The latest update regarding speciality debts centres on the location, or ‘situs’ of the debt for the purposes of
inheritance tax (IHT).
A specialty debt is generally a debt created by deed or instrument under seal and can be secured or unsecured. Specialty debts are treated differently from simple debts created under contract.
Currently, non-doms only pay IHT on their assets situated in the UK; their non-UK assets are generally outside the tax net as 'excluded property'.
In the same way, non-UK assets held by the trustees of a trust made by a non-domiciled settlor are (with limited exceptions) considered excluded property.
There has been uncertainty around HMRC’s position on specialty debts and their location for IHT purposes since 2013. Prior to this, HMRC's view was that both secured and unsecured specialty debts were situated where the document evidencing the debt was physically located.
In January 2013, HMRC updated its guidance, stating they “now believe that these debts are situated where the debtor resides”.
In 2014, HMRC commented further that “many” specialty debts “are likely to be located where the debtor resides, or where property taken as security for the debts is situated”. HMRC said that they believed their pre-2014 position was “unlikely to be correct”, but many commentators disagreed. Consultation with external stakeholders followed, and now HMRC has updated its IHT manual.
The new guidance applies regardless of when the debt was created. The key sections of the updated guidance state that:
Secured debt - Where a specialty debt is secured solely on UK land or other tangible UK property, the debt will have a UK situs for IHT purposes. HMRC considers that the situs of the debt follows the genuine interest of the creditor in the secured property, not merely the personal obligation of the debtor to repay (which may be situated elsewhere, for example, where the debtor is resident).
Unsecured debt - Where a specialty debt is unsecured, the situs is usually where the relevant deed or document evidencing the debt is physically located. However, where both the debtor and creditor are resident in the UK, HMRC may argue that the debt is nevertheless situated in the UK for IHT purposes. In these instances they believe that their usual approach to unsecured debts is exploited by artificially removing a debt document from the UK, to avoid an IHT charge.
In light of this change in HMRC’s position, non-UK domiciliaries should review their debt arrangements; in particular they should identify any secured debt which may now be considered to be UK-situs by HMRC.
Planning with unsecured specialty debts should clearly be approached with caution where the debtor and creditor are UK residents. It is not yet clear how HMRC will distinguish between situations where documentation is located offshore for IHT avoidance purposes, and where it is offshore for some other purpose.
Regardless of whether HMRC’s opinion is correct, it will be important that any IHT situs-related planning is carried out with a full understanding of the potential tax implications. The issue may have a significant impact on the wider use of debt financing in offshore estate planning.
Published: 18 October 2018
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