Introduction
In an earlier piece I looked at how a US citizen who has become a long-term UK resident can find his worldwide estate within the charge to inheritance tax, only for the 1978 estate and gift tax treaty to pull most of it back out again where he is treaty domiciled in the United States. I left a loose thread, which was the suggestion that such a person might borrow against his UK home and invest the proceeds outside the UK. The obvious objection is the set of debt-deduction rules introduced in 2013, which were designed precisely to stop value being stripped out of a UK estate and parked in property that escapes the charge. On closer inspection, though, those rules do not reach the case at all, and the reason they do not is worth setting out.
Back to our American in the UK
Let us start with the position the treaty produces. Where our American is treaty domiciled in the United States, the treaty confines the UK’s taxing rights to UK real property and the assets of any UK business establishment. His UK home is therefore within the charge, but his other assets, wherever situated, are not. If he owns a home here worth £1.5m and little else that the UK may tax, the home is the whole of his exposure. The thought is a simple one: borrow, say, £1m against the home, invest the money outside the UK, and the net value of the only asset the UK can tax falls to £500,000.
The rules that arguably ought to spoil this were introduced by the Finance Act 2013, and section 162A Inheritance Act 1984 needs to be considered. It was aimed squarely at a well-used, and arguably abused, arrangement. A non-domiciled individual would borrow against a UK asset, secure the loan on it, and use the money to buy foreign property which, being non-UK property of a non-domiciliary, was excluded property and so outside the charge. Before 2013 the debt reduced the UK asset while the foreign property sat beyond the reach of the tax, and the estate was diminished on both sides of the same transaction. Section 162A put a stop to it by providing that a liability attributable to financing the acquisition, maintenance or enhancement of excluded property is set against that property rather than allowed against anything else. The companion provisions deal with their own narrow targets: section 162B does the same job for property qualifying for business, agricultural or woodlands relief, and section 162AA for the foreign currency accounts of non-residents. Excluded property, relievable property, foreign currency accounts. That is the whole list.
Our American, however, is not cuaght by any of this. Excluded property is non-UK property of someone who is not a long-term resident. He is a long-term resident, so by definition his foreign assets are not excluded property. They escape UK inheritance tax not because they are excluded but because the treaty exempts them, which is a different mechanism altogether. Section 162A was drafted by reference to excluded property and nothing else, so it hsimply does not apply. Nor do the sections surrounding s.162A assist HMRC: the offshore investments are not relievable property and need not be a foreign currency account. The debt-deduction code, in short, was built to catch excluded property and was never extended to catch property exempted by treaty.
At which point one naturally asks whether the terms of the treaty itself supply what the domestic rules lack, i.e., whether it apportions the debt, or restricts the deduction to the assets the UK may tax. n fact, iIt does neither. The deductions article provides simply that permitted deductions are allowed in accordance with the law of the state imposing the tax. It defers to domestic law rather than laying down any rule of its own, and the treaty goes further by providing that nothing in the treaty is to restrict any deduction or allowance given under domestic law. So the treaty does not apportion the debt; it lets domestic law decide. And section 162(4) IHTA takes a debt charged on the home to reduce the value of the home. The deduction therefore stands in full.
However, the treaty allows a state to tax property after all where that property would otherwise be taxable only in the other state and tax there, though chargeable, is not paid. But the provision does not apply if non-payment results from a specific exemption, deduction, credit or allowance. For a US citizen the offshore assets fall within the US worldwide estate base and if they escape US tax, they do so only because of the unified credit, which is exactly such an allowance.
Purposive construction of s.162A does not assist HMRC. This merely interprets the words Parliament used, not the words Parliament omitted. HMRC had their opportunity to deal with this point when they recast the excluded property rules around long-term residence, and they did not take it. They may legislate yet, and on the merits they arguably should.
The only argument left to HMRC is the general anti-abuse rule (GAAR), andthe question is whether the arrangement is one that cannot reasonably be regarded as a reasonable course of action. A loan secured on the home, with the money genuinely invested abroad, is an ordinary commercial transaction with real economic substance, not the circular or self-cancelling sort of scheme at which the GAAR is aimed; t. The GAAR is therefore a theoretical risk to be noted rather than a real obstacle, which is not the same as one to be ignored.
There is a final irony, based on long years of experience, is that gaps of this kind tend not to survive being written about. Debt deduction rules drafted around excluded property, and never amended to follow the move from domicile to long-term residence, is the sort of thing a Finance Act quietly closes down once enough people have noticed it.