Discretionary Loan Trust query about distributing assets and tax

Strawbs_fan

Hi there, 

I have a query about how to distributing assets from a discretionary loan trust, and taxation, which I'd be really welcome for some advice on. 

I've just found out that my father, who died recently, had set up a discretionary loan trust for which he was the settlor, and he and my mum were trustees. The beneficiaries are myself and my sister (50/50).  

My mum has dementia and is in a care home and my sister and I are managing her finances via lasting power of attorney.

The loan plan is currently valued around £100K and consists of various investments in St James's Place funds. 

I understand that the original loan (£60K) that established the trust may be repayable to my dad's estate (we're waiting to find out if the trust is set up to be waived on death) and if so, it'd be subject to IHT if his estate reaches the threshold - which it won't.  

My question is what happens with the £40K remaining? Can my sister and I, as our mum's attorneys just arrange for these to be sold (as our mum is now the sole trustee) and then give/distribute the £40K to ourselves? 

And if so, what is the tax position? I've read the gov.uk article and a little confused about claiming tax back. I'm a basic rate tax payer, so would that mean I could claim back 25% in tax (45-20), i.e. I would get a total of £25K eventually. Or does it mean I need to pay 20% tax, so I'd only get £15K. 

I am planning on getting some professional advice, but any insights at this stage would be really helpful, many thanks. 
 

masonic

Strawbs_fan said:

And if so, what is the tax position? I've read the gov.uk article and a little confused about claiming tax back. I'm a basic rate tax payer, so would that mean I could claim back 25% in tax (45-20), i.e. I would get a total of £25K eventually. Or does it mean I need to pay 20% tax, so I'd only get £15K.

My understanding is that the surviving trustee (your mum) would be taxed at 45% and receive a tax credit for 20% (since corporation tax is paid within the underlying investments). So would have to pay an additional 25% tax, ending up with £30k to distribute to the two of you. Or as beneficiaries, you may be taxed according to your own income tax rates. But these are expensive products that mainly benefit those arranging them, so it is not a product I am all that familiar with.

poseidon1

I am fairly familiar with these gift and loan trusts  in that invariably the underlying  trust asset were in all likelihood an insurance company investment bond, ie a single premium unit linked insurance policy issued in the uk. If indeed a UK policy ( and not offshore) , I agree with masonic's analysis of the income tax outcome if the bond is encashed whilst still subject to the terms of the original trust.

However, assuming there is a way to replace your mother as  current sole trustee of the trust, there is a way to mitigate or wholly avoid income tax on £40k profit. This however,  assumes the bond was written on the joint life ( 2nd death )  of your father and mother, so that the bond remains intact notwithstanding your father's demise. If originally written solely on his life, then none of the following will be relevant.

Assuming you and sister are both comfortably basic rate tax payers, units of the investment bond equal to £20k each ( or such amount necessary to leave  behind the £60k loan), are  distributed to each of you free and discharged from the trust,  thereafter you both proceed to encash your shares of the bond in your own respective names.  This, then allows you each to take advantage of a facility known as 'top slicing relief' which in effects minimises the taxable policy gains liable to income tax, depending on how long the policy had been running prior to your encashment. Using this option, you and sister should escape tax entirely.

Turning to the £60k loan represented by the remaining investment bond units, you state this is likely to fall into the residue of your father's estate.
Assuming, no part of the original loan was ever repaid to your father during his lifetime using the investment bond's 5% tax deferred annual withdrawal facility, that part of the bond is not liable to the  trust income tax regime outlined by Masonic since the loan is an unpaid creditor of the trust.

 Instead if the loan falls to be distributable to your mother as the primary residuary beneficiary of the estate, then it is her personal income tax position that will dictate whether she will have a personal income tax liability  on the encashment of her the portion of the bond repsenting the loan, again with the benefit of top slicing relief in her favour.

In summary, the objective here is  to mitigate or avoid income tax entirely,  by ensuring no part of the investment bond is encashed whilst subject to the original terms of the discretionary trust.

Strawbs_fan

Many thanks to you all for advice, it's much appreciated. It's helpful to be pre-warned of the complexities ahead of getting specialist advice. 

I've just found the original agreement and can see that my sister and I are named under 'lives assured' not sure what the implications are for that?

poseidon1

Strawbs_fan said:

Many thanks to you all for advice, it's much appreciated. It's helpful to be pre-warned of the complexities ahead of getting specialist advice. 

I've just found the original agreement and can see that my sister and I are named under 'lives assured' not sure what the implications are for that?

That was a prudent move by the adviser. 

It ensures the Investment bond survives the death of the trust settlor ( and indeed his spouse), so that the bond does not automatically trigger income tax liabilities on the trust by reason of the death of the settlor  and the resultant encashment of the bond in the event it had been written on his life alone ( the bond as previously indicated, is in essence a single premium life policy ).

The continued survival of the bond following  your father's death should ensure you and your sister have time to reorganise how it is encashed to take advantage of the income tax mitigation strategies  I highlighed.

A word of warning however, some  trust documents for these arrangements, sometimes stipulate that the trust itself must terminate within 2 years of the settlor's death, and the trust assets distributed within that time span.
If the trustee fails to excercise discretion to distribute within that period ( such powers for example would permit diverting trust capital to others such as granchildren), there maybe a default provision that the trust assets automatically revert to the ownership of the named beneficiaries ( ie yourself  and your sister ) after the 2 years has elapsed.

  Therefore the clock maybe ticking to resolve the problem of your mother's capacity to act as trustee in order to exercise the trustee power to distribute bond units to you and your sister sooner rather than later.

I would suggest St James's Place should be able to explain the intricacies of the particular trust they sold to your parents, even if they demur in preparing the necessary trust documents to wind it up tax efficiently. 

Strawbs_fan

Good to know, thanks again for the advice, it’s much appreciated. 

jjimjam

Hi, it would be great if you keep us informed on how you get on.  I'm in a position with similarities to you, although all original investment was withdrawn during the first 20 years.  It's interesting that you plan to get professional advice.    Our SJP agent says that he can provide all the financial advice we need.   He says it should stay and not be distributed.

poseidon1

jjimjam said:

Hi, it would be great if you keep us informed on how you get on.  I'm in a position with similarities to you, although all original investment was withdrawn during the first 20 years.  It's interesting that you plan to get professional advice.    Our SJP agent says that he can provide all the financial advice we need.   He says it should stay and not be distributed.

jjimjam, your situation doesn't appear to be quite the same as the OP in that you indicate the entire original bond investment has been withdrawn over the 1st 20 years of the trust's exsistence. This had not occurred in the OP's case.

In your case, top slicing relief will not apply to mitigate or avoid income tax going forward  assuming the bond is now in personal ownership and free from the constraints of the trust ( top slicing  in any event does not apply if a bond is encashed whilst in the trust). 

Once original investment is withdrawn, HMRC deems all future bond encashments as triggering an automatic chargeable event on the recipient. This results in the amount withdrawn being adding to your other income and if this takes you to 40 or 45% tax brackets you face a tax liability thereon at your highest marginal rate but with a 20% credit for income tax deemed paid within the bond (assuming it is a UK issued policy ).

Incidentally, you state the SJP agent says ( in your case ) the bond should remain ( in trust? ) and not distributed. Does that mean he is recommending no future encashments be made and the bond simply continues to roll up with no one taking any benefits because of the likelihood of chargeable events?

 As to advice, is he purporting to provide specialist  tax and trust advice, as well as general financial advice? Unless  SJP has an in house department of technicians the agent can call upon to opine on tax and the legalities of trusts, financial advisers ( in the wealth management sector) rarely purport to be personally competent to advise in these arcane areas.

poseidon1

Hi jjimjam, I have just noticed you have an entirely separate thread running on your own family predicament with an SJP created gift and loan trust.

Based on the information you provided there, and my familiarity with these schemes I would be happy to contribute  on  your own thread,  my thoughts on possible course of action should you wish? I certainly don't agree that the trust should not be busted whilst your father is alive, and it is very helpful that you are a trustee in this respect.