Trustees are permitted to grant interest-free loans from trusts to beneficiaries under certain circumstances. Canada Life's Kim Jarvis runs through the intricacies.
The main role of a trustee is to take control of the trust property, hold it and administer it for the benefit of the beneficiaries.
The full extent of their duties is governed by the terms of the trust document and the principles of common law, equity and state, which can vary between Scotland, Northern Ireland and England and Wales.
It is important that trustees understand their duties and responsibilities as they need to comply strictly with the duties and directions set out in the trust document.
Trustees should read the trust document carefully, to familiarise themselves with the terms of the trust. They need to remember that as a trustee they cannot act outside of their powers – for example, by making or facilitating payments to a non-beneficiary.
Duty of care
Under the Trustee Act 2000, the trustees have a statutory duty of care. This means that the trustees must act in the best interests of the beneficiaries; they must not allow one beneficiary to suffer at the expense of another, acting impartially between beneficiaries.
Within the trust document, there will be both dispositive and administrative powers. A dispositive power is one that when exercised affects the beneficial interest arising under a trust, for example, a power of advancement or a power of appointment. An administrative power is one that is used by the trustees to run the trust, for example, a power to buy and sell trust assets or a power to lease property.
Most trust deeds nowadays include a specific power to allow trustees to make interest-free loans to beneficiaries. As this power affects the beneficial interest it is seen as a dispositive power.
Before agreeing to grant an interest-free loan to a specific beneficiary the trustees must first consider whether a loan will be the most appropriate way to assist that beneficiary. They should also be aware of the anti-avoidance provisions introduced by the Finance Act 2013 which can limit the deductions that can be made when calculating the chargeable value of a deceased’s estate for inheritance tax purposes.
Duty to all
Trustees have a duty to all beneficiaries so when deciding on whether to make a loan to a specific beneficiary they need to consider whether that beneficiary is capable of repaying the loan. If there are doubts as to the financial ability of the beneficiary to repay the loan then are the trustees properly considering all the different beneficial interests? Should the trustees be making a capital advance from the trust fund instead?
If the trustees decide that an interest-free loan is the best option; going forward the loan is an asset of the trust and a liability of the beneficiary.
The trustees should consider the impact of holding an asset that is not earning any interest; it also reduces the amount of trust fund invested meaning that there will be less growth generated for the trust fund and ultimately the beneficiaries. As the trustees are waiving their right to receive interest they need to consider the anti-avoidance rules.
When the beneficiary dies, under s5(3) Inheritance Act 1984 (‘IHTA’), any liabilities owed by the deceased may be deducted from the estate at death provided the liability is not disallowed under any other provisions of the Act. So, if the loan was still outstanding then potentially it could be deducted from the beneficiary’s estate reducing the value of their estate and their potential inheritance tax liability.
Before 17 July 2013 money lent to a beneficiary was an allowable deduction irrespective of whether it was repaid.
However, from 17 July 2013 when a beneficiary dies s175A IHTA restricts which outstanding liabilities, at the date of death, can be used to reduce the overall value of their estate for the purposes of inheritance tax. Liabilities that would otherwise be allowed as a deduction from the value of an estate may only be allowed as a deduction against the estate if they are actually repaid out of the estate on or after death.
So, where the trustees have loaned a sum of money to a beneficiary who subsequently dies the outstanding loan can normally only be deducted from the value of the estate if it is repaid on death.
I say normally because if there is a real commercial reason for the liability to remain outstanding then on death it could be deducted. Under S175A(3) IHTA a ‘real commercial reason’ would be present if the liability was to a person dealing at ‘arm’s length’ where the creditor did not require the liability to be repaid on death and leaving the liability outstanding did not secure a ‘tax advantage’.
Tax advantage is defined in s175A(4) IHTA as any situation where a liability would be left outstanding to secure (or increase the rate of) a relief from tax or repayment of tax, or avoid, reduce or delay the payment or assessment of tax. By the trustees not applying interest they are receiving less income which leads to a reduced income tax liability for the trust – could this be a tax advantage and therefore fall foul of the anti-avoidance rules? As HMRC is potentially receiving less tax the trustees need to give careful consideration to the impact of not applying interest to a loan.
The final point, that trustees need to consider is are they, by giving an interest-free loan, making a distribution to the beneficiary? HMRC inheritance tax manual (IHTM14317) states that while an interest-free loan is not a transfer of value it is a gift because there is a clear intention to confer a benefit.
The property being disposed of is the interest or growth that the trustees are missing out on. Therefore, if the trustees make an interest-free loan to a beneficiary they must be making a distribution of the interest; which could have potential inheritance tax implications.
While the power to making a loan to beneficiaries is useful to trustees, before agreeing to the transaction they must be fully aware of their duties to the other beneficiaries and the potential future tax implications.
Kim Jarvis, Technical Manager at Canada Life
This article was also published in Retirement Planner.