The deductibility of debts for inheritance tax (IHT) purposes is a hot topic at the moment, following the changes introduced to IHTA 1984 by this year’s Finance Act. However, it’s easy to overlook more mundane loans between family members.
Not surprisingly, these loans often remain undocumented as they tend to be informal arrangements. However, that rarely makes for good IHT planning.
How can it be demonstrated to HMRC that a transfer of money from a child to his mother to make her life a little more comfortable was a loan and not a gift, after the mother’s death? If it’s a gift, 40% IHT may be due on the mother’s death on the amount transferred and unspent. If the money was lent by the child instead then, unless the debt is disallowed because of section 103 FA 1986 (e.g. pre-loan gift by mother to child) or not legally enforceable, the money should not form part of the mother’s estate for IHT. Also, as a result of the Finance Act changes, the loan may have to be repaid to the child before the estate administration is completed if it is to be deductible for IHT, unless any of the section 175(2) IHTA 1984 exceptions apply. Using a deed of gift or loan agreement would help put matters beyond doubt.
Another classic trap in this area affects parents who have made loans to children. The child is convinced that the loan was waived more than seven years before the parent’s death. But HMRC are quick to point out that loans cannot be waived unless by deed or for consideration. We don’t enjoy having to be the bearer of bad news to bereaved children! Intra-family debts need documenting and, ideally, the tax implications considered, before funds change hands.
Documentation also helps reduce another potential problem with intra-family debts: intra-family disputes.