Liabilities

A liability may be taken into account in valuing a person’s estate (unless otherwise provided by tax law) if it is:

• imposed by law (eg income tax and capital gains tax up to the date of death, fines, penalties and council tax; see IHTM28381); or
• incurred for a consideration in money or money’s worth (IHTA 1984, s 5(5)).

For example, if executors claim the deduction of a liability incurred shortly before death, HMRC may be interested to know the whereabouts of the money obtained by the deceased from entering into the liability. If the money cannot be traced and there is no evidence that it has been given away, a deduction may be denied.

A deduction is given in the deceased’s estate where certain income tax liabilities arise as a result of death (ie in relation to offshore funds and deeply discounted securities) (IHTA 1984, s 174(1)).

Mortgages or secured loans can generally be deducted from the property they are charged against (but see below). If the mortgage is for more than the value of the property, the excess can generally be deducted from the deceased’s other assets after the mortgage has firstly been deducted from the property against which it has been charged (IHTM28210). However, where a person with liabilities in excess of his assets is the beneficial tenant for life of a fund, his personal indebtedness cannot offset the value of the trust fund (St Barbe Green v Inland Revenue Commissioners [2005] EWHC 14 (Ch)).

There are certain conditions and potential restrictions in respect of the deduction of liabilities such as mortgages, to the extent that the liability was used to acquire, maintain or enhance certain types of property (IHTA 1984, ss 162A–162C).

In addition, the deduction of liabilities discharged after death is subject to certain requirements (IHTA 1984, s 175A) (see 5.13).

Deductions for gambling debts are allowed if they can be legally enforced. This applies (following the introduction of the Gambling Act 2005 from 1 September 2007) to debts relating to lawful gambling in England, Wales and Scotland, but not Northern Ireland (IHTM28130).

Prior to 1 September 2007, gambling debts were not an allowable deduction, because the debt could not be legally enforced.

However, the above restriction does not apply if it can be demonstrated that:

• the original disposition by the deceased was not a transfer of value; and
• it was not part of associated operations (including as set out in FA 1986, s 103(4)).

This anti-avoidance rule can affect estate planning (eg ‘debt’ or ‘charge’ arrangements), as illustrated in Phizackerley v HMRC [2007] SpC 591 (see 15.12).

A disallowance of the debt may result in a double IHT charge.

However, relief is given in such circumstances (FA 1986, s 104(1)(c); Inheritance Tax (Double Charges Relief) Regulations 1987, SI 1987/1130, reg 6).

The effect is broadly that whichever of the two transfers results in the higher overall IHT liability remains chargeable, and the value transferred by the other is reduced (ie either the debt is disallowed and the gift is correspondingly reduced (SI 1987/1130, reg 6(3)(a)), or the gift is taxed and the debt allowed (SI 1987/1130, reg 6(3)(b)).

Examples illustrating the operation of these rules are included as a Schedule to SI 1987/1130, although they do not prevail over the regulations themselves (reg 9).

No liabilities (eg debts or premiums) in respect of life assurance policies are allowable unless the policy proceeds form part of the estate (FA 1986, s 103(7)).

A guarantee debt (ie a promise to pay the debts of a borrower if he is unable to repay those debts) to which the deceased agreed to act as guarantor may be deductible from the death estate if the loan remained outstanding at the time of death. However, before allowing a deduction, HMRC may seek to establish whether consideration was given for the debt (IHTA 1984, s 5(5)), and the likelihood of the debt being reimbursed.

A deduction will generally be available in connection with commercial loan arrangements, but possibly not in family situations (eg where a parent gratuitously agrees to guarantee a child’s bank borrowings). In addition, HMRC may consider the financial resources of the borrower at the date of death, as a liability is only taken into account to the extent that reimbursement cannot reasonably be expected (IHTA 1984, s 162(1); see 5.13).

HMRC may regard the giving of the guarantee as a lifetime transfer by the deceased. For example, if the borrower is a ‘man of straw’ with no financial resources, the outstanding liability should be deductible in full, but the guarantee may be a lifetime transfer up to the full amount of the liability.

Even if there is no outstanding liability at the date of the guarantor’s death, HMRC consider that lifetime transfers may nevertheless arise if the guarantee was made within seven years of death and the guarantee was called in and paid within that time, depending on the borrower’s financial position when the guarantee was given (IHTM28356–7).