Valuing loan receivables for inheritance tax
11th October 2022
Posted in Articles, Capital Gains Tax, IHT, Inheritance Tax, Trusts and Estates by Andrew Marr
The issue
Loan receivables are generally within the charge to inheritance tax (IHT) on death (that is why preference shares in companies are often preferred to loans but that is a digression….). There is often confusion about whether it is possible to value a loan receivable at less than its market value.
Example
Lorenzo died and on his death was owed £50,000 by his elderly aunt. Although this loan is interest-free and ‘repayable on demand’ the aunt lives off a pension and is 103 years old and does not have any assets. The question arises of whether the full £50,000 should be subject to IHT, or whether a lower value can be used.
Analysis
The legislation at section 160 of the 1984 IHT Act that governs the market value of assets, says:
Except as otherwise provided by this Act, the value at any time of any property shall for the purposes of this Act be the price which the property might reasonably be expected to fetch if sold in the open market at that time; but that price shall not be assumed to be reduced on the ground that the whole property is to be placed on the market at one and the same time.
This, however, is subject to section 166 relating specifically to loans, that states:
In determining the value of a right to receive a sum due under any obligation it shall be assumed that the obligation will be duly discharged, except if or to the extent that recovery of the sum is impossible or not reasonably practicable and has not become so by any act or omission of the person to whom the sum is due.
Therefore, the starting point for the market value of any repayable upon demand loan, is face value. We know from our recent wranglings with HMRC on Employee Benefit Trust loans that they are reluctant to budge from this position. The only time they may accept this, is if can be shown that the debt cannot be repaid (i.e.,“…it is impossible or not reasonably practicable….” to recover the sum).
If it can be shown that the loan cannot be discharged, s160 then becomes relevant and we need to consider what a theoretical third party would pay for the debt. At the very least, this would allow us to reduce the debt by any anticipated recovery costs.
In Lorenzo’s aunt’s case, it should be possible to show that recovery of the debt (at least in full) will be impossible. Thus, we should be able to reduce to the value of the loan to the amount that can be repaid.
Depending on the full circumstances, it may be possible to reduce the aunt’s debt down to nil for the purposes of IHT, although it is likely that HMRC will query the basis for this. They say in their guidance:
Sometimes it may be claimed that the market value of a sum due to the deceased …………..is less than its face value. Such claims should always be dealt with by a valuer.
Don’t forget about capital gains tax
If a discount is taken to the face value of a loan, then the beneficiaries will receive an asset which is potentially subject to capital gains tax when paid. If a nil value is used in the above example, and the aunt wins the lottery and repays the loan, then the beneficiaries will realise a capital gain of £50,000. However, any gains may be covered by their £12,300 capital gains tax annual exemption.
Forbes Dawson view
Often, it will be appropriate to value loans at their face value for IHT purposes – particularly where they are interest-bearing, on commercial terms and the creditor is financially stable. Conversely, where there are any problems with enforceability, or creditor risk, we believe it is appropriate to discount the face value of the loan for IHT purposes, reducing the IHT payable on the estate. However, be aware that you are likely to be challenged by HMRC to prove the validity of the reductions. Therefore, the basis behind doing this should always be clearly documented and an explanation will need to be provided within the IHT return.
