Inheritance tax and specialty debts: not so special?
Following consultation with professional bodies, HMRC has updated its guidance on the inheritance tax treatment of specialty debts.
A specialty debt is:
- a debt made by deed, or
- a deed which records or creates obligations, or
- a debt incurred by way of statute, or
- a certain type of debt that is given the nature of a specialty debt by statute.
Under common law, a debt due on a deed or other specialty is situated where the deed is situated at the relevant time. Its situs does not depend on the residence of the debtor.
How & why do the changes to specialty debts matter?
This is of particular importance for inheritance tax where a debt might otherwise be ‘excluded property’ and therefore fall outside of the UK’s inheritance tax net.
For example, a debt owed by a UK resident to an excluded property trust will fall within the usual trust inheritance tax regime of ten-year anniversary charges and exit charges, but a specialty debt located outside the UK would not be. It may impact the estates of individuals too. For example, a non-UK domiciled settlor retaining an interest in a trust holding a UK situs debt would have the value of that debt included in his or her estate for inheritance tax purposes, whereas if it was a specialty debt, it would be excluded property.
Secured Specialty Debts; The Facts
HMRC now state that the where the debt is solely secured on land or other tangible UK property, the situs of the debt will also be in the UK. HMRC consider the situs of the debt follows the “genuine interest of the creditor in the secured property” and not merely the personal obligation of the debtor to repay, which may be situated elsewhere, for example, where the debtor resides.
Unsecured Specialty Debts; The Facts
Where the debt is not secured, HMRC will generally accept that the situs of the debt is where the relevant deed or instrument evidencing the debt is found. However, HMRC note that it is possible to exploit this approach artificially by removing the document from the UK to avoid an inheritance tax charge. Therefore, where the creditor and debtor both reside in the UK by the deed evidencing the debt has been removed from the UK, HMRC may argue that the debt is nevertheless situated in the UK for the purposes of inheritance tax. HMRC’s inheritance tax manual directs officers to refer cases where a specialty debt is claimed to be situated outside the UK to a technical team for closer review.
Loans for the acquisition of UK residential property
Additionally, as introduced by Finance (No 2) Act 2017, from 6 April 2017, where a debtor has used a loan to acquire UK residential property, even if the debt is regarded as having a situs outside the UK, it may be that the debt is not excluded property in any case.
The new guidance will also apply to the remittance basis; however, the treatment of specialty debts for capital gains tax and income tax withholding obligations is set out in statute and remains unchanged.
HMRC previously (and controversially) updated its guidance on inheritance tax and specialty debts in 2013. The new guidance appears less controversial, though HMRC’s views are yet to be tested in the tax tribunals. Nevertheless, it would be prudent for holders of specialty debts to review their position in light of the updated guidance.
For more information on any of the topics raised above, please feel free to contact our help team of tax advisers who are here to help. You can also read more about HMRC below.