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.
https://www.gov.uk/government/publications/rates-and-allowances-beneficial-loan-arrangements-hmrc-official-rates/beneficial-loan-arrangements-hmrc-official-rates
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
https://www.taxadvisermagazine.com/article/weighing-it
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....