Periodic Charge, Business Relief and a Soft Loan to a Beneficiary
The Fenwick Discretionary Trust was created in 2014 by Mr Fenwick with £2 million. The beneficiaries are his widow, Margaret, and their two adult children. The trust fund was valued at £3.2 million on 1 June 2024, its first ten-year anniversary. It comprises £1.1 million of shares in a UK trading company that the trustees believe qualifies for 100% business property relief, a £1.4 million quoted portfolio and £700,000 cash. In 2023 the trustees lent Margaret £250,000 interest-free, repayable on demand, to buy a flat; no security was taken. Margaret has no other substantial assets. The trustees have accumulated £40,000 of trust income in 2023/24 and propose to add it to capital. The trust deed gives the trustees power to lend to beneficiaries and to accumulate income. The trustees have not previously calculated a periodic charge. Margaret is 78 and in poor health. The trust's accounts show the loan as a debtor at face value.
1. Explain how the periodic charge should be approached and how the business property relief and the loan affect it.
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The starting point is that this is a relevant property trust, not an interest in possession trust. The first ten-year anniversary on 1 June 2024 requires a periodic charge based on the value of the relevant property immediately before the anniversary. The trustees must value the trust fund, deduct liabilities, and identify property qualifying for business property relief. The £1.1 million trading company shares may qualify for 100% BPR if the company is a trading company and the shares are not excepted assets, but the trustees need evidence, not belief. If BPR is due, the chargeable value is reduced substantially.
The £250,000 loan is an asset of the trust, but its value is not necessarily face value. If it is interest-free, unsecured and repayable on demand to a beneficiary with no other substantial assets, the trustees should consider whether it is recoverable. If it is not commercial, HMRC may treat it as a distribution or as a transfer of value, which would affect the periodic charge and may trigger an exit charge. The nil rate band is applied to the notional transfer, and the rate is 30% of the effective rate. The accumulation of £40,000 income does not change the capital value for IHT, but the trustees must keep income and capital distinct in the accounts.
2. Analyse the income tax and capital gains tax consequences of accumulating income and of the loan.
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Income tax: the discretionary trust pays tax on trust income at the trust rate, subject to the dividend and savings rates. Accumulating income and adding it to capital is not itself a disposal or a chargeable event, but the trustees must ensure the deed permits accumulation and that they have considered the beneficiaries' interests. The accumulated income retains its nature and should be recorded separately so that it can be appointed correctly.
The interest-free loan produces no interest income. If the trustees later charge interest, that is trust income. If the loan is written off, it is a capital distribution, not income. Capital gains tax: adding income to capital is not a disposal. If the trustees sell trust investments to fund a distribution or to repay borrowing, chargeable gains arise and the trustees are liable at the trust rate, subject to reliefs. The loan itself is not a disposal. The trustees should consider whether the loan is a settlement for income tax purposes; it is not normally, but a soft loan to a beneficiary can be evidence of a benefit that needs to be documented.
3. Advise on the trustees' duties and whether the loan should be called in.
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The trustees have a duty to act impartially between beneficiaries and to invest prudently. The loan to Margaret is a breach risk: it is unsecured, interest-free and repayable on demand, and Margaret has no other substantial assets. The trustees should call in the loan or regularise it on commercial terms, with security and interest, unless they can justify the benefit as being in the interests of all beneficiaries. Margaret's poor health makes recovery from her estate uncertain and may create pressure to prefer her over the children.
The BPR asset should not be jeopardised. The trustees must ensure the company remains trading and that the shares continue to qualify; taking a large loan or changing the company's activities could affect relief. They should review the investment policy, diversify if appropriate, and consider whether the £700,000 cash should be used to reduce risk. If the loan is not recovered, the trustees may face a breach of trust claim from the children. They should minute their reasoning and take independent advice on the IHT and trustees' duties. If Margaret's capacity declines, they should consider who can act for her and whether the loan should be repaid from her estate.