Take care with interest on loans from offshore pension schemes

The issue

Offshore pension schemes are a fairly common phenomenon and it is common for these schemes to provide loans to beneficiaries. Interest free loans from such schemes attract an income tax charge in the hands of the beneficiary by reference to HMRC approved rates and this point is reasonably well understood.  However there is a common misconception that simply charging interest without paying it is enough to alleviate this charge. This is incorrect. The tax legislation (section 175 ITEPA 2003) states that only payments can mitigate a beneficial loan charge. Therefore to the extent that interest has not been paid at the time of assessment then there is a charge to tax.

 

The solution

We have been working with a number of individuals to regularise this position, hopefully without penalties. It should generally be possible to agree with HMRC that any assessment is limited to the last 6 years on the basis that any omissions have not been deliberate. It is generally preferable to agree a position which involves paying tax on the benefit rather than paying the interest to the pension scheme (to avoid the charge). This is because it is preferable for the beneficiary to pay the tax out of taxed income rather than avoiding the tax by paying the outstanding interest out of taxed income  – which will then itself be taxed in the pension scheme at 45%!

Care needs to be taken over any strategy along these lines and regard also needs to be given to rules coming in in 2019 which could trigger a charge on outstanding loans. Indeed these rules themselves may serve to bring any ongoing irregularities to HMRC’s attention.

 

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