17 Dec 2019

Taxation Readers’ Forum: Family settlement – discretionary trusts and loans

Publications

Writing for Taxation magazine’s Readers’ Forum, BKL tax consultant Terry Jordan answers a reader’s query on loans by beneficiaries of a discretionary trust.

‘My client’s parents – who were both UK resident and UK domiciled individuals – set up a discretionary trust in the 1980s. The trust owns property and all the shares in a private limited company and these sources generate income each year. The beneficiaries of the settlement are the client’s children and grandchildren.

One of the trustees is also a discretionary beneficiary of the settlement and receives a distribution each year. They have also loaned money to the trust and do not charge interest. Are there any tax implications to consider relating to the loans? And can the loans from the beneficiaries also be interest free?

The trust has also lent money to the limited company that it owns. The company regularly makes transfers to the trust. Again, are there any tax implications to consider or should these payments simply be treated as repayments of the loan?

Finally, the trust lent money to another trust set up by the same settlors but where the beneficiaries are only the client’s grandchildren. Does this have tax implications and does interest need to be charged at arm’s length?’ Query 19,476 – Chelsea.

Terry Jordan’s reply

‘Has the beneficiary added value to the trust?

Because there were two settlors there are two settlements for inheritance tax purposes (IHTA 1984, s 44(2)). Ten-year charges will have arisen in the 1990s and on subsequent ten-year anniversaries of the creation of the settlement.

The potential issue if a trustee beneficiary has lent money to the trust interest-free is that the beneficiary has arguably added value to the trust and constituted themself as a settlor to a small extent. On the face of it, not taking a discretionary benefit from the trust would have been preferable to taking it and lending it back.

We are also told that the company has been lent money by the trust and makes regular payments. As above, those payments may be dividends or may simply be repayments of the money lent; the latter would not have any tax implications whereas the trustees would be liable at the trust dividend rate of 38.1% on the dividends.

The trust has lent money to a trust for the benefit of the settlors’ grandchildren. Here, the key question is whether the trustees of the discretionary trust are empowered to make such a loan or is it ultra vires their powers? It may well be authorised because the grandchildren are beneficiaries of the discretionary trust.

As a general proposition, care should be taken if loans are made by settlors to their trusts. The effect of ITTOIA 2005, s 633 is to impose an income tax charge on the settlor when the loan is repaid to the extent that there is available income, in simple terms being income that has not already been taxed as a beneficiary’s.’

The article is also available on the Taxation website.

For more information about trusts and their tax implications, please get in touch with your usual BKL contact or use our enquiry form.