I am trying to unravel what appears to be some flawed IHT planning.
A discretionary trust has loaned money to A. There is a promissory note showing that the loan is repayable on demand & that interest is to be calculated with reference to the RPI when the loan was made and the RPI ‘for the month in which the [re]payment is made.’
If the trust were to write off the loan and it became a capital appointment am I correct in my reading that, as there was no repayment, the value of the appointment is the value of the original loan and there is no income to the trust? This would mean that no returns would be required and no income tax liability for the trust. I am concerned that I am missing something or that the foregone interest gets caught by some provision with which I am not familiar.
There are also loans on the same terms made by A to each of her children. These will be written off by the beneficiary of her estate (after being declared on the IHT400 as assets) and the similar question is what is the value for the write off?
Because interest is taxable as income to a non-corporate on a received (and not a receivable) basis, it is possible to avoid tax on it by effectively relinquishing entitlement to it before it becomes due and payable. In less straightforward cases this may require careful analysis of the precise timing of that event e.g. rolled-up, capitalised, bullet, and other exotic idiosyncrasies.
Methodology is critical. A deed will dispel casuistic exegeses about the need for and fatal absence of consideration.
Provided the interest has not become receivable (as opposed to just not received) it will not form part of the IHT estate of the lender so a s3 (with ss 52 or 65) IHTA (omission to exercise a right) would not be in point. In this context while ss14 and 15 deal with waived remuneration and dividends there is no similar specific provision for interest, so general principles apply.
While the terms of a loan could in theory be varied in good time by mutual agreement, under hand or, much less desirably, even orally, there might then be a properly arguable case of no or past consideration, open to HMRC even as a non-party. DOVS have enabled HMRC to identify consideration in the dark from 500 miles away. A deed can be drafted by anyone but if for reward this must be done by a qualified AML-supervised person (regardless of experience or competence). Such a person must also in law draft a trust deed but anyone can draft a Will containing trusts of voluminous mind-boggling complexity. Res ipsa loquitur, sed quaere.
I understand the points you make about received/receivable and IHT but I am afraid that you lost me with regard to consideration.
Is it that there must not be any consideration given in exchange for the loan to be written off or is it that the removal of consideration (i.e. no interest becoming due on the loan) itself creates a problem with the loan?
As the loan is contractual, presumably consideration was originally given e.g. interest but which is past. In principle it is open to the parties to agree change the terms, either orally or in writing, but if this is gratuitous there would be no new consideration rendering the agreement unenforceable contractually . Leaving tax aside, this is an issue for the parties themselves e.g. could the borrower enforce an agreement by the lender no longer to charge interest? In theory nominal consideration, say of £1, could overcome this. Consideration does not have to be sufficient.
The point is that such an agreement (best in writing for evidence) would not require a lawyer to document it. A contractually valid agreement would have to be respected by HMRC. The parties may not be too concerned about validity; even trustees may not fear a later attack by a beneficiary and they may have proper power to lend interest-free. But HMRC may challenge the tax effect of a simple agreement between taxpayers which is not contractually valid. A deed, whose formalities have now been reduced to the vestigial, and can be written on a bus ticket, must be drafted by a lawyer who can conduct the particular reserved activity.
HMRC can and do challenge the tax efficacy of gratuitous transactions (not done for “consideration”) which lay clients in particular often fail to realise can be cured by a deed. It can be cured after the event, for all purposes and even retrospectively as between the parties, but not retrospectively as to the operative tax date. So forgiveness of interest by deed must become effective prospectively before it is received (income tax) or before its due and payable date (IHT) or HMRC can tax it regardless and notwithstanding that, as between the parties, the deed may be fully effective to change their mutual rights and obligations.
The tangential connection with DOVs is that a deed is not strictly necessary for IHT/CGT read-back treatment but still needs to be enforceable as between parties (and must deal with estate income before it arises if the person otherwise entitled is to be deprived of it but avoid tax on it, as no income tax read-back). The problem with DOVs is that any consideration, even for a deed, other than another estate interest, nullifies that IHT/CGT treatment without altering the strict legal position as between the parties as per their bargain.
As it is the business and delight of HMRC to frustrate taxpayers’ intentions, and make advisers write letters to their insurers, they are very adept at spotting whether or not consideration is legally present in any relevant tax context and the tax consequences that follow. Unless, possibly, the latter are not in their favour (see Nelson of old). Unfortunately such issues often arise before the adviser is instructed, limiting room for action but not diminishing the need to attenuate client expectations before HMRC do so.