I am dealing with a situation where there have been some interfamily loans made by the deceased. The loans were interest free and therefore there is an element of a reservation of benefit due to the foregone interest.
The question that arises is how to establish the rate of interest to apply in order to calculate the value foregone?
Can anyone tell me how HMRC approach this? Do they apply the average or actual official interest rates or some other measure?
I don’t see that the GWR rules are in point.
A demand loan is not an IHT transfer of value even if interest-free as the estate is not diminished. If there is a fixed repayment date the right to receive repayment at that date is worth when the loan is made less than the amount repayable so the estate is diminished in value. The value transferred is equal to the amount repayable less its present vale. Present vale tables can be found on the internet.
The rate of interest to be used is a vital ingredient and should be what the market rate of interest might have been when the loan was made taking into account appropriate actual characteristics like any other actual terms od the loan whether secured and creditworthiness of borrower.
Jack Harper
I agree with Jack that a loan granted repayable on demand does not give rise to any reservation of benefit issue even if made interest free. It’s difficult to see how the person making the loan. somehow continues to enjoy the monies loaned.
If the loan is granted with a fixed repayment date and bearing interest at the market rate when granted (again no GWR) there is no transfer of value. For example, a loan of 100 granted for 5 years (say) at a rate of 10% (say) when the market rate is 10% has a present value of 100. There has therefore been no transfer of value.
If, however, in the above example the rate of interest charged on the loan was 5% (say) when the. market rate as above was 10% there would be a transfer of value equal to the difference between the 100 when granted and the loan 's present value. The loan’s present value would be
[[100] x 1/[1.05]^5] = 100 x 0.784 = 78.40.
Hence a transfer of value of [100 - 78.40] has been made.
Malcolm Finney
Thank you both for your responses.
The IHTM at 14317 sets out the following:
The grant of an interest free loan repayable on demand
- is not a transfer of value (because the value of the right to repayment of the loan is equal to the amount of it)
- but it is a gift because there is a clear intention to confer bounty: the property disposed of is the interest foregone.
But, the grant of such a loan is not, in itself, a GWR.
So it seems to me from that entry that the interest foregone is deemed to have been a gift hence the question as to how it ought to be valued in the obvious absence of an agreed rate.
For what it’s worth (which I accept may not be much), HMRC comment on interest free loans and GWRs in their manual at IHTM14317, but only in relation to loans which are repayable on demand. In their view, there is no GWR, but there is a “gift” of the foregone interest. I have not investigated, but feel that such “gift” might then be exempt as normal expenditure out of income, perhaps calculated on an annual basis?
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If you say so. What do Malcolm and I know?
Jack Harper
I disagree with HMRC’s analysis.
There clearly cannot be a gift of something which doesn’t exist. The lender decides to lend at 0% interest.This does not give rise to a gift of interest which could have been charged but wasn’t.
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I make a last attempt to confirm my view and agree with Malcolm’s. The value transferred by a non-demand loan interest-free or at less than a market rate of interest is measured by applying the loss to donor principle i.e the amount by which the donor’s estate is diminished as a result of the disposition i.e the loan. Malcom has even done the maths for you.
Human beings hold sincere beliefs in all manner of strange things and absolute faith in the text of the Revenue Manuals is not at all unusual. IHT is not charged on the value of property disposed of by a lifetime gift; it is charged on the value transferred by a transfer of value:“a transfer of value is a disposition made by a person (the transferor) as a result of which the value of his estate immediately after the disposition is less than it would be but for the disposition; and the amount by which it is less is the value transferred by the transfer”: s3(1) IHTA 1984.
Legislation trumps Manuals. There is no such thing as a gift of the interest forgone (sic). HMRC can’t even spell correctly.
HMRC think the normal expenditure exemption can apply to loans by virtue of s29(4) modifying s21(1) (a) and (b) removing both the out of income test and the need for recurrence or at least its possibility: IHTM 14326. Do they really mean that a once-off transaction causing a loss to donor can be exempt? S21(c) is not modified: “after allowing for all transfers of value forming part of his normal expenditure, the transferor was left with sufficient income to maintain his usual standard of living” so there is still an income connection, presumably of the single year. Note that IHTM14326 also says: “If you come across any such case, you should refer to Technical for advice”. Jolly helpful then in our predicting the outcome.
The main instance where income forgone is taxed is by the pre-asset charge in FA 2004 Sch 15 but it only applies to land chattels and intangible settled property and is an income tax charge. It does not apply to loans of cash.
Jack Harper
Original Message-----
With thanks to @diana.smart , IHTM14317 begins:
“The grant of an interest free loan repayable on demand is not a transfer of value.”
If it is not a transfer of value it cannot be a PET either - s3A IHTA 1984.
IHTM14317 does go on to say that such a loan may be a “gift”, but a “gift” does not mean a “PET”. A “gift” is a general term relating to the conferring of bounty on another person. A “PET” (or a “transfer of value”, for that matter) is something very specific, as set out in the IHTA. It is important not to conflate the two.
Something may be a gift but not a transfer of value and, despite not being a transfer of value, that “gift” might have other tax or legal implications. For example, the “settlements legislation” may be in point; or there may be an issue in relation to a loan to a trust; or it could be that one might want to avoid being seen as receiving any form of “gift” from a particular individual / company / etc, maybe trustees of a trust are not permitted to confer a benefit of anyone other than a named beneficiary.
Paul Davidoff
New Quadrant
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The term “gift” is liberally used within IHT legislation but never actually defined. For example a gift with reservation in s102 FA 1986 (an individual disposes of property “by way of gift”) and various exempt transfers. IHTM 14316 expresses the view that: “A sale for less than full consideration, which is not merely a bad bargain, is a gift, the property disposed of by way of gift being the undervalue. A transaction which looks, for all appearances, to be a sale for less than full consideration may be a gift of the whole property but with a reserved benefit”.
This is based on the estate duty cases which required an “element of bounty”. It is curious that CTT did not define gift in this way in 1974 or in 1986 when GWRs were re-introduced. The partial consideration was only deductible by concession in quantifying the amount gifted for ED (with one exception). The loss to donor principle for IHT now deals statutorily with that aspect but the absence of a definition for GWRs remains hard to explain. So as IHTM 14315 says it must be given its ordinary meaning though presumably the old ED cases (which are not mentioned) still import an element of bounty. HMRC confuse the issue by not using that term but rather conferring a “gratuitous benefit”. Probably equivalent but surprising as the “element of bounty” (also ordinary words) has a long income tax pedigree (TSEM 4110:“Settlement must include an element of bounty, as decided in the tax case of CIR v Plummer (54 TC 1). Bounty is the provision of value without any corresponding quid pro quo, usually a gift or a transfer at less than full value”.
Jack Harper
Jack’s comment is of universal import.
Revenue law is not a separate body of law, statute aside. In IHT matters, like CTT, estate duty and succession duty before it, it evolves within the framework of the law of property. Otherwise it is impractical and impracticable as you will have two laws applicable to every transaction, if not three if you count Equity as a separate body of law to the common law and statute.
For example, Jack’s exposition of the position resolves the usufructuary dismemberment issue in a classic and irrefutable manner. There is no bounty involved in the retention of the usufruit and the gift of the nue-propriété other than a gift of the nue-propriété. The French usufruitier acts as owner, not “as if” they were owner. It is not a reservation of benefit but a retention of a legal right. How does that work? Simply by applying the law of the substance of the right, the lex situs if immovable or the law of its registration, rather than attempting to ensnare it unlawfully in the law of indigenous procedure, whether that be Scottish, English or Northern Irish.
Back to legal profits Ă prender(re) to evoke the Norman legal foundation of English property law?
That is what happens when short cuts are taken with definitions in order to achieve an advantage in what is wrongly presupposed to be a “fictional” situation under, in this Jack’s case s.102 and in mine the last paragraph of s.43(2) ITA.
Jack’s point is of wider significance than the topic, apologies for raising that hare which HMRC are still attempting to convince all and sundry to have been jugged.
The old estate duty cases are not “old hat” as they describe the application of a given tax statute within an existing and continuing legal context which itself remains unchanged by Revenue statutes – to attempt to change the law of property by a Tax statute without clear wording to that effect is not constitutional and would be, in my humble opinion, unlawful.
For those alert, the law draftsman effectively overrode their Lordships’ avoidance of Latin in Philipson-Stow by reasserting a separate meaning for regulated and for governed – both have Latinate roots. One, the first, “regulated” is applied in relation to an existing foreign law trust under s. 43(2) (a) or (b) (see Henderson LJ in Barclays Wealth) and the second, “governed”, is for the conversion of a foreign entity into a settlement by a fictional appropriation of the proper law governing an entity which HMRC seeks to assimilate to a trust settlement under s. 43(2) a or b.(e.g. foundations and anstalts). It is rank illiteracy and therefore stupid to assert that “regulated” can go so far as to change the foreign law governing the property right for the sake of illiterate convenience. There is no evidence or proof that such was Parliament’s intention and I submitted it would be unlawful in the conflict and foreign law context after the case of Dreyfus which was very clear on the effect to be given both by the Courts and by the administration when applying indigenous tax law to foreign property and entities. The Court of Appeal did no more than set out the existing common law principles of recognition which have not been repealed even by the over-assertive pretentions of HMRC which the wording of s 43 ITA does not support.
There is no other way of “parsing” i.e. reading the paragraph correctly, although it appears to be all Greek to certain including HMRC.
Peter Harris