The need to set up this sort of arrangement has become much less common since the TNRB, although it will still be useful from time to time (mainly where either spouse had been widowed previously and there is an extra NRB floating around needing to be captured).
The indexation and interest will increase the amount of the loan/charge, which in turn will reduce the surviving spouse’s net estate and, thereby, save IHT. However, I would ensure that there is a mechanism/power for waiving any indexation/interest.
It may be that one can waive the indexation/interest without it affecting the amount of IHT. For example, suppose the taxable estate after deducting all NRBs but before deducting the debt/charge amounts to £300k and the debt/charge amount is a total of £425k, comprising £325k plus £100k indexation/interest: there is no IHT to pay; even if the £100k indexation/interest is waived, there is still no IHT because the debt/charge of £325k covers the whole of the taxable element of the estate.
However, if the estate is larger, then all of the indexation and interest will serve to save IHT @ 40%; if only one of indexation/interest is charged, then HMRC will seek to tax that as income; if that “income” is distributed to a taxpayer (or divided amongst a number of beneficiaries, possibly even split over two tax years) who is not going to pay 45% income tax, then either the net effect is likely to be the same (eg although the estate saves 40% IHT while the beneficiary is taxed at 40%, or there will be some tax saving if the beneficiary is a 0%/20% taxpayer).
I did read it discussed that if both indexation and interest were charged (according to the documentation), then only the interest would be subject to income tax, whilst the indexation would not be chargeable. The consequence of that was that if the interest were waived, the indexation would not be subject to income tax, as it was only the interest that was going to be chargeable. I would not like to rely on that view without the client appreciating that HMRC might take a different view.
As I say, if the indexation/interest is needed to save IHT, then the income tax can often be mitigated to an extent by judicious distribution to beneficiaries, so I would look to see whether it is possible to achieve that in the first instance.
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