Loan Trust Taxation

In October 2009, a joint Loan Trust of £50,000 was set up using an Investment Bond for the purpose of paying IHT by allowing their 2 children, (the beneficiaries), to access capital for taxes.

By August 2018 the Bond had grown to £66,201 and Trustees felt this was not very good, so encashed the Bond and placed the capital with an Investment Platform who accepted the Loan Trust and capital was invested using unit trust funds only. No tax was payable on encashment of the Bond.

With the increased residential allowances against IHT and additional expenditure, the settlors feel that IHT will no longer be a problem and have taken some returns of their loan over the last few years, leaving only around £3,000 of the original loan remaining, but this could be fully returned if appropriate.

Trustees have made loans to the beneficiaries of £5,000 each and ae considering similar loans with the value of the capital now remaining at around £37,000.

The settlors were under the impression that this investment would not be subject to tax, but that may have been their understanding with their original Investment Bond returning 5% annually if required.

I cannot find any examples of taxation when moving from a Bond to Unit Trust investment in a Loan Trust and would appreciate any guidance.

Since the capital was moved into unit trust Funds in 2018 are the Trustees or the settlors liable for any tax on final disposal before or after death as no provision has been made for dealing with the Loan Trust in their Wills?

The encashment of the bond would have been a chargeable event gain precipitating a possible income tax charge on the settlor (who presumably was alive at that time).

If the original loan was made interest free and repayable on demand the settlor is liable to income tax on any trust income (excluding any 5% withdrawals) under ITTOIA 2005 ss 624/625. Such income includes that generated from the unit trust investments.

Disposals of unit trusts give rise to a CGT charge on any gain on the part of the trustees (TCGA 1992 s 77 repealed).

The trust is a relevant property settlement (ie possible exit and 10 year charges).

On the settlor’s death any outstanding loan element will form part of his IHT estate.

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Thank you for your reply on this, but just to clarify, at the time the Bond was encashed to move into unit trusts, no withdrawals had been made and the company concerned confirmed that no tax was payable, as the Loan Trust continued and it was simply a change of investment.

The original loan to the Trust was interest free, but any gains were for the beneficiaries as the only return to settlors was the original loan.

The settlors are concerned that there may be tax on the gains made by the time of the second death when disposal of the unit trust funds would be made. That gain would be over a period of 15 years assuming that were in say 2 years time. An alternative would be to dissolve the Trust earlier, as the original need no longer exists.

The surrender of the investment bond will have triggered a ‘chargeable event’ with the taxable gain being £16,201 (the investment profit).

The gain falls to be taxed as income of the settlors - presumably 50% each.

If this was a bond issued by a UK life office there would be a basic rate credit so tax would only have been payable if the settlors were higher or additional rate taxpayers for the year in which gain was made. (Additionally top slicing relief might have been available if the settlors were higher rate taxpayers.)

As already pointed out a disposal of the units (on the second death or before) would trigger a charge to capital gains tax. This would fall on the trustees.

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Many thanks to both of you for the clarification.

The bonds were encashed (at no charge you say) and the monies in whole or in part were then invested in unit trusts by the trustees?

Any disposal of the units by the trustees may give rise to a CGT charge on their part if of course any gains arise, not on the part of the beneficiaries.

Prior to any such disposals the trustees could appoint the assets out to the beneficiaries (claiming hold-over relief) allowing them to sell and realise any capital gains if this proved CGT efficient.

Malcolm Finney

Much appreciated Malcolm. It all helps to fire up the old grey matter.