Family Loan Arrangements: Tax Planning, HMRC Rules, and Inheritance Tax Implications

The instinct to support adult children or grandchildren financially — helping with a house purchase, funding a business, bridging a cash-flow gap — is universal among high-net-worth families. The mechanism chosen matters considerably for tax purposes. An outright gift starts the seven-year potentially exempt transfer (PET) clock for Inheritance Tax. A loan, if structured properly, is a debt of the estate rather than a gift — it does not reduce the estate for IHT purposes, and if the borrower cannot repay, it can be forgiven (becoming a gift) at the optimal moment.

This guide explains the tax rules governing intra-family loans, the HMRC official rate, and how lending within a family fits into an overall gifting and estate planning strategy.

Loans vs Gifts: The Fundamental Distinction

A gift is a transfer of value with no expectation of repayment. For IHT purposes, most gifts to individuals are potentially exempt transfers (PETs) — they fall out of the estate if the donor survives seven years. Gifts to trusts are typically chargeable lifetime transfers, subject to 20% IHT above the nil rate band at the time of transfer, with further charges possible on ten-year anniversaries and exits.

A loan is a transfer of assets with an expectation of repayment. The lender's estate retains the value of the loan as an asset — a debt owed to the estate. On the lender's death, the outstanding loan forms part of the estate and is subject to IHT. This has an important implication: making a loan rather than a gift does not remove value from the estate while the loan is outstanding.

The two strategies serve different purposes:

• Outright gifts are appropriate when the donor wants to transfer wealth permanently, can accept the potential IHT (tapering over 7 years), and does not need the assets back.
• Loans are appropriate when the donor wants to transfer money now (to help with a house purchase, for example) but needs to retain the ability to call it back, or wants to delay the decision about whether to give it permanently.

The HMRC Official Rate

The HMRC "official rate of interest" is the minimum rate at which a loan between connected parties must be charged if it is to be treated as a genuine loan rather than a benefit-in-kind or a notional gift.

For 2025-26, the official rate is 3.75% per year (increased from 2.25% on 6 April 2025). From April 2025, HMRC reviews the rate quarterly — on 6 April, 6 July, 6 October, and 6 January — so the applicable rate can change during the tax year. Always verify the current rate on GOV.UK or with your adviser before documenting a loan arrangement.

If a family loan is interest-free or charges below the official rate, HMRC may treat the interest foregone as:

• A taxable benefit in kind for an employee-director (if the loan is from a company the borrower works for — not relevant to personal family loans but relevant to director loans).
• Income for the lender (on the notional interest that should have been charged — relevant under anti-avoidance provisions for settlements on minor children).
• A gift element (the value of the interest foregone may be treated as a gift for IHT purposes, though this is subject to the "no consideration" test and de minimis rules).

For loans between adults (parent to adult child, for example), the technical income tax position on interest-free loans is not straightforward. HMRC does not routinely assess income tax on notional interest foregone between adults, but professional advice is recommended for loans above £100,000 or for high-profile family wealth situations.

For loans from a company director to their own company (or the reverse), the s.455 tax charge and benefit-in-kind rules apply strictly — the official rate is directly relevant to both tax positions.

Formal Documentation

For a loan to be treated as a genuine loan — not a gift — it must be properly evidenced:

1. Deed of loan or promissory note: a written agreement setting out the principal, interest rate, repayment terms, and what happens on default or the lender's death.
2. Interest rate: either the official rate or market rate; if below the official rate, document the reason and consider advice on tax implications.
3. Repayment schedule: even if flexible ("on demand" or "from the sale of property X"), there should be genuine expectation and mechanism for repayment.
4. Interest payments (or written waiver): if interest is charged, it should actually be paid (or explicitly waived by deed, noting tax implications of the waiver).

An undocumented family loan is vulnerable to HMRC treating it as a gift, or an insolvency practitioner treating it as a preference payment (in circumstances of either party's financial difficulty). Documentation costs relatively little compared to the potential tax exposure.

Loans and Inheritance Tax: The Interplay

While a loan is outstanding, its value sits in the lender's estate as an asset. On the lender's death, the loan is either repaid (reducing the borrower's assets and replenishing the estate — net IHT impact: neutral) or it forms part of the estate at its face value (potentially subject to 40% IHT).

The planning interest arises when the lender forgives the loan — that is, releases the borrower from the obligation to repay. A loan forgiveness is treated as a gift at the date of forgiveness. From that date, the seven-year PET clock begins to run. The value of the forgiven loan leaves the estate.

This creates a useful planning tool:

• Make a loan to the child (house purchase, for example). The estate retains the asset; the child has the use of the money.
• At a later date — when the lender's health is good and the estate is at a size where removing value is valuable — forgive the loan by executing a deed of release. This starts the seven-year clock.

The practical advantage over an immediate outright gift is flexibility: the loan can be called back if the lender's circumstances change (illness, investment loss, unexpected expense). A gift once made cannot be recalled.

Interaction with the Normal Expenditure Out of Income Exemption

The most tax-efficient gifting strategy for those with income substantially exceeding their living expenses is the "normal expenditure out of income" exemption. Gifts that meet the conditions (made out of income, habitual, and not impairing the donor's standard of living) are immediately outside the estate — no seven-year clock, no nil-rate band consumed.

Family loans do not qualify for this exemption — they are not gifts. But if the loan is later forgiven in regular instalments (for example, forgiving £X per year), each forgiveness may qualify as a gift made from income if the other conditions are met.

Loans to Trusts and Third Parties

Loans to trusts (rather than to beneficiaries directly) have different tax treatment. A loan to a trust is not a gift — the estate retains the loan asset. Interest on the loan (at the official rate or above) is taxable income of the lender. However, the loan can be used by the trustees to invest and accumulate for trust beneficiaries, with the loan repaid over time.

This is the basis of several IHT planning structures — including Loan Trusts and Discounted Gift Trusts — which use the combination of a loan and trust investment to gradually move value out of the estate. These structures require specialist advice as they involve complex trust and tax rules.

Common Mistakes

Treating undocumented transfers as loans. HMRC challenges undocumented "loans" where repayment has never been demanded, interest has never been paid, and the borrower treats the money as a gift. Documentation must reflect reality.

Repaying the wrong party on death. If the lender dies and their Will leaves the estate to beneficiaries, the loan asset is part of the estate. Executors must collect it (or formally release it as part of the estate administration). Borrowers should not assume the debt is automatically forgiven on the lender's death — only an explicit provision in the Will or a deed of release achieves this.

Loans without repayment mechanism. "Open-ended" loans with no repayment mechanism or date may be challenged as gifts. Establishing a realistic repayment structure — even if long-term — supports the genuine loan characterisation.

Tax rules, including the HMRC official rate, are subject to change. From April 2025, HMRC may revise the official rate quarterly; the rate in this article reflects published rates as at June 2026 — always verify the current rate on GOV.UK before entering into or documenting a loan arrangement. This article does not constitute legal or tax advice. Family loan arrangements should be documented with the assistance of a solicitor, and tax implications reviewed with a qualified adviser.

How Global Investments Can Help

Global Investments advises HNW families on estate and succession planning, including the strategic use of intra-family loans, loan forgiveness planning, and the broader estate planning context in which lending decisions sit. We work alongside specialist tax and legal advisers to ensure that family financial arrangements are structured effectively and documented correctly. Contact us to discuss your family's estate planning needs.