Interest-Free Loan IHT UK (2026): Inheritance Tax Treatment of Interest-Free Family Loans

An interest-free loan to a family member is NOT a potentially exempt transfer (PET) for IHT purposes — it is a LOAN, not a gift: (1) THE GENERAL RULE — LOANS ARE NOT TRANSFERS OF VALUE: when a person lends money to a family member interest-free, they have not given the money away — the loan is repayable. It does not reduce the lender's estate permanently (since the loan remains as an asset in the lender's estate — a debt owed back to them). Accordingly, making an interest-free loan is NOT a transfer of value for IHT, and does NOT start the 7-year clock for potentially exempt transfers; (2) HOWEVER — S.162A REDUCTION FOR INTEREST-FREE TERM: IHTA 1984 s.162A (inserted by Finance Act 2013) requires HMRC to reduce the value of an interest-free or below-market-rate loan in the lender's estate. The reduction reflects the fact that the loan is LESS VALUABLE than a loan at market interest rates — because the lender is foregoing the interest they could have earned. The s.162A reduction equals the net present value of the future stream of foregone interest over the remaining term; (3) THE S.162A DISCOUNT IS NOT A TRANSFER OF VALUE: the s.162A discount is a REDUCTION IN VALUE of the loan in the lender's estate — it is not treated as a transfer of value itself. It simply reflects that the loan asset is worth less than its face value on a present-value basis. The practical effect is that the lender's estate is slightly smaller (because the loan is worth less than its face value) but no PET clock runs; (4) REPAYMENT: when the borrower repays the loan (or when the lender dies and the loan is repaid from the borrower's funds), the loan ceases to be an asset of the lender's estate — the full face value is received back. Repayment of a loan is NOT a transfer of value by the borrower.

The s.162A discount reduces the value of an interest-free or below-market-rate loan in the lender's estate. The calculation is as follows: (1) THE VALUATION DATE: the discount is calculated at the date of the transfer of value (i.e. at the date the lender dies, or the date of any chargeable lifetime transfer involving the loan). For a loan outstanding at the date of death, the discount is calculated at the date of death; (2) THE DISCOUNT METHODOLOGY: the discount equals the difference between: (a) the face value of the loan (the amount outstanding at the valuation date); (b) the present value of the loan, calculated by discounting the future repayment amount at the official rate of interest for beneficial loans. HMRC publishes the official rate — it is the rate used for the employment income benefit-in-kind calculation for beneficial loans (currently 2.25% per annum as at 2026 — check the current rate on HMRC's website); (3) EXAMPLE OF S.162A DISCOUNT: a parent lends £100,000 to their child interest-free, repayable in 10 years. At the date of the parent's death (5 years after the loan is made), £100,000 is still outstanding. The present value of £100,000 repayable in 5 years at 2.25% is approximately £89,500. The s.162A discount is approximately £10,500. The value of the loan in the parent's estate is treated as £89,500 (not £100,000) for IHT purposes; (4) ON-DEMAND LOANS: for loans repayable on demand (no fixed term), the s.162A discount may be nil or minimal — because there is no term over which to discount. A loan repayable immediately on demand is already at present value; (5) BELOW-MARKET-RATE INTEREST: s.162A also applies to loans that charge below-market interest — not just completely interest-free loans. The discount reflects the shortfall between the actual interest rate and the official rate, discounted over the remaining term.

Interest-free loans are a recognised tool in IHT planning, particularly as part of a LOAN TRUST arrangement: (1) THE BASIC LOAN TRUST MECHANISM: a loan trust works as follows: (a) the settlor (typically a parent or grandparent) makes an INTEREST-FREE LOAN (usually documented in a loan agreement) to a trust — typically a discretionary trust for the benefit of children and grandchildren; (b) the trust invests the loan monies in a life assurance investment bond or other asset; (c) the trustees make distributions from the trust to the beneficiaries over time; (d) the loan remains outstanding in the settlor's estate — available to be repaid from the trust if needed; (e) on the settlor's death, the outstanding loan is repayable to the estate — it is a debt owed TO the estate. The s.162A discount reduces its value; (2) THE IHT BENEFIT: the trust can invest the loan and generate returns — those returns can accumulate outside the settlor's estate. The settlor's estate is NOT reduced by the loan (since the loan remains outstanding) — but the GROWTH on the invested funds is outside the estate, in the trust. Over time, the trust's value exceeds the outstanding loan; (3) THE LOAN TRUST IS NOT A PET: crucially, the loan is not a PET — the 7-year clock does NOT run on the principal of the loan. This makes loan trusts particularly suitable for people who: (a) cannot survive 7 years; (b) need access to the loan capital (the loan can be repaid from the trust if needed — subject to trustees' discretion); (4) COMPARISON WITH DISCOUNTED GIFT TRUST: a loan trust is distinct from a Discounted Gift Trust. In a DGT, the settlor makes a gift to a trust and retains a fixed income stream — the gifted capital is a PET (7-year clock runs). In a loan trust, the principal is NOT given away — it remains a loan; (5) PRACTICAL REQUIREMENTS: a loan trust requires: (a) a formal loan agreement; (b) a discretionary trust deed; (c) a suitable investment (typically an investment bond); (d) careful ongoing administration; (e) annual reporting to HMRC where required.

When the lender dies with an interest-free loan outstanding, the loan is treated as an ASSET of the lender's estate for IHT: (1) LOAN AS AN ESTATE ASSET: the outstanding loan is a CHOSE IN ACTION — a contractual right to repayment. It is an asset of the lender's estate at the date of death. It must be included in the IHT account (form IHT400) at its value as at the date of death; (2) S.162A DISCOUNT APPLIES: as discussed above, the value of the loan in the estate is reduced by the s.162A discount — reflecting the interest-free or below-market rate nature of the loan. The discounted value is reported in the IHT account; (3) LOAN REPAYMENT BY BORROWER — NOT A GIFT TO THE ESTATE: when the personal representatives of the lender's estate call in the outstanding loan, the repayment by the borrower is NOT a transfer of value by the borrower — it is simply the repayment of a legal debt. It does NOT reduce the borrower's estate for IHT purposes either; (4) LOAN WRITTEN OFF BY WILL — A GIFT: if the lender's will WRITES OFF the outstanding loan (i.e. leaves the debt to the borrower by way of legacy), that is a GIFT from the estate to the borrower — taxable as part of the estate under IHT if the estate is above the nil-rate band. The written-off loan is included in the estate at its value (subject to any s.162A discount) for IHT purposes; (5) DEBT IN THE BORROWER'S ESTATE — DEDUCTIBLE: if the borrower ALSO dies with the loan outstanding, the loan is a LIABILITY in the borrower's estate — deductible from the borrower's estate for IHT purposes. However, Finance Act 2013 s.176 (IHTA 1984 s.162A et seq.) introduced restrictions on deducting liabilities incurred to acquire excluded property — care is needed in complex cross-border arrangements; (6) PRACTICAL POINT — WRITTEN LOAN AGREEMENTS: every family loan should be documented in a written loan agreement, regardless of whether any security is taken. A written agreement: (a) establishes the existence of the debt; (b) records the repayment terms; (c) makes the IHT reporting straightforward; (d) prevents a posthumous dispute about whether the loan was a gift.

While the focus of this guide is IHT, interest-free loans also have income tax and CGT implications: (1) INCOME TAX — NOTIONAL INTEREST: if a COMPANY makes an interest-free loan to a director or employee, the employee is treated as receiving a benefit-in-kind (employment income) equal to the notional interest at the official rate — income tax applies. However, for PERSONAL loans between INDIVIDUALS, there is NO income tax charge on the notional interest foregone by the lender. The lender is simply not earning interest — they are not taxable on what they have not received; (2) CGT — NO CGT ON MAKING A LOAN: making a loan (whether interest-free or not) is NOT a disposal for CGT purposes — the lender retains an asset (the right to repayment). No CGT arises on making the loan; (3) CGT ON WAIVING OR WRITING OFF A LOAN: if the lender WAIVES the right to repayment (releases the borrower from the debt), this is a disposal for CGT — but typically for no consideration and with no gain (the loan was made at its face value and the right to repayment is waived at face value — no gain). A gift of the right to repayment is valued at arm's length for CGT; (4) THE LOAN TRUST AND CGT: within a loan trust, the trustees invest the loan monies. Any gains within the trust are subject to CGT at the trust rate (currently 24% — effective from 30 October 2024). Gains realised on the underlying investment within an investment bond wrapper are deferred until a chargeable event occurs. The annual CGT exempt amount for trusts is half the individual amount (£1,500 for 2026/27); (5) STAMP DUTY LAND TAX — LOAN IN PROPERTY PURCHASE: if an interest-free family loan is used to fund a property purchase, the loan itself is not subject to SDLT — SDLT arises on the property purchase, not on the financing. However, if the lender takes a legal charge over the property as security, that charge is a registrable disposition for Land Registry purposes.