increased as a result of the acquired asset being disposed of either partly or completely, which is dealt with by IHTA84/S162A(2) (IHTM28015).

Subsection (7)(a) prevents a deduction being taken into account where:

  • borrowed money has been used to acquire excluded property, and
  • the value of those assets is then artificially depressed to create an excess liability that could be deducted from the estate.

But, at the same time the provisions protect the situation where a person who is not domiciled in the UK borrows money to buy an asset abroad which then, through no fault of their own, falls in value. The excess over and above the reduced value may still be taken into account and deducted against any other assets that are subject to the Inheritance Tax charge. Where the money was borrowed from abroad, the rules for setting a liability against assets situated in different countries apply (IHTM28394).

The meaning of ‘arrangements’ is defined in IHTA84/S162A(8) and includes any scheme, transaction, or series of transactions, agreement or understanding whether or not legally enforceable, and any associated operations (IHTM14822).

In view of the definition of ‘tax’ in IHTA84/S272, a tax advantage here means an Inheritance Tax advantage. This is defined in IHTA84/S162A(8) as meaning the avoidance or reduction of a charge to tax or the avoidance of a determination of tax.

Subsection (7)(b) prevents any element of interest or other increase in the value of the liability over and above the value of the assets acquired with it being deducted against the chargeable estate. If the value of the loan is greater than the value of the assets acquired with it only because of accrued interest or indexation, the whole amount of the loan is disallowed.

Subsection (7)(c) prevents any overlap between IHTA84/S162A(2) and (3). Where the asset that is not subject to tax has been disposed of, the provisions relating to disposal (IHTM28015) apply.

Example 1

Dominique, who is not domiciled in the UK, borrows £800,000 which is charged on UK assets worth £1.5m. She uses the £800,000 to acquire a villa in Spain, which is excluded property. The open market value of the Spanish villa falls to £500,000 by the date of her death.

The £800,000 liability has been incurred to directly acquire excluded property, so would normally be disallowed by IHTA84/S162A(1). However, the reason for the liability being greater than the value of the excluded asset is not due to:

  • it being part of an arrangement to secure a tax advantage, or
  • an increase in the value of the liability, or
  • a disposal of the whole or part of the excluded asset.

So £300,000 of the liability (£800,000 liability less the £500,000 value of the excluded asset) is allowed and reduces the chargeable value of the UK assets to £1.2m.

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Example 2

If, in the example above:

  • the money had been borrowed from abroad,
  • it had not been charged on UK property, and
  • the deceased had also owned assets in France,

the £300,000 should first be set against the French assets before any balance is then set against UK assets.

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Example 3

The trustees of an excluded property trust, which includes UK property worth £1.5m, borrow £1m which they charge on UK property. They use the funds to acquire excluded property. At the date of death interest has accrued on the loan so that the debt is £1.3m, whilst the value of the excluded property is only £1.1m.

In this example IHTA84/S162A(4) does not allow the excess value of the liability over the asset (£200,000) to be taken into account because IHTA84/S162A(7)(b) applies. The value of the liability is more than the value of the excluded property due to an increase in the amount of the liability. The whole liability of £1.3m is disallowed by IHTA84/S162A, so the chargeable value of the trust is £1.5m.