Thank you to all who have commented.
Could I pose two scenarios?
Scenario 1 – Trust makes a loan of £100K to a beneficiary. Since the loan is given interest free the beneficiary will need to declare the benefit on their tax return to HMRC and pay an interest charge to HMRC, in 20/21, of 2.25%. In this case a £2,250 interest charge is payable by the beneficiary to HMRC. See link below.
In this scenario there is no liability of tax on the trust since its received no income and has not made a distribution of capital.
Q4: Do you agree with the logic?
Scenario 2 - Trust makes a loan of £100K to a beneficiary. Since the loan is charged at 0.5% by the trust, the beneficiary will need to pay the trust 0.5% of £100K, £500 interest will be due to the trust from the beneficiary, after 12 months.
The beneficiary finds a building society paying 1% and leaves the money on deposit. Assume this strategy is agreeable to the trust. £1000 of building society interest accrues over 12 months and the interest will appear on the beneficiary’s tax return, along with any other interest.
The trust receives the £500 interest charge from the beneficiary and declares it on the trust tax return and pays trust income tax at 45% (for trust income over £1000) to HMRC. The trust has an income tax bill of £225.
Q5 – I am assuming the beneficiary would NOT need to pay the 2.25% tax charge on the loan to HMRC, as the loan was not free. Is this correct?
Q6 – Can the trust charge the beneficiary any interest rate it wants, provided its not zero percent? E.g. could the trust charge interest at 0.5% or 1%, or does the trust need to charge a minimum of 2.25%.
Q7: Does anyone have any references to relevant HMRC documentation, or legislation that I should be reading?
Thank you again to all.
Scenario 1 - the loan benefit is £2,250. At 40% the beneficiaries tax charge is £900. At 20% or considering personal allowances etc, it is lower. The trustees should have no tax liability although they should ensure that documentation supports that a distribution has not been made; which it arguably has for IHT purposes. Considering the relatively low tax charge, I would suggest it may be better to charge some interest.
Scenario 2 -
Q5 - the beneficaries taxable benefit is £2,250 less £500 = £1,750.
Q6 - It can charge any amount of interest; at least 2.25% avoids the beneficiary having a reportable benefit.
Q7 - The legislative references include s493 ITA 2007
Further reading: https://www.step.org/sites/default/files/Jersey_Slides_180118.pdf
This should generally be considered a reliable source and I quote:
Trustees can make loans to UK resident beneficiaries. The ‘benefit’ of an interest-free loan is taxable at the ‘official rate of interest’ (currently 4%), but it may be possible to structure loans in order to avoid such an annual tax liability. Trustees may be able to invest seed capital into a UK business start-up without creating any UK tax liabilities.
The only thing that has changed that directly effects this article is the ORI....