Frequently asked questions

I am advising the trustees of a Flexible Inheritance Loan Trust Plan (ILTP), set up in 2004, who now – in agreement with the Donor - wish to repay the outstanding loan to him and to then distribute the balance of the value of the Trust Fund amongst the beneficiaries. I am considering recommending the assignment of policies to the Donor in satisfaction of his loan so as to avoid the trustees having to surrender some of the policies, thereby triggering a chargeable event and the application of the early surrender provisions. Once the Donor has been “repaid” the remaining policies can be assigned to the intended beneficiaries. Will this work?

Firstly, it must be remembered that the trustees cannot transfer to the Donor any amount of the Trust Fund in excess of the value of the outstanding loan – to do so would compromise the IHT saving the ILTP will otherwise have secured. Since it is very improbable that the amount of the outstanding loan exactly matches the value of a whole number of policies it is highly likely that at least one policy would have to be surrendered in order to repay to the Donor the exact amount he is owed.

Secondly, because the trustees would be transferring the legal ownership of the policies to the Donor in satisfaction of the monetary debt they owe to him, thiswould constitute an assignment in value for money or money’s worth thereby giving rise to a chargeable event in accordance with ITTOIA 2005/s.484 (1) (a) (ii).

The amount that would fall to be treated as the gain would be the excess of the consideration given (i.e. the amount of the outstanding loan being repaid by way of the assignment), plus the amount of any capital payments (e.g. any previous loan repayments using the 5% withdrawal “allowance”) over the sum of the total premiums paid (e.g. original loan made) plus the total of gains on previous chargeable events (e.g. previous loan repayments in excess of the cumulative 5% allowance).

Any gain that results will be assessed to tax on the Donor (provided he is UK resident in the tax year the assignment takes place), but with the availability of top-slicing relief and the notional 20% tax credit (in respect of an onshore bond). If any tax is actually paid the Donor has the statutory right to recover this from the trustees (as previously described). Should he choose to exercise this right, the trustees may still have to surrender one or more of the policies it was intended to assign to the trust beneficiaries so as to release funds in order to be able to reimburse the Donor. Alternatively, they may be able to raise sufficient monies by making use of any cumulative 5% allowance available in respect of the policies still held within the trust – although this will largely depend upon how much of the loan had already been repaid using the regular withdrawal facility.

With regards to the policies assigned in satisfaction of the outstanding loan, these will now be treated as “second hand” policies in the Donor’s hands. As a consequence, when they are subsequently disposed of any gains arising could be chargeable to capital gains tax (CGT) under TCGA 1992/s.102. This is so because the gains have accrued to someone, other than the original beneficial owner of the policies, who acquired the rights (to the policies) in money or money’s worth. If the manner in which the policies are disposed of also gives rise to a chargeable event under the chargeable event regime, there will also be a charge to income tax in accordance with Para.102 Sch.2 ITTOIA 2005. As a consequence, the Donor could face a double tax charge: an income tax charge under the chargeable event regime and a CGT charge by virtue of TCGA 1992/s.210. However, a double tax liability can be avoided provided the conditions set out in TCGA 1992/s.37 (1) are met. This is a complex issue and any policyholder in possession of a “second hand” policy(s) should seek professional tax advice before taking any action with regards to that policy(s). Further information on the relationship between CGT and life policies can be found at http://www.hmrc.gov.uk/manuals/cg4manual/cg69040+.htm.