Nature of finance, and consequences

Nature of finance, and consequences

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A young man (over 18) wishes to buy a residential house in which to live. Cost cca £300K. He can raise £200K himself, and shortfall of £100K is to be provided by father. The house is sufficiently large that he expects to get some rental income from surplus accommodation within the property. Father will have no equitable or beneficial interest in the property, nor does he ever expect repayment of £100K nor interest thereon. However the arrangement is that any speculative rental income that may arise from letting part of the property will be paid over to the father.

Leaving aside any rent-a-room deduction that may be available to the son, we are concerned that, in the worst case scenario, the rental income will be taxable on the son, the amounts paid over to the father will likewise be (income) taxable on the father, and there may be no mechanism for tax relief in the hands of the son for the amount taxable on the father, giving rise to an overall double charge to tax on the rents. Any ideas? How should the transactions be categorised? Is the reality that the "rent" transferred from son to father is in fact interest in nature, albeit unquantifiable in advance at any instant?

2nd worst case scenario is that father is taxed in full on amount received from son, and son gets corresponding relief but which would largely be covered by rent-a-room, so there remains a net tax hit.

With kind regards

Clint Westwood

Replies (16)

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By Tim Vane
15th Jun 2015 09:38

Father loans son £100,000.

Father loans son £100,000.

Son buys house.

Son rents room and claims rent-a-room relief.

As and when, son pays back loan to father.

Father doesn't die in next 7 years.

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By nogammonsinanundoubledgame
15th Jun 2015 12:05

There is no loan

As discussed above.  Original provision of £100K is not a loan.  It is a gift, albeit subject to an understanding regarding the treatment of subsequent rents.  There is no expectation that the £100K will ever be repaid.  Nor would there be any restitution if, contrary to expectation, no rental income arose.

I am not a lawyer but at worst, if father and son fall out and it goes to law, father could sue son for any rents received by the latter and retained by him.  Probably a chose in action or chose in possession or some such legal technicality.

Care to revise?

With kind regards

Clint Westwood

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Stepurhan
By stepurhan
15th Jun 2015 13:08

Legal question

The problem you have is that the payments from son to father (should any be made) are in a sort of legal limbo. Without a formal agreement between the two, any payments made are open to interpretation.

I think calling them interest is a non-starter. For them to be interest they would have to have some relation to the amount lent. That would clearly not be the case.

I think the best scenario is that it is an interest-free loan that the son will repay "as funds allow". This would allow the payments to the father to be treated as loan repayments rather than rental income. The rental income would still be taxable on the son (subject to rent-a-room relief as noted).

Is the son an only child? If not, then legal advice is a must as there is risk of other siblings seeking repayment of the loan as part of their inheritance. Regardless, to guard against the two having a falling out, I'd say some sort of legal agreement is at least advisable.

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By nogammonsinanundoubledgame
15th Jun 2015 13:49

Thanks stepurhan

There are no other siblings to consider.

I appreciate that the arrangement might be "dressed up" in an alternative manner. For most alternative dressings up I can work out the consequences. While I can appreciate that the presentation that you suggest may be an improvement, I still need to state an improvement on what. Ie order to compare the alternatives I need to understand the consequences of each alternative, one of which is the scenario set out in the OP which, to be frank, most closely aligns with the intentions of the parties. That intention does not involve any loan repayment however described, whether interest free or otherwise.

Another concern is that if HMRC were to reqard the paper trail as differing from the genuine reality of the transactions, they might seek to impose the tax consequences of the genuine reality, despite our presentation to the contrary, and I need to appreciate what those consequences might be.

With kind regards

Clint Westwood

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By Steve Kesby
15th Jun 2015 13:55

Under the proposed arrangements...

... why should any of the amounts paid over to the father be taxable income? As you describe it, they have no source, which is essential for the receipts (from the son) to be income; it is established law that income arises from sources.

If there is no loan from father to son, and the father has no interest in the property, where is the source?

They are just as much gifts as the father's gift of capital, in the circumstances described. As has been noted, what you describe is not legally enforceable.

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By nogammonsinanundoubledgame
16th Jun 2015 06:52

£100K is source?

It is agreed between the parties that the father is entitled to an amount equal to any rents that are derived by the son.  That agreement is a condition of the provision of a non-returnable amount of £100K.  I expect that this right has a value at the time of gift based on estimated future rents.

Normally I hesitate to disagree with you but on this occasion I think that a source is identifiable.  Open to persuasion.

It does not appear to be a return of capital, as there is no loan and certainly no diminution of such loan.

It is not a gift, because it is the father's property as of right, as agreed as term and condition of the transfer of £100K

What is left?

Incidentally, a deed of covenant is income, is it not?  OK, the tax treatment has changed by statute over the years, but that does not alter its fundamental nature.  What is the "source" in such a case?

With kind regards

Clint Westwood

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By Matrix
16th Jun 2015 07:02

I expect the reason that the loan is not repayable is the mortgage company will only lend their £200k (assuming all borrowed) if there is no other debt.

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By nogammonsinanundoubledgame
16th Jun 2015 08:08

Does it matter ... why the loan (sic) is not repayable?

Another reason might be that the father wishes to reduce his IHT estate.

With kind regards

Clint Westwood

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By Matrix
16th Jun 2015 09:15

My point was that if they put a loan agreement in place per the above advice then he may not be able to get a mortgage.

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By nogammonsinanundoubledgame
16th Jun 2015 10:00

Thanks for the clarification

I think that there is a risk of thread drift.  Staying on focus let's assume for the sake of argument that there is no objection from the mortgage company.  And sorry to be pedantic, but there is no "loan agreement" as there is no "loan".  The £100K is irrecoverable.  I agree that the mortgage company would need to be informed of the terms, and that could cause a problem in theory, but let's say not.

With kind regards

Clint Westwood

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By MBK
16th Jun 2015 12:16

Ok - so father has made a gift of £100k....

... in consideration of his son entering into a (let's imagine its legally binding) commitment by his son to pay to him any "surplus" rents.

That doesn't change the fact that the son may pay tax on the rents, so the notional legal agreement between father and son would have to be expressed in net of tax terms.

So father has exchanged one asset (cash) for another (the contractual expectant right to income). I don't see that there is any tax consequence arising from that exchange except (query) could the son be charged to income tax at the outset on the disposal of the right to income that he would otherwise have under the anti-avoidance legislation at ITA2007, Part 13, Chapter 5A?

The expectant right to income is a contractual right which presumably exists (potentially) for as long as his son is alive. So it must have a value, although an actuary would be required to value it because of the uncertainty of the amount of income.

Every time father receives surplus rent it seems to me that he makes a part disposal of the expectant right to receive income. That right must (I think) be a chose in action, so each receipt would be a part disposal of that asset and he would have to do the normal part disposal calculations. Which would involve a revaluation of the expectant right at the time of receipt.

I think that may well be the technical position. If so, it's hopelessly impractical. Who wants to pay for a new actuarial valuation (at least) once a year?

So, they should be persuaded if at all possible to have nothing contractual, and if son chooses to make a gift to father out of his income, then that's up to him, - as suggested above.

 

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By nogammonsinanundoubledgame
16th Jun 2015 12:22

Thanks MKB

I agree it sounds tortuous.  The only point that I would disagree is your assertion that the contractual terms between father and son must necessarily be net of tax borne by son on rental income.  It is entirely between the two parties what terms they impose, and they could (if so minded) agree that the son pays double the gross rents to the father.  It would be madness (although it might more closely resemble a commercial rate of interest on £100K), but it would be possible.

With kind regards

Clint Westwood

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By MBK
16th Jun 2015 12:30

Yes - I agree ...

... that there is no compulsion for it to be net of tax rents.

Which kind of points up the absurdity of it all. If it were at arms length then the son simply wouldn't let the surplus space - why would he go to that trouble for no reward? So you might even argue that the father's retained right was of little or no value but an asset nevertheless that was partially disposed on the occasion of each rental receipt. It could then well be within annual CGT exemptions and not reportable at all.

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By nogammonsinanundoubledgame
17th Jun 2015 14:12

Final point:

If father does acquire a chose in action in the form of a right to future rents, does the creation of that asset comprise a disposal by the son on which CGT is potentially chargeable on the son?

With kind regards

Clint Westwood

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Stepurhan
By stepurhan
17th Jun 2015 14:18

Essential contradiction

The problem is that the father is said not to have a beneficial interest in the property, but the right to receive surplus rents shows that he clearly still does have a beneficial interest in the property. That is the substance of the arrangement, whatever the legal form. 

It sounds like a case of wanting to have their cake and eating it.

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By MBK
17th Jun 2015 15:45

Re your "Final Point"

Interesting question.

In essence what we have here is rent factoring - son has taken £100k from father which is partly gift and partly consideration for the assignment of the right to the rents. Only an actuary could split the total into those two heads.

My understanding of rent factoring is that the John Lewis case established that a rent factoring agreement is capital in nature and would thus prima facie be subject to CGT as a part disposal of son's property.

However, rent factoring was open to abuse - particularly by non resident property owners who could exchange taxable UK property income for a non taxable capital sum. Which is why we now have ITA2007 Part 13.

So, in summary, I think son is probably chargeable to income tax on the actuarial value of the right retained by father.

Most unsatisfactory.

 

 

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