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Loan and behold

Tax Planning, Tony Wickenden

Last week, I closed with the thought that in bigger loan trust cases based on other than a bare trust, there could be a risk that a periodic charge could arise.

The majority of the attention in connection with packaged inheritance tax plans seems to have been focused on discounted gift trusts. This is understandable. With these trusts, there is an initial gift (albeit discounted in value) and if the trust used is other than a bare trust (say, a discretionary or flexible interest in possession trust) there will be an initial transfer of value for IHT.

Currently, if this amount, after applying any available annual exemption including any unused amount carried forward from the previous year, causes chargeable transfers in the same year to exceed 10,0000 or 40,000, taking account of transfers made by the settlor in the preceding 10 years, then a return needs to be made on form IHT 100a.

It is understood that there is a reasonably strong chance that these limits will be increased significantly, possibly to 200,000, but right now that we are where we are.

As things stand, the Revenue will be set to carry out a lot of administration through the submission of forms IHT 100a but with the collection of very little, if any, additional tax.

In connection with a discounted gift trust qualifying for, say, a 50 per cent discount, even a 500,000 plan effected by a settlor with a nil cumulative total of transfers will not give rise to any immediate IHT liability but a return will certainly have to be made.

Even with the industry average case size probably significantly below 500,000, it is probably true to say that under the current rules every discounted gift trust is likely to result in the need to submit a return.

Not so with loan trusts. Even loan trusts established with a gift (gift and loan trusts) are highly likely to fall below the 10,000 return limit. Most gifts, as the starter for a gift and loan trust, would be of a nominal amount and, at most, would be equal to the minimum level of single premium required by the life office providing the investment and draft documentation. Suffice it to say that most loan trusts would not give rise to the need to make a return and loan-only structures would not even involve a gift.

However, at the 10-year anniversary, the time at which the first periodic charge is due, the same benign position may not hold good.

My concern stems especially from a feeling (uncorroborated, I might add) that more than a few loan trust creators do not actually take loan repayments. There is no inherent problem with this, of course. If there is no requirement for funds to spend, from an IHT standpoint it would seem to make sense to leave funds on trust so that any growth generated arises outside the taxable estate of the settlor – the essence of an estate freezing strategy.

In the new world post- trust alignment, however, if the trust used is other than a bare trust, it is necessary to consider the value of the relevant property in the trust at the date of the periodic charge. The more growth that has been fuelled by loan repayments not taken, the greater will be the value of the relevant property. Of course, the value of the relevant property will be net of any outstanding loan and any loan repayments made in the 10 years preceding the charge will not have to be added back.

However, bigger loan trusts that triggered no IHT charges on establishment could give rise to a charge at the first 10-year anniversary. Say a loan-only trust was established with 500,000 and the trust used was a flexible or discretionary trust. If there had been growth of, say, 7 per cent a year after charges and no loan repayments taken, the value of the settled property at the 10-year anniversary would be 983,575. The outstanding loan would be 500,000 as no loan repayments would have been taken.

The net value of the relevant property would thus be 483,575. If the nil-rate band had increased at 2.5 per cent a year from its current level, it would stand at around 364,825 at the 10-year anniversary. This would leave nearly 120,000 subject to the charge at a rate of 6 per cent.

If this is a concern, then the investor/lender could consider a bare trust for part or all of the amount to be invested or, if the inherent rigidity of a bare trust is unacceptable, could consider splitting the invested sum in two and lending a separate sum of 250,000 to each trust on different days.

This should operate under current law to give each trust its own nil-rate band that would be more than sufficient, based on the illustrative figures above, to reduce or remove the risk of a periodic charge.

Looking ahead, it may pay to split the invested amount into a greater number of trusts to offer even greater protection from IHT.

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