IHT is usually thought of as a tax that applies to a deceased person’s estate after any debts due have been deducted. However, to have to pay IHT on funds which are then paid away to satisfy creditors will take some getting used to – but, unless you qualify for the very specific exception in section 175A(2) IHTA 1984, that is the effect of the new rules if debts are not discharged on or after death out of the estate.
Before the IHT transferable nil rate band was introduced for married couples/civil partners in October 2007, it was common practice for families worried about their IHT liability to ‘use up’ the first spouse to die’s IHT nil rate band, otherwise only the surviving spouse’s nil rate band would be available to reduce the IHT bill after the survivor’s death. Usually the surviving spouse wanted to inherit all the first-to-die’s assets and so the first-to-die’s will would make a gift of the nil rate band to a discretionary will trust and, rather than the trustees accepting assets equivalent to the nil rate band in satisfaction of that gift, all the first-to-die’s assets were transferred to the surviving spouse who promised to repay the will trustees a sum equivalent to the nil rate band, usually with interest which, to avoid giving the will trustees an Income Tax problem, was rolled up. And the rolled up interest made the debt grow in value, which increased the IHT saving on the second death – neat! Many declared this planning obsolete following the arrival of the transferable nil rate band but as we are back to rising house prices and (unless the Chancellor changes his mind) stuck with a frozen nil rate band until tax year 2018/2019, maybe it’s time for advisers to reassimilate this option back into their planning toolkit.
The changes to the deductibility of debts on death means that all families with nil rate band will trusts and debt arrangements need to reassess the position, perhaps as part of the will trustees’ regular reviews of the arrangements (which are happening, right?!). Can the surviving spouse’s estate afford to repay the debt after death? If the debt is repaid with interest, what will be the Income Tax implications for the will trustees? Abandoning the arrangement is likely to be the worst of all worlds as the transferable nil rate band will not be available, so a way has to be found to make the debt deductible. What to do? Surprisingly, you may find some ideas in recent guidance issued by HMRC on their website (IHT Manual 28029 and onwards). Christmas must be on its way. 
