When a settlement is in need of funds, it may be tempting for the trustees to ask the settlor to provide additional cash by way of loan. This may seem like the easiest option, for example, where the only asset in the trust is a property with no cash or the cash has run out. The settlor may be the only person other than the trustees and the beneficiaries with a genuine interest in keeping the trust going without the need to sell its main asset.
If no terms (e.g. as to interest or the arrangements for repayment) are specified, the loan is likely to be interest-free and repayable immediately, without prior demand.1 The circumstances may, however, indicate that the loan is only intended to be repayable when demanded by the settlor, so that a loan repayable on demand is created. Often, no thought may have been given to whether the payment by the settlor is a contribution or a loan. There is no presumption of advancement by a settlor to their trust, so a payment by a settlor to an existing trust may well be analysed as a loan, if nothing is specified that indicates otherwise. There are a number of tax issues that arise, some of which are outlined in the example below.
Tax considerations
Dougie is the settlor of a trust for his niece, the sole asset of which is a small house in Never Never Land. The trustees have run out of funds to pay for various expenses on the property. Dougie kindly agrees to provide GBP10,000 to assist. Nothing is said, so that, if Dougie were to want his GBP10,000 back, he would have a reasonable argument that the funding was intended by him to be a loan, assuming no evidence to the contrary.
Assuming there is a loan, interest-free, repayable on demand (because it can be inferred from the circumstances that it is not intended for immediate repayment), there are two main issues. First, is there a gift for inheritance tax purposes? Second, do certain anti-avoidance provisions in the income tax legislation apply?
There is no presumption of advancement by a settlor to their trust, so a payment by a settlor to an existing trust may well be analysed as a loan
HMRC takes the view that the making of an interest-free loan repayable on demand is not in itself a transfer of value, provided the value of the loan/right to repayment is equal to the amount of the debt. As the whole of Dougie’s loan is repayable, the loan of the principal cannot amount to a gift. However, HMRC considers that there is an element of bounty in making an interest-free loan and that there is, as a result, a reservation of benefit. The property disposed of is deemed to be the interest foregone. This analysis is not accepted by some authorities because the interest has never existed and therefore has never been owed or paid.2
There may also be income tax implications when the loan is repaid. Section 633 of the Income Tax (Trading and Other Income) Act 2005 taxes capital receipts, and ‘capital sum’ includes any repayment of a loan to the settlor (or to a third party paid at his direction). The sum repaid is matched with ‘available income’, being the total amount of undistributed income in the trust (after certain deductions, e.g. for expenses and income already taxed on the settlor). Where the trusts are interest in possession, as are the trusts for Dougie’s niece, there is no available income, as the life tenant is entitled to the income as it arises and s633 will not apply.
There are additional complications where a settlor can themselves benefit from the trust, as the Finance Act 1986, Schedule 20, paragraph 5(4)(b) provides that any settled property derived from the loan is deemed to be settled for gift-with-reservation purposes, if the lender has also given property to the trust at any time.
- 1Under the general law, interest is not payable on a loan in the absence of express agreement or some course of dealing or custom to that effect: Professor H Beale, Chitty on Contracts, volume two, ‘Specific Contracts’, chapter 38
- 2E Chamberlain and C Whitehouse, Trust Taxation, 3rd edn (Sweet & Maxwell, 2011), 24.31