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Where Taxpayers and Advisers Meet

Disc Trust provides a loan to beneficiary (Tax Implications?)

jrullion
Posts: 2
Joined: Fri Jan 03, 2014 10:05 pm

Disc Trust provides a loan to beneficiary (Tax Implications?)

Postby jrullion » Wed May 20, 2020 3:29 pm

Discretionary Trust provides a loan to a Trust beneficiary (Tax Implications??)

Under a discretionary trust deed, as trustees, we are able to make loans to the Trust beneficiary’s.

If we were to do this we would produce a formal loan agreement.

Our desire would be to make a loan to the beneficiary on an interest free basis.

What is the taxation position / financial implications - from two perspectives :-
a) The trust
b) The beneficiary

Questions in my mind are:-
1 - Would HMRC make a tax charge on the loan, to the trust?
2 - Would the beneficiary have to pay an interest charge to the trust?
3 - Would HMRC treat the loan as a distribution out of the trust?

Any thoughts would be most welcome.

Thank you

Jack

AGoodman
Posts: 1057
Joined: Fri May 16, 2014 3:47 pm

Re: Disc Trust provides a loan to beneficiary (Tax Implications?)

Postby AGoodman » Wed May 20, 2020 4:08 pm

In general:

1. No
2. No
3. No

The position will be different if the source of funds somehow related to an employment or the trust was offshore.

If the trustees did change interest then it could be subject to income tax.

jerome.lane
Posts: 237
Joined: Mon Aug 12, 2019 8:41 am
Location: Sandhurst, Berkshire
Contact:

Re: Disc Trust provides a loan to beneficiary (Tax Implications?)

Postby jerome.lane » Wed May 20, 2020 9:02 pm

Although trustees can make loans to UK resident beneficiaries, an interest-free loan is taxable by reference to the official rate of interest.
Jerome Lane
Tax Adviser
Telephone: 07943 005902

maths
Posts: 7908
Joined: Wed Aug 06, 2008 3:25 pm

Re: Disc Trust provides a loan to beneficiary (Tax Implications?)

Postby maths » Wed May 20, 2020 9:33 pm

Jerome, why do you say this?

No directors/employees are involved.

jerome.lane
Posts: 237
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Location: Sandhurst, Berkshire
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Re: Disc Trust provides a loan to beneficiary (Tax Implications?)

Postby jerome.lane » Thu May 21, 2020 7:03 am

Jerome, why do you say this?

No directors/employees are involved.
Beneficiaries are taxable on all payments from Trustees under the same principals as getting the use of a house or yacht would be. If the payment is an interest free loan that is repayable, then it’s “money’s worth” is taxable under the same principles applying to employee benefits in kind (even if there is no employment relationship). If it’s not repayable, then it’s an income or capital payment and taxable as such. It’s easy to see how lack of provisions to bring into charge interest free loans to beneficiaries can be abused and that’s why there’s legislation covering such scenarios.
Jerome Lane
Tax Adviser
Telephone: 07943 005902

maths
Posts: 7908
Joined: Wed Aug 06, 2008 3:25 pm

Re: Disc Trust provides a loan to beneficiary (Tax Implications?)

Postby maths » Thu May 21, 2020 11:58 am

It’s easy to see how lack of provisions to bring into charge interest free loans to beneficiaries can be abused and that’s why there’s legislation covering such scenarios.
Which legislation. are you referring to?

jrullion
Posts: 2
Joined: Fri Jan 03, 2014 10:05 pm

Re: Disc Trust provides a loan to beneficiary (Tax Implications?)

Postby jrullion » Thu May 21, 2020 12:09 pm

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.

maths
Posts: 7908
Joined: Wed Aug 06, 2008 3:25 pm

Re: Disc Trust provides a loan to beneficiary (Tax Implications?)

Postby maths » Thu May 21, 2020 12:30 pm

I am awaiting Jerome's response to my last query. In the meantime re your last post:
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

Disagree.

Q5 Irrelevant

Q6 Interest free loans are acceptable (subject to trust provisions). No requirement to charge interest.

Q7 Jerome will provide this.

jerome.lane
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Location: Sandhurst, Berkshire
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Re: Disc Trust provides a loan to beneficiary (Tax Implications?)

Postby jerome.lane » Thu May 21, 2020 12:49 pm

It’s easy to see how lack of provisions to bring into charge interest free loans to beneficiaries can be abused and that’s why there’s legislation covering such scenarios.
Which legislation. are you referring to?
s493 ITA 2007 can apply.

493Discretionary payments by trustees
(1)Sections 494 and 495 apply for income tax purposes if—
(a)in a tax year the trustees of a settlement make an annual payment to a person (“the beneficiary”) in the exercise of a discretion (whether exercisable by the trustees or any other person),
(b)the trustees are UK resident for the tax year, and
(c)condition A or condition B is met.
(2)Condition A is that what is paid to the beneficiary is, only because of the payment, income of the beneficiary for income tax or corporation tax purposes.
“Income” does not include employment income.
(3)Condition B is that the payment is treated for income tax purposes as the income of a settlor under section 629 of ITTOIA 2005 (income paid to relevant children of settlor).
“Settlor” is to be read in accordance with section 620 of ITTOIA 2005.
(4)The payment is referred to in sections 494 and 495 as “the discretionary payment”.
(5)In this Chapter “payment” includes payment in money's worth.

Without supporting documentation, HMRC may also challenge that a distribution has been made and the Trustees could be liaible to IHT exit charges while the beneficiary may also suffer increased income tax and CGT issues. All that aside, loans can be made without a tax charge in certain circumstances (say where they are made for business purposes).
Jerome Lane
Tax Adviser
Telephone: 07943 005902

jerome.lane
Posts: 237
Joined: Mon Aug 12, 2019 8:41 am
Location: Sandhurst, Berkshire
Contact:

Re: Disc Trust provides a loan to beneficiary (Tax Implications?)

Postby jerome.lane » Thu May 21, 2020 1:10 pm

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....
Jerome Lane
Tax Adviser
Telephone: 07943 005902


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