The trustees of a nil rate band discretionary trust are coming up to a 10 year charge. The trust fund includes a loan to the surviving spouse and the amount repayable “on demand” under the loan agreement is linked to RPI.
Whatever the rights or wrongs of HMRC’s stance on the tax treatment of the indexed increase on the debt, if the trustees are facing the possibility of a 45% income tax charge on that increase there is nothing to be gained by retaining the indexed element of the loan and it may actually result in more tax being payable, because (I believe) the anticipated indexed increase is included in the IHT charge at the 10 year anniversary.
I am therefore contemplating whether to advise the trustees to waive the indexed element prior to the 10 year charge, but am grappling with the question of whether this action in itself would be a transfer of value? I feel like it must be because it will reduce the value of the trust fund and increase the value of the spouse’s estate, but should be glad to know whether others agree, particularly as this is bound to be an issue which crops up increasingly in relation to these trusts.
Diana Smart
Gordons LLP
If the RPI element is taxed as income, how can it be included as taxable to iht? It has not been received/accumulated/undistributed and should certainly not be taxed twice. If it is distributed, it is in the tax pool and treated as income by the beneficiary.
If it is not taxable to iht then waiving the RPI should not be treated as a chargeable transfer for iht either, as it does not reduce the capital of the trust fund.
Simon Northcott
On the basis that the “interest” is rolled up and presumably paid when the loan itself is repaid then prior thereto it will not have been received by the trustees and hence no income tax charge arises on the part of the trustees [Parkside Leasing v Smith (1984)].
On the basis of “interest”, ie income, then it does not form part of the relevant property of the trust unless it has been formally accumulated and/or falls foul of s. 64(1A) neither of which presumably apply as no “interest” has actually been received.
Malcolm Finney
1 Like
If you include both indexation and interest on the debt, HMRC will treat the indexation as a capital increase. The trustees can then waive the interest. My previous firm sought counsel’s advice on this and that was what they were advised to do. I have been doing it ever since.
However, if you just have indexation which is only due when the loan is repaid and HMRC will treat this as income, I don’t see how it can be liable to IHT as well.
Lorna Sansom
Blandy & Blandy LLP
Thank you, all, for your responses. It is interesting to note the degree of certainty expressed that if the indexed increase is taxed as income it can’t be taxed as capital as well. I am not sure I share that degree of certainty, given such examples as the taxation of accrued income, and as Paul Saunders responded earlier this year to a post on a similar topic, “after all, when has logic controlled the taxation of trusts?”. I have also had specific instances (prior to the April 2017 statement by HMRC regarding taxation of the indexed increase) of HMRC including the indexed increase in the charge to IHT at the 10 year anniversary. No doubt one could now ask them to revisit those charges if it were worthwhile to do so.
And of course, there is also the argument that the indexed increase is not subject to income tax at all, in which case how do we square that with not treating it as capital? I suppose all one can do at present is have a clear file note explaining the reasons why a particular stance has been taken, and provided that accords with HMRC’s stated approach, i.e. that it is interest, then at least the stance taken will be “reasonable”.
Slightly off the original topic, but if the indexed element is interest, not payable until the debt is called in, then it seems to me that the indexed element of the debt will not be included in the value of the debt at the date of death of the surviving spouse (unless the trustees have had the foresight to call in the debt shortly prior to the date of death), in which case we come back to the point that it really serves no purpose, and may give rise to a high income tax charge in the hands of the trustees. Is it also then correct, however, that the income tax charge could be reduced by converting the trust to an IIP trust prior to calling in the debt?
Diana Smart
Gordons LLP
1 Like