The Sovereign Loan Trust is a Gibraltar-based trust designed for clients who want to reduce their exposure to UK Inheritance Tax (IHT) over time, but who also wish to retain control of – and access to – their original capital. The Loan Trust allows clients access to their original capital at any point and in any amount, whether to supplement income or to provide a safety net in case of changing circumstances, but the growth in the trust fund from the underlying investments will not be included in their estate for IHT purposes.
How it works
Firstly, the Sovereign Loan Trust provides a potential IHT saving. The gift (or ‘settlement’) made to establish the loan trust is a Potentially Exempt Transfer (PET) for IHT purposes. This means that seven years after the date of the transfer into trust, the gift will become exempt from IHT. If the client (the ‘settlor’) dies within the seven years, the PET will become chargeable to IHT. As a result, this gift is typically quite small.
Secondly, once the trust has been established, the bulk of value is added by way of a loan from the client to the trust. The loan is interest free and repayable on demand. The trustees will use the money contributed to purchase a life insurance bond within which investments can be made. The growth of value in the assets transferred within the life policy is immediately outside the client’s estate for IHT purposes. However, the loan itself remains in the client’s estate.
The client only has access to any outstanding loan and not to the trust fund itself. All the growth from the underlying investments, together with any amounts waived from the loan, must be held for the benefit of the beneficiaries. In the case of joint settlors, the right to repayment of the loan will automatically pass to the survivor.
There is no entitlement to the outstanding loan by the beneficiaries. However, if the full value of the loan is not required by the client, the loan can be waived in part or in full at any time. This is an opportunity for clients to use their IHT annual exemption and waive £3,000 per year (or £6,000 per year in a joint settlor trust). Any amounts waived in excess of the IHT annual exemption will be a PET and so will only be free of IHT after a period of seven years.
The loan itself remains in the client’s estate for IHT purposes but, over a period of time, the outstanding loan can also be reduced in value by making partial loan repayments from the trust to the client. In this way the value of the outstanding loan can be steadily reduced so that on the client’s death the remaining value for IHT purposes is very small or nil.
If these repayments are matched against life policy withdrawals using the ‘part-surrender’ method, the individual can also benefit from the 5% tax-deferred allowance. This means that in each policy year, the client can withdraw 5% of the sum originally invested without any immediate liability to income tax. The allowance is cumulative, so any unused allowance in a given policy year can be set against future part-withdrawals at any time. If this is achieved successfully, the loan trust can be structured to achieve an effective tax-free income over a period of years.
Loan Trust Guidance
The Sovereign Loan Trust is a highly effective solution for clients seeking to mitigate their IHT exposure over time whilst also allowing continued access to the original capital. It is significant that when the UK government issued the Inheritance Tax Avoidance Schemes (Prescribed Descriptions of Arrangements) Regulations 2017, effective 1 April 2018, it did not cover arrangements involving a loan trust because these do not reduce the value of a person’s estate within the terms of the regulations.
Accordingly, the Sovereign Loan Trust is as a legitimate form of estate planning that is not notifiable to HM Revenue & Customs under the Disclosure of Tax Avoidance Schemes (DOTAS) regime.
Under the Sovereign Loan Trust, the investment portfolio is held within a life insurance policy. If the client wishes to select the choice of investments within the bond rather than rely on an insurance company to manage this function, then the bond will potentially fall within the UK’s Personal Portfolio Bond (PPB) regime.
The PPB is an anti-avoidance measure that imposes a yearly deemed charge to tax on life insurance and capital redemption policies, where the policyholder has the ability to select the property that determines the policy benefits and therefore retains nearly all the advantages of direct personal ownership of that property. The PPB deemed gain assumes a gain of 15% of the premium and the cumulative gains for each year the policy has been in force.
The PPB charge is only an issue if the client is UK tax resident; it does not apply to non-UK resident individuals. To ensure that the bond does not fall within the scope of the PPB regime, the funds should be managed by professional managers who make the decisions as to where the funds are ultimately invested.
For UK resident individuals, UK income tax and /or capital gains tax will be a consideration in respect of any growth in the trust. Specific tax advice should be sought in the client’s country of residence and/or domicile and any country where investments are located.
Gibraltar recognises and gives full legal effect to the concept of a trust and Gibraltar is at the forefront of international best practice in the area of trusts. The Trustee Act, the main legislation governing trusts in Gibraltar, is based on the English Trustee Act 1893 and has been supplemented and updated by amending legislation.
Gibraltar was one of the first jurisdictions to introduce the regulation and supervision of trust companies. Professional trustees must be licensed under the Financial Services Act 2019 and are regulated by the Financial Services Commission (FSC). Sovereign Trust (Gibraltar) Ltd is fully licensed to act as professional trustees in Gibraltar.
A non-UK resident trust that is established in Gibraltar and where all the trustees are Gibraltar-based, and the investments are held via a life insurance bond will be exempt from registration under the UK’s Trust Registration Service (TRS).
If there are no UK assets or UK resident or domiciled beneficiaries, then the Loan Trust can hold an investment portfolio directly instead of via an insurance bond.
If Sovereign Wealth, our Gibraltar-based asset manager, is appointed by the Gibraltar trustees to act as the investment adviser, it will ensure that the fund will not fall under the UK’s Personal Portfolio Bond (PPB) regime.