The deceased died over two years ago. Residue is left on discretionary trust, the principal beneficiaries of which are the deceased’s nephew (16 yrs old) and niece (18 yrs old). The deceased’s partner (who is also an executor) made an interest free loan of £70k to the deceased c.18 months before death, to assist with various expenses. The loan was documented by a loan agreement (they were both lawyers!).
On death the loan was claimed as a deduction against the deceased’s estate. IHT was paid on the estate and no communication has been received to date from HMRC with regard to the IHT position.
HMRC’s IHT Manual states that any loan claimed as a deduction against an estate must be repaid within a reasonable period, unless there is a real commercial reason for the liability remaining undischarged and the main purpose, or one of the main purposes of leaving the liability, or part of it, undischarged is not to secure a tax advantage.
The only assets left in the estate are (a) a 50% share in an overseas apartment in which the Deceased’s father lives rent free (and will not be sold until his death); and (b) a UK flat which is let and produces a modest rent. All cash from the deceased’s bank accounts/investments was used to meet estate liabilities and there is no capital cash in the estate. The executors do not want to sell the UK flat for some years. They hope in due course it will appreciate in value and in the meantime the tenant is very settled and it provides some income. However the loan cannot be repaid until one of the properties is sold and it seems difficult to argue there is a “commercial reason” for the loan to remain undischarged.
If a liability which has been claimed as a deduction against the estate is not repaid within a reasonable period HMRC can refuse to allow it as a deduction. What is meant by a “reasonable period” in this context? Are the executors obliged to sell the UK flat to repay the loan now? Otherwise are they at risk of HMRC refusing the loan as a deduction, and could be faced with an additional IHT liability? If they swapped the non-interest bearing loan for a commercial mortgage it would seem to be acceptable for the loan to remain unpaid, but the cost of doing so would be prohibitive. Could they instead grant a charge over the UK flat to the value of £70k in favour of the deceased’s partner, and thereby argue that they have discharged the original £70k loan?
The deceased intended the residue of her estate to be used to meet the nephew and niece’s school fees and education expenses. To date these have been met out of the proceeds of a life insurance policy which was written in trust, but these will shortly be exhausted. The deceased’s partner (who is also within the class of beneficiaries), has proposed making a loan to the estate on an annual basis to meet the school fees and would wait until the eventual sale of the flat to be repaid this loan. Presumably he should charge interest on the loan to avoid the risk of HMRC asserting that he is settling funds? The interest could be rolled up and paid upon sale of the property. The payment of school fees on behalf of the nephew and niece would be income distributions/capital appointments (to the extent not covered by income), so there would be exit charges each year.
If the trust was still ongoing on the 10th anniversary, the value of the trust fund for the purposes of the periodic charge would be the value of the UK flat and 50% interest in the overseas flat, less the loans made by the deceased’s partner for school fees, and, potentially, less the £70k charge secured against the flat – but that rather feels like having one’s cake and eating it - having already claimed the original £70k loan as a deduction against the IHT on death.
I would welcome members’ views.
Thank you.
Julia Richards
Hunters Incorporating May, May & Merrimans