We are seeking clarification regarding the potential Inheritance Tax (IHT) implications of waiving the indexation on a loan within a NRB DT. We have been unable to find a definitive answer and have come across differing opinions on whether a waiver of the indexation obligation would constitute a capital distribution for IHT purposes, thereby requiring an exit charge return for the trust.
Our understanding is that if the indexation were not waived, the indexed uplift would generally be subject to Income Tax within the trust. However, some sources suggest that the indexed amount may be treated as capital for IHT purposes, which raises uncertainty as to whether waiving the indexation could be regarded as a capital advancement from the trust.
Any guidance or clarification on the correct treatment in this situation would be greatly appreciated.
The question is whether an exit charge could arise by a combination of s.3(3) IHTA (trustees are persons) and s.65(1).
A preliminary issue is whether indexation of loan principal is income or capital for trust law on the one hand and tax on the other. It seems clear to me, at least, that for trust law it is capital. This will rarely matter in a RPT unless there are different classes of income and capital objects.
There are several instances of capital items liable to income tax and will suffer tax at 45%. TSEM3201 and 3021. Payments of trust capital will not usually be liable to income tax so will not attract a credit from the “pool”. TSEM3750-3790. In theory the trustees could contrive to pay capital as taxable income: TSEM3781-7.
A profit on a plain vanilla loan courtesy of indexation will normally escape CGT as it will not be a chargeable asset.
HMRC seem to strenuously argue that indexation is income. That can only be right if it is in the nature of interest. That is payment for the use of money by reference to the period of usage. This is not the purpose of indexation but rather to compensate for the erosion of the value of the repayable capital through inflation. So the argument represents a deficit of intellectual integrity on the part of HMRC: a cynical biased position designed to collect income tax given that CGT is not chargeable. They do not extend this analysis to indexed-linked gilts and there would be no need for deep discount security tax treatment if it was correct.
But even if their view must be accepted for a quiet life the indexation element cannot be due and payable until the principal is. Income can be waived by deed at any time before it falls due and payable and in the case of interest certainly before receipt. So gratefully accept the proper characterisation of it as income and waive in time: before demand with a demand loan or otherwise before the due date. (There might be the scurrilous argument that not making a demand is an associated operation which includes an omission: s.268(1)).
HMRC are meretricious enough to argue if it suits them that it is capital: but no matter as the same timing works for that also.
There is no chargeable event because the “estate” of the trustees is not “diminished” within s.3(3) so no TOV within s.3(1) do not a chargeable transfer by the trustees within s.2(3). Nor is it a disposition by them as a result of which the value of relevant property is less than it would be within s.65(1)(b). In colloquial terms what you never have you never miss: the immediate extinguishment of a right to which trustees may only become entitled in the future does not reduce the current value of the trust fund.
The dishonourable turncoat argument that indexation is capital could be supplemented by the not so barmy rider that it is not a future right at all but a present one. This is not good at all with a demand loan as it could mean a TOV of the indexation to date, even without the associated operation point. With a term loan the TOV would have to be discounted by reference to the repayment date on which it falls payable, not only for the deferral in payment but also for the uncertainty of the amount of indexation.
HMRC will look to charge income tax on the indexation at the point in receipt. I have had an instance where we where the Trustees were able to waive the indexation and then call in the unindexed loan afterwards. HMRC accepted this 15 months after submission of the final IHT100. I had to keep chasing for them to respond.