Inheritance tax home loan scheme beats HMRC but lawyers warn of the risks

A once-popular home loan scheme, designed to reduce the value of an estate for inheritance tax purposes, has been deemed valid by the courts in a recent case – but lawyers warn the victory may only be temporary.

Also known as a ‘double trust’ scheme, a home loan was a popular way of planning to save on inheritance tax (IHT) back in 2002/03, according to law firm Paris Smith.

It worked by arranging a ‘sale’ from a homeowner to a trust for their own benefit. A debt for the unpaid purchase price was used to then reduce the value of the home liable to inheritance tax.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

An individual could essentially give away the value of their home, whilst continuing to live in it rent-free.

However despite a recent win in the courts for the family of a woman who used such a scheme, lawyers warn those with similar schemes they may not be so lucky.

Julia Rosenbloom, tax partner at law firm Shakespeare Martineau, said: “The Elborne case was decided in favour of the taxpayer which is obviously very positive. However, the facts of the case were very specific and it seems highly likely that HMRC will appeal the decision.

“There has been a sustained attack on home loan schemes for many years and it is unlikely that HMRC will accept the decision without challenge.”

How have people used home loan schemes to avoid inheritance tax?

In 2003, Leslie Vivienne Elborne (now deceased) entered into such a scheme. She sold, on paper at least, her home for £1.8 million to the trustees of a trust set up for the benefit of her children.

In exchange she received a loan note for £1.8 million – the home loan element of the scheme. This note she gave over to the trustees of a second trust – the double trust part – that she had no benefit from.

Under the terms of the scheme, she was allowed to remain living in the property rent-free for the rest of her life. Elborne lived in the property until her death in 2011.

When it came to winding up her estate, the executors understood the loan note to be a potentially exempt transfer on which IHT was not payable because Elborne had outlived the transfer by more than seven years.

Because Elborne had a life interest in the property, it was included as part of her estate for IHT purposes but its value was reduced by the amount of the loan note.

HMRC disagreed with this arrangement, arguing IHT was due on the property, and took its case to the first tier tribunal, where it won.

However Elborne’s executors appealed to the upper tribunal and in February HMRC lost this case. The tax office is, however, expected to appeal this latest decision.

It is only in the last couple of years that cases on double trust home loan schemes have reached the tax tribunals, law firm Paris Smith pointed out – HMRC has so far won twice (on different grounds) at the first tier tribunal.

Can I still use home loan schemes to avoid inheritance tax?

HMRC closed the double trust home loan loophole two decades ago and it is no longer possible to set up such schemes. But Paris Smith suspects many still exist and will come to light as the original homeowners die in the coming years.

The introduction of the ‘pre-owned assets tax’ (POAT) in 2005 made home loan schemes unattractive by creating an income tax liability linked to the rental value of the house that inheritors would have to pay.

Rosenbloom, tax partner at law firm Shakespeare Martineau, said: “HMRC has simply never accepted that such schemes worked, although there are arguments to the contrary.

“This can mean that the intended inheritance tax saving is not achieved, and the overall tax liabilities could actually be higher than if people had simply not entered into the scheme.”

If you or a loved one has a home loan scheme, you should take specialist tax advice.

“In some cases, you may be better off winding up the structure than leaving it in place,” said Rosenbloom.

“Apart from this potentially creating a better tax position than keeping it, settling the position with HMRC in advance can create certainty and peace of mind for all involved.”

We explain how you could avoid inheritance tax by utilising gift allowances in a separate article.