The Gibraltar Loan Trust: the key to unlocking Inheritance Tax exposure for UK residents

Inheritance Tax (IHT) is a major consideration for many UK-based business owners, as well as professional advisors and financial advisors. For those looking to balance access to capital with long-term tax efficiency, the Sovereign Gibraltar Loan Trust provides an innovative and practical solution.

The challenge of IHT Estate Planning

Reducing a potential IHT liability generally requires the individual or couple to make lifetime gifts of capital to lower the value of their taxable estate. However, many clients find outright gifts impractical because they involve giving up access to income or capital – assets that might be needed in the future.

For clients who want to retain control over their capital while benefiting from IHT savings, the Sovereign Loan Trust offers a flexible and compliant approach. By using a Loan Trust, the individual or couple can achieve a gradual reduction in their estate for IHT purposes, ensure that any growth in the value of the invested cash is outside of their estate while still retaining access to their original capital.

How the Sovereign Gibraltar Loan Trust works

1 – Establishing the trust

• The trust is initiated with a nominal gift, typically around £100, from the settlor. This gift will be covered by the annual IHT exemption (up to £3,000 in each tax year), ensuring no immediate tax implications.
• A loan agreement is then executed with the trustees and the funds, which constitute the bulk of the trust’s value, are transferred to the trustees as a loan. To avoid any negative IHT consequences, the loan is specified to be interest free and repayable on demand. The trustees then invest the funds in an investment bond (life policy) and hold the bond as a trust asset.
• Under an ‘absolute’ Loan Trust, there will be a named beneficiary or beneficiaries entitled to the residual fund. A ‘discretionary’ Loan Trust offers more flexibility to the trustees to decide which of the potential beneficiaries should benefit, taking into account any guidance in a settlor’s ‘letter of wishes’.

2 – Key tax benefits

• Importantly, the IHT ‘gift with reservation’ (GWR) rules do not apply to Loan Trusts because the settlor’s right to have their loan repaid does not amount to a reservation of benefit. Their right to repayment is in their separate capacity as a creditor rather than a settlor.
• The growth of investments within the investment bond is excluded from the settlor’s taxable estate for IHT purposes, provided they are not included as a beneficiary of the trust.
• If the settlor requests a repayment of part of the loan, the trustees can make a partial withdrawal from the bond and repay the amount requested. Over time, the outstanding loan can therefore be reduced through repayments, further diminishing the taxable estate. If withdrawals are kept within the 5% annual cumulative allowances, there should be no immediate income tax liability.
• Once all the loan has been repaid, the rest of the trust fund can be passed to the trust beneficiaries.

3 – Flexibility in access to capital

• If the settlor no longer requires the full loan amount, he / she can assign the remaining loan balance to family members. This gift will be classified as a potentially exempt transfer (PET) and will therefore become IHT-free after seven years.

Why choose the Sovereign Gibraltar Loan Trust?

1. HMRC compliance

• HMRC generally accepts loan trust planning and has not categorised it as reportable under the Disclosure of Tax Avoidance Schemes (DOTAS) rules. However, bespoke tax advice is essential to ensure compliance.

2. Personal Portfolio Bond considerations

• For UK tax residents, managing investments within the investment bond must avoid falling into the personal portfolio bond regime, which could trigger annual income tax charges based on deemed gains.

3. Global applicability

• The trust is not limited to the UK tax residents. UK nationals or individuals with global, cross-border tax concerns can benefit from the trust’s structure, provided they seek local advice.

Who should consider a Gibraltar Loan Trust?

This strategy is particularly beneficial for:

• Business Owners – those with significant assets who want to reduce IHT exposure while retaining access to their capital.
• Tax Advisors and Accountants – professionals advisors seeking compliant and innovative solutions for their clients’ estate planning.
• IFAs – Independent financial advisors managing clients’ portfolios and exploring flexible tax-efficient investment structures.

Final Thoughts

The Sovereign Gibraltar Loan Trust is a tried and tested method for individuals to undertake a degree of lifetime IHT planning with their investment and achieve a gradual reduction of their estate without losing access to the funds available for investment, as well as leaving a residual fund for their beneficiaries after their death.

It strikes a highly effective balance between IHT savings and capital accessibility, making it a powerful tool for UK-based individuals and their advisors. While HMRC’s current stance supports this approach, customised tax advice is essential to assess individual circumstances, potential risks and cross-border complexities.

If you are ready to explore how the Loan Trust could benefit you or your clients, contact Sovereign for tailored advice and assistance in structuring a compliant solution that will meet their financial goals.