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Loans from discretionary trusts

Practical Issues
hiriskpaul
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Loans from discretionary trusts

#236617

Postby hiriskpaul » July 14th, 2019, 5:17 pm

As part of the Will I am sorting out, a proportion of the estate is going into a Family Trust (a discretionary trust), so I have been reading up on the rules, taxation, etc. of trusts. As far as I can tell, interest free loans to beneficiaries are permitted from discretionary trusts. Is that true or does the trust specifically have to permit loans?

If discretionary trusts can be set up to allow interest free loans, would the following arrangement be permitted and not fall foul of a tax rule somewhere?

A and B are married or in a civil partnership. A sets up a discretionary trust, with B as a potential beneficiary and B sets up a discretionary trust, with A as a potential beneficiary. Both trusts below the NRB and value of gifts in the preceding 7 years does not push the total gifts over the NRB, so no IHT is payable on transfer of cash to the trusts. A's trust then lends the entire amount in the trust to B and vice versa. After 7 years, assuming A and B survive that long, the cash paid into each trust is now outside A and B's estates. When A and/or B dies, any outstanding debt to the trust is recorded and so reduces the IHT liability. I know and am finding trusts to be fiendishly complicated, but is there anything I have missed that would rule out this arrangement? Or make it undesirable?

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Re: Loans from discretionary trusts

#236631

Postby genou » July 14th, 2019, 6:14 pm

hiriskpaul wrote:As part of the Will I am sorting out, a proportion of the estate is going into a Family Trust (a discretionary trust), so I have been reading up on the rules, taxation, etc. of trusts. As far as I can tell, interest free loans to beneficiaries are permitted from discretionary trusts. Is that true or does the trust specifically have to permit loans?

If discretionary trusts can be set up to allow interest free loans, would the following arrangement be permitted and not fall foul of a tax rule somewhere?

A and B are married or in a civil partnership. A sets up a discretionary trust, with B as a potential beneficiary and B sets up a discretionary trust, with A as a potential beneficiary. Both trusts below the NRB and value of gifts in the preceding 7 years does not push the total gifts over the NRB, so no IHT is payable on transfer of cash to the trusts. A's trust then lends the entire amount in the trust to B and vice versa. After 7 years, assuming A and B survive that long, the cash paid into each trust is now outside A and B's estates. When A and/or B dies, any outstanding debt to the trust is recorded and so reduces the IHT liability. I know and am finding trusts to be fiendishly complicated, but is there anything I have missed that would rule out this arrangement? Or make it undesirable?


Give us a clue what you are trying to achieve. Who are the other beneficiaries and where do you want the money to end up ? Clearly there is no IHT liability on wealth moving between the couple.

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Re: Loans from discretionary trusts

#236633

Postby hiriskpaul » July 14th, 2019, 6:38 pm

genou wrote:
hiriskpaul wrote:As part of the Will I am sorting out, a proportion of the estate is going into a Family Trust (a discretionary trust), so I have been reading up on the rules, taxation, etc. of trusts. As far as I can tell, interest free loans to beneficiaries are permitted from discretionary trusts. Is that true or does the trust specifically have to permit loans?

If discretionary trusts can be set up to allow interest free loans, would the following arrangement be permitted and not fall foul of a tax rule somewhere?

A and B are married or in a civil partnership. A sets up a discretionary trust, with B as a potential beneficiary and B sets up a discretionary trust, with A as a potential beneficiary. Both trusts below the NRB and value of gifts in the preceding 7 years does not push the total gifts over the NRB, so no IHT is payable on transfer of cash to the trusts. A's trust then lends the entire amount in the trust to B and vice versa. After 7 years, assuming A and B survive that long, the cash paid into each trust is now outside A and B's estates. When A and/or B dies, any outstanding debt to the trust is recorded and so reduces the IHT liability. I know and am finding trusts to be fiendishly complicated, but is there anything I have missed that would rule out this arrangement? Or make it undesirable?


Give us a clue what you are trying to achieve. Who are the other beneficiaries and where do you want the money to end up ? Clearly there is no IHT liability on wealth moving between the couple.

No concrete case, just exploring possibilities and trying to understand the rules and restrictions of trusts. I am thinking/motivated along these lines:

1) The long term intention is to (hopefully) pass on assets to children, etc. in a tax efficient way.
2) There being some uncertainty or unwillingness to make an irreversible decision to simply give money away in case it turns out that money is needed, such as for long term care, or vanishes out of the family due to a child's divorce.
3) A desire to get cash out of the estate early so as to increase the likelihood of surviving 7 years (and so reduce the size of the joint estate).
4) Taxes on capital gains and income from trusts can be relatively high, so making tax free loans of the capital reduces the return to the trust (potentially to zero). The loan recipients can invest in ISAs, etc. for tax free returns, or to spend without having to pay interest to borrow.

I currently am lending (interest free) to a niece to help her with her business and to my daughter to help buy a property. Might it be better if I did this sort of thing from a discretionary trust? Could I also lend to my wife from the trust?

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Re: Loans from discretionary trusts

#236638

Postby Jabd2001 » July 14th, 2019, 7:26 pm

I’m sure you’ll have thought of this, but it seems that the most tax efficient way to pass on assets to children is via pensions.

Trusts seem complicated and potentially expensive. Is there any absolute reason why you can’t opt for a more straightforward option, giving away what you feel is prudent in your lifetime, and bequeathing the remainder? A million nil rate band for IHT does still allow for pretty hefty inheritance, unless perhaps you have a dozen children...

If your children divorce, that’s sad and painful, obviously, but are you really likely to think so little of your children’s choice of life partner that you can’t bear them to benefit from your money?. Chances are it would be indirectly supporting your grandchildren anyway.

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Re: Loans from discretionary trusts

#236641

Postby hiriskpaul » July 14th, 2019, 7:45 pm

Jabd2001 wrote:I’m sure you’ll have thought of this, but it seems that the most tax efficient way to pass on assets to children is via pensions.

Trusts seem complicated and potentially expensive. Is there any absolute reason why you can’t opt for a more straightforward option, giving away what you feel is prudent in your lifetime, and bequeathing the remainder? A million nil rate band for IHT does still allow for pretty hefty inheritance, unless perhaps you have a dozen children...

If your children divorce, that’s sad and painful, obviously, but are you really likely to think so little of your children’s choice of life partner that you can’t bear them to benefit from your money?. Chances are it would be indirectly supporting your grandchildren anyway.

Yes, current DC pension freedoms are very good, but lets assume that is taken care of with pensions maxed out. Also, AFAIK you cannot make unsecured interest free loans to potential beneficiaries from a SIPP! So not quite as flexible as a discretionary trust.

Personally I am not particularly worried about divorces, but it does concern some people and I was just using it as an example.

So pensions maxed out, cash given away as far as currently comfortable, now explore whether trusts can be of use to further reduce the estate. I know life assurance is another option, but currently focusing on what can and cannot be done with discretionary trusts. Or what can be done, but is not worth doing due to taxation or complexity issues/risks.

A million does not get you very far if you live and want to remain in London by the way. There isn't a house in my road worth less than £2m.

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Re: Loans from discretionary trusts

#236649

Postby scrumpyjack » July 14th, 2019, 8:37 pm

Somewhat facetiously you could libel your children and settle out of court... Damages not taxable and not a gift!

On a similar tack you could have a high stakes game of poker with them where you lose big time!

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Re: Loans from discretionary trusts

#236659

Postby hiriskpaul » July 14th, 2019, 9:10 pm

scrumpyjack wrote:Somewhat facetiously you could libel your children and settle out of court... Damages not taxable and not a gift!

On a similar tack you could have a high stakes game of poker with them where you lose big time!

Are you sure about the gambling? I have a feeling that would only apply for legally enforceable gambling debts. So losing at the bookies, casinos, online or through spread betting legitimately reduces your estate, but losing a poker game to someone would be classified as a gift.

Could be wrong, just something I think I read somewhere.

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Re: Loans from discretionary trusts

#236664

Postby Jabd2001 » July 14th, 2019, 9:22 pm

hiriskpaul wrote:
A million does not get you very far if you live and want to remain in London by the way. There isn't a house in my road worth less than £2m.


Yes, sure, but we’re talking about inheritance/gifts here, which one would hope your children will not be relying upon to make their finances work. Ie this is a happy bonus rather than a necessity. Certainly, by the time I inherited from my parents I had already sorted out my job, my house, my pension, my kids....

(Btw perhaps it would be tax efficient for you to downsize, as you’ll lose the residential property nil rate band if your estate is worth more than £2m).

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Re: Loans from discretionary trusts

#236665

Postby PinkDalek » July 14th, 2019, 9:29 pm

hiriskpaul wrote:
scrumpyjack wrote:Somewhat facetiously you could libel your children and settle out of court... Damages not taxable and not a gift!

On a similar tack you could have a high stakes game of poker with them where you lose big time!

Are you sure about the gambling? I have a feeling that would only apply for legally enforceable gambling debts. So losing at the bookies, casinos, online or through spread betting legitimately reduces your estate, but losing a poker game to someone would be classified as a gift.

Could be wrong, just something I think I read somewhere.


Noting the facetiously in scrumpyjack's reply.

This link may not work but it summarises what the position might be in that the diminution in the value of the estate might be considered to be a transfer of value (or words to that effect):

a way to avoid inheritance tax????
https://www.taxationweb.co.uk/forum/a-w ... 25526.html

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Re: Loans from discretionary trusts

#236772

Postby genou » July 15th, 2019, 1:27 pm

hiriskpaul wrote:There being some uncertainty or unwillingness to make an irreversible decision to simply give money away in case it turns out that money is needed, such as for long term care, or vanishes out of the family due to a child's divorce.


This is the nub of the matter - if either spouse is a potential beneficiary of the trust then the whole value will remain in the estate of the settlor. The best book on the subject is Ray and McLaughlin's Practical Inheritance Tax Planning. I see the latest edition is now £138, but if IHT planning is a real issue, that's peanuts.

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Re: Loans from discretionary trusts

#236981

Postby Kantwebefriends » July 16th, 2019, 12:26 pm

Consider setting up a trust where the settlor is not a beneficiary and his wife is not a beneficiary until she's his widow. Then set up a mirror one too, if you like.

If that doesn't solve your problem seek a different course of action.

The cost of running a Discretionary Trust might put you off, mind.

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Re: Loans from discretionary trusts

#236992

Postby hiriskpaul » July 16th, 2019, 1:37 pm

genou wrote:
hiriskpaul wrote:There being some uncertainty or unwillingness to make an irreversible decision to simply give money away in case it turns out that money is needed, such as for long term care, or vanishes out of the family due to a child's divorce.


This is the nub of the matter - if either spouse is a potential beneficiary of the trust then the whole value will remain in the estate of the settlor. The best book on the subject is Ray and McLaughlin's Practical Inheritance Tax Planning. I see the latest edition is now £138, but if IHT planning is a real issue, that's peanuts.

Thanks, I thought there must be some flaw in my cunning plan!

Thanks for the book recommendation. At that price I might try and look through a copy of that book in a bookshop before I order a copy.

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Re: Loans from discretionary trusts

#236994

Postby hiriskpaul » July 16th, 2019, 1:48 pm

Kantwebefriends wrote:Consider setting up a trust where the settlor is not a beneficiary and his wife is not a beneficiary until she's his widow. Then set up a mirror one too, if you like.

If that doesn't solve your problem seek a different course of action.

The cost of running a Discretionary Trust might put you off, mind.

Not as flexible, but a possibility, assuming no other pitfalls.

I will be a trustee of a DT soon, set up in the Will I am actioning. I am not a beneficiary of the Will or Trust and the other executors/beneficiaries are a useless bunch, so I have had to do most of the work. It has been fairly time consuming, not helped by awful record keeping, but a very useful learning exercise. I expect that I will end up doing most of the work for the DT and I will see how onerous this is before setting up one of my own!

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Re: Loans from discretionary trusts

#242545

Postby hiriskpaul » August 7th, 2019, 8:32 pm

Kantwebefriends wrote:Consider setting up a trust where the settlor is not a beneficiary and his wife is not a beneficiary until she's his widow. Then set up a mirror one too, if you like.

If that doesn't solve your problem seek a different course of action.

The cost of running a Discretionary Trust might put you off, mind.

I have read through the 2015/16 version of the Trusts and Estates book and found that this option is probably the best that can be done for some kind of claw back mechanism. There are anti-avoidance rules (FA 1986, s103) that targets the artificial creation of liabilities. So if I gift money to my daughter which she then puts in trust and the trust lends back to me, a debt would be created, but the rules prevent the debt from reducing my estate for IHT purposes.

I find it curious that wiďows/widowers are allowed to be beneficiaries of trusts set up by their spouse.

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Re: Loans from discretionary trusts

#243930

Postby Gan020 » August 13th, 2019, 9:27 am

It seems with the greatest respect you are trying to achieve the impossible here in that the settlors want the widest possible inheritance tax benefits of giving money away by putting it into a Trust but don't want to actually give it away (in case it's needed for healthcare and there is presumably a lack of trust that the trustees and beneficiaries would work together to pay for this from the Trust).

It would be great if this was possible but HMRC and they have protections in place as you have researched which negate complex schemes of arrangement to try and achieve this aim.

I perceive 3 options for you to explore:
1. An interest in possession trust
2. AIM shares (yes I know, finding safe AIM shares isn't easy and if the chancellor reduces this incentive they are going to tank)
3. Seek professional advice (and if you find someone decent please let me know)

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Re: Loans from discretionary trusts

#244089

Postby hiriskpaul » August 13th, 2019, 8:53 pm

Gan020 wrote:It seems with the greatest respect you are trying to achieve the impossible here in that the settlors want the widest possible inheritance tax benefits of giving money away by putting it into a Trust but don't want to actually give it away (in case it's needed for healthcare and there is presumably a lack of trust that the trustees and beneficiaries would work together to pay for this from the Trust).

It would be great if this was possible but HMRC and they have protections in place as you have researched which negate complex schemes of arrangement to try and achieve this aim.

I perceive 3 options for you to explore:
1. An interest in possession trust
2. AIM shares (yes I know, finding safe AIM shares isn't easy and if the chancellor reduces this incentive they are going to tank)
3. Seek professional advice (and if you find someone decent please let me know)

This was more of an exploration of the possible rather than me having definitive requirements. I really need to work out what those requirements are, but I can see discretionary trusts being useful as they have their own nil rate bands. Interest free loans from discretionary trusts seem like a good idea as well (Ray and McLaughlin's Practical Inheritance Tax Planning advises making any loans repayable on demand), as the debt reduces a beneficiaries estate and so mitigates their IHT. Emptying a discretionary trust via interest free loans simplifies admin as it means no trust income or capital gains to declare and no 10 year IHT charge if the trust remains in the nil rate band.

Paying each £3,000 annual exemption into a trust seems a good idea as, apart from 1 year carry forward, this exemption is lost if not used. Other gifts can be covered by the £250 to anyone, gifts from income and gifts from the discretionary trust.

Adding ones widow/widower to a discretionary trust does not create an interest in possession trust, so might as well be done.

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Re: Loans from discretionary trusts

#244164

Postby Gan020 » August 14th, 2019, 9:12 am

hiriskpaul wrote:This was more of an exploration of the possible rather than me having definitive requirements. I really need to work out what those requirements are, but I can see discretionary trusts being useful as they have their own nil rate bands. Interest free loans from discretionary trusts seem like a good idea as well (Ray and McLaughlin's Practical Inheritance Tax Planning advises making any loans repayable on demand), as the debt reduces a beneficiaries estate and so mitigates their IHT. Emptying a discretionary trust via interest free loans simplifies admin as it means no trust income or capital gains to declare and no 10 year IHT charge if the trust remains in the nil rate band.

Paying each £3,000 annual exemption into a trust seems a good idea as, apart from 1 year carry forward, this exemption is lost if not used. Other gifts can be covered by the £250 to anyone, gifts from income and gifts from the discretionary trust.

Adding ones widow/widower to a discretionary trust does not create an interest in possession trust, so might as well be done.



I will start by saying I'm no expert on Trusts, more that I have picked up a few things whilst being a Trustee of a Discretionary Trust for over 20 years. There's lots I have to learn so I write from that perspective not a legal expert.

You are correct that placing the settlors and/or his spouse's into a discretionary trust moves up to £325k each out of their estate and as long as the value of the Trust does not grow above £325k each there is no IHT to pay. The trusts will have to be registered with HMRC (at no cost). I am unclear whether a tax return is required as there is no income, capital gains or distributions but I would imagine so. Note that Labour are considering moving the nil rate allowance to £125k, which personally I don't think will happen as it would be highly unpopular but it might be setting things up for a different amount in-between. Of course that is going to hurt regardless of whether the money is inside or outside of a Trust.

I am not that familiar with emptying the trust through an interest free loan and I'm not sure how usual this is. My searches on the web suggest this is possible but I would assume the Trustees are legally responsible in ensuring the debt is repaid. If for example you are the third trustee and the loan gets spent on gambling and cannot be repaid you would be personally responsible for it's repayment with the other trustees. I do not think it likely the Trust could just walk away from the debt as the Trustees are legally obliged to persue it (otherwise everyone would be doing this!). What security would the Trust have for the loan? (I think the challenge here is probably more around what the receiever of the loan does with it. A building society account? a 1 year building socieity bond? a 5 year building society bond? what then if they decide to go for a bit more interest? say some Burford Bonds? say a bond investment fund? return of the capital may not be assured)

In addition by loaning out all the money the trust would not utilise it's £6k zero rate capital gains tax band which in effect means you have moved the tax burden (income tax and FGT) on the £325k from the settlors to beneficiaries without taking the tax advantage available within the Trust. Perhaps this is not important in this case. It would depend on the size of the numbers and the invidual tax rates of the settlors and beneficiaries (and the beneficiaries children?)

You mention gifts from the discretionary trust. I didn't realise this was possible. I've searched the web and couldn't find anything.

It is my understanding adding a widow to a disrectionary Trust is pretty much standard practice (unless there are thoughts of divorce or you are uber-rich and your tax planning is complex)

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Re: Loans from discretionary trusts

#244176

Postby hiriskpaul » August 14th, 2019, 10:30 am

Gan020 wrote:
hiriskpaul wrote:This was more of an exploration of the possible rather than me having definitive requirements. I really need to work out what those requirements are, but I can see discretionary trusts being useful as they have their own nil rate bands. Interest free loans from discretionary trusts seem like a good idea as well (Ray and McLaughlin's Practical Inheritance Tax Planning advises making any loans repayable on demand), as the debt reduces a beneficiaries estate and so mitigates their IHT. Emptying a discretionary trust via interest free loans simplifies admin as it means no trust income or capital gains to declare and no 10 year IHT charge if the trust remains in the nil rate band.

Paying each £3,000 annual exemption into a trust seems a good idea as, apart from 1 year carry forward, this exemption is lost if not used. Other gifts can be covered by the £250 to anyone, gifts from income and gifts from the discretionary trust.

Adding ones widow/widower to a discretionary trust does not create an interest in possession trust, so might as well be done.



I will start by saying I'm no expert on Trusts, more that I have picked up a few things whilst being a Trustee of a Discretionary Trust for over 20 years. There's lots I have to learn so I write from that perspective not a legal expert.

You are correct that placing the settlors and/or his spouse's into a discretionary trust moves up to £325k each out of their estate and as long as the value of the Trust does not grow above £325k each there is no IHT to pay. The trusts will have to be registered with HMRC (at no cost). I am unclear whether a tax return is required as there is no income, capital gains or distributions but I would imagine so. Note that Labour are considering moving the nil rate allowance to £125k, which personally I don't think will happen as it would be highly unpopular but it might be setting things up for a different amount in-between. Of course that is going to hurt regardless of whether the money is inside or outside of a Trust.

Reducing to 125k would be a pain. Illustrates the risk of ongoing rule changes with trusts.

I am not that familiar with emptying the trust through an interest free loan and I'm not sure how usual this is. My searches on the web suggest this is possible but I would assume the Trustees are legally responsible in ensuring the debt is repaid. If for example you are the third trustee and the loan gets spent on gambling and cannot be repaid you would be personally responsible for it's repayment with the other trustees. I do not think it likely the Trust could just walk away from the debt as the Trustees are legally obliged to persue it (otherwise everyone would be doing this!). What security would the Trust have for the loan? (I think the challenge here is probably more around what the receiever of the loan does with it. A building society account? a 1 year building socieity bond? a 5 year building society bond? what then if they decide to go for a bit more interest? say some Burford Bonds? say a bond investment fund? return of the capital may not be assured)

From the inheritance tax planning book I have been reading it would appear that loans to beneficiaries on any terms, including interest free with no collateral, are ok. It does suggest not putting an end date on a loan as this may then be considered giving away interest. Instead a loan should be repayable on demand. In practice, the loan would not be repaid until such time as was convenient for the beneficiary, or could be cancelled in which case it would be treated as a transfer of capital on the date of cancellation. If I was doing this I would not make a loan to a beneficiary I thought was unreliable. I would make loans to my daughters who would then work the cash into their ISAs/SIPPS, or use to help buy a home. If they die before repayment, then the loan reduces the size of their estate.

I am far from being an expert, just reading from books and the Web. If anyone has alternative views, experience and links I would be very interested in exploring use of loans.

As far as I can see so far, interest free loans can work the other way. I could make an interest free loan to a trust, repayable on demand, which the trust then invests or passes to beneficiaries. Insurance companies have turned this option into products, albeit limited to 5% return per year due to the nature of the bond held in the trust.

In addition by loaning out all the money the trust would not utilise it's £6k zero rate capital gains tax band which in effect means you have moved the tax burden (income tax and FGT) on the £325k from the settlors to beneficiaries without taking the tax advantage available within the Trust. Perhaps this is not important in this case. It would depend on the size of the numbers and the invidual tax rates of the settlors and beneficiaries (and the beneficiaries children?)

Yes true, the £6k band looks useful. No harm keeping small amounts in the trust to use this, then pass the income on to those who can claim back the tax.

You mention gifts from the discretionary trust. I didn't realise this was possible. I've searched the web and couldn't find anything.

Yes sorry, wrong term. Transfers of capital to beneficiaries is what I meant. A discretionary trust has useful smoothing properties, as you can fully utilise the £3k annual exemption, but make more lumpy transfers out of capital, exceeding £3k in some years without worrying about them being PETs.

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Re: Loans from discretionary trusts

#244201

Postby PinkDalek » August 14th, 2019, 11:45 am

I haven't studied the entire thread.

hiriskpaul wrote:From the inheritance tax planning book I have been reading it would appear that loans to beneficiaries on any terms, including interest free with no collateral, are ok. ... If anyone has alternative views, experience and links I would be very interested in exploring use of loans.


I'm not an expert but have used IFLRODs in the past on a personal level as against from a trust. Suitably documented and the paperwork was acceptable to our solicitors, as a debt of the Estate, when the time came.

1. One thing I have noticed online (random link to a 2013 discussion which was about a slightly different scenario) https://www.accountingweb.co.uk/any-answers/trusts-loan-to-beneficiary is the suggestion that such use of an interest free loan may not be using the trust funds appropriately. The first reply doesn't provide a source for the extract and I can't immediately tell if the last paragraph is that poster's views or also taken from elsewhere. The second reply adds to the discussion there.

Presumably Ray & McLaughlin’s Practical Inheritance Tax Planning also covers the point, if it is a valid one at all.

2. Another potential pitfall is outlined below (I haven't signed up for the full article nor do I know anything of the website):

SECTION 175 A (1) (a) IHT Act 1984 – discharge of liabilities “out of the estate”
Oct 24 2014
https://www.trusts-estates.co.uk/taxation/section-175-a-1-a-iht-act-1984--discharge-of-liabilities-out-of-the-estate-103911.htm

Extract only:

Where IHT is charged on the estate of a person who died on or after 17 July 2013 ... a new s175A (1) (a) IHT Act 1984 provides that a liability is not to be taken into calculating the IHT liability unless it is “discharged out of the estate”. ...

HMRC's views on this may be found here:

Liabilities: restricted deductions: repayment of liabilities deducted against the estate on death
https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm28027 and related links.

Presumably it would be difficult to discharge if the loaned monies are tied up in (an already mortgaged?) property, where by that stage the beneficiary's family may also live.

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Re: Loans from discretionary trusts

#244296

Postby genou » August 14th, 2019, 4:24 pm

hiriskpaul wrote:As far as I can see so far, interest free loans can work the other way. I could make an interest free loan to a trust, repayable on demand, which the trust then invests or passes to beneficiaries.


Be careful with that idea, as it can prove expensive in some circumstances - https://www.gov.uk/hmrc-internal-manual ... l/tsem4400 .

I think you would get away with it where you envisage the trust having no assets / income as all its funds are out on loan, but not in the case where the trust retains and invests the loaned funds.


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