I am currently looking at a position where a family investment company has been set up using a loan to create the funds necessary to operate the company. The shares are held as to freezer shares held by the parents with voting rights. All other share classes are non voting.
At the same time a discretionary trust has been set up. Again finance by way of a loan. The settlors and trustees are the voting shareholders and the trust has subscribed for a holding in growth shares of the FIC.
It is my understanding that the settlements legislation applies so that the loan to the FIC should be on commercial terms so as to avoid settlor interested issues.
It is also my understanding that a repayment of the loan to the trustees is treated as a capital distribution which would also trigger settlor interestes issues. Again should the loan be on commercial terms.
Finally, as the FIC is a close company and as such connected to the trust as the participators are the same would it make sense to add an independent professional trustee to avoid settlor interested issues between the FIC and the trust.
I was involved in many FICs either as a startup or conversion. A loan with a startup designed to minimise the value of all shares initially issued is routine. The growth shares can then be given away by PETs or CLT into trust with minimum or no IHT or CGT. As the shares will be of low value it defuses the ERS issue too by share issues at market value.
The idiosyncratic feature of your case is making a loan to a DT, to subscribe presumably. This runs the risk of the settlor being taxed on the income of the trust under the capital sum rules of the settlements legislation, despite a settlor/spouse inclusion clause in the trust… I don’t see the point of it. Loans to close companies are fraught with danger.
Interest-free loans to the company repayable on demand to avoid IHT are unlikely to be caught by that legislation: IRC v Levy [1982] STC 442, 56 TC 68. Though a company in conjunction with a trust can be an “arrangement” the company’s own income is not at risk unless distributed up to a trust that owns shares in it. Alphabet shares are used to (carefully) avoid the traps of dividend waivers. TSEM 4325 carries proper health warnings but need not deter the the clued-up and justifiably intrepid.
I really don’t get :“It is also my understanding that a repayment of the loan to the trustees is treated as a capital distribution which would also trigger settlor interested issues”. I can’t fathom why the trust would lend money to the FIC. If you are stuck with such a peculiar structure or features you need to don a Hazchem suit in handling it. I have seen many FICs set up with loans and their shares given to trusts but never a loan to those trusts. The shares put into trust should have such a low initial value that the trustees can be given cash to subscribe or the shares issue to the settlor and then settled.
The point in respect of the loan to trust is that s633 ITTOIA states that capial sums
paid to the settlor, which includes, repaying a loan to the settlor or their spouse is caught by the settlement legislation. Presumably this is in relation to available income. so capital payments (proceeds) from growth share but not income shares would be okay.
I have advised on the settlements legislation all my career. Capital sums are an issue as they include a loan or repayment of a loan for full consideration. There can also be issues with connected bodies corporate and associated payments.
In a normal FIC startup there will be a loan to the company but none to a trust and certainly not a loan by any trust to the company. Subscription for growth shares by the trustees if that route is chosen should require only modest funds and such a sum (paid otherwise by loan or repayment of loan) for full consideration in money’s worth is neither a “capital sum” nor an “associated payment”. Small loans to a trust may be viable where either the trust is intended to be “dry” (no dividends or other income) or so small that any taxable capital sum will also be small.
On the very limited facts you have supplied I am unable to say more.