Is the Bank of Mum & Dad still in line for a tax hit?
It’s a lender that’s been around for decades, giving low cost (mainly free) loans to its select customer base.
Its financial firepower appears to have grown in recent years, but so too has the demand for its services and the size of the loans.
Although it operates quietly all over the country, it came to prominence once again here in the last fortnight.
The Government’s Finance Bill put the spotlight on the ‘Bank of Mum and Dad’ – specifically on how it does its business and the tax treatment of such.
Proposed changes to the way family loans are treated as gifts for the purpose of tax were rowed back on at the eleventh hour, but is there change coming and is Revenue about to focus more closely on how money is transferred within families?
What is the current tax arrangement when it comes to family loans?
The parent could charge interest on a loan that it gives to a child to top up a deposit for a house purchase, for example, and negate any tax liability for them or their offspring.
But that’s generally not the practice and it would be seen as running counter to the logic of giving a child some financial assistance in what is a very competitive housing market.
The current tax liability is dictated by the prevailing deposit rate on the market.
Effectively, it’s calculated on the basis of the loss that the lender (Mum and Dad) would be incurring by not having the money in a deposit account.
Once upon a time, a deposit would have attracted an interest rate of around, say, 2%.
So, if the parent was giving a loan of €100,000 with no interest rate attached, Revenue would consider that a gift of €2,000 a year.
However, because deposit rates have been at zero – or close to – for the last number of years, the gift was essentially being given with no tax liability arising.
So, what was in the Finance Bill?
The Finance Bill had proposed dealing with this anomaly by switching the focus from the deposit rate to the lending rate.
In other words, it was putting the onus on the borrower to determine the benefit that was accruing to them by not having to pay the prevailing rate available on the market had they borrowed the money from a financial institution.
It was going to involve a bit of homework and some documentary compilation on the part of the borrower.
The details hadn’t been furnished but if the rate was to be based on the lowest mortgage lending rate available on the market, it would come in around 2 to 3%.
So, for the loan of €100,000 mentioned above, the liability would come in at around €2,000 to €3,000.
If, however, the lending rate was based on a personal loan, it would be a heftier 5 to 7%, meaning the liability would come in at between €5,000 and €7,000 on the same €100,000.
Why was it withdrawn by the Minister?
“There was no obvious benefit to the Exchequer,” Norah Collender, Professional Tax Leader with Chartered Accountants Ireland surmised.
She explained this in the context of the small gift tax exemption of €3,000 that a person can give in one year.
“You can get a small gift of €3,000 from each parent that would be €6,000, which could cover the interest element.”
So, even if the taxable benefit was based on the lending rate rather than the deposit rate, it would still – in most cases – come in below the small gift exemption threshold.
Mortgage broker Michael Dowling, Managing Director of Dowling Financial, suspects that there may have been a political motivation in the decision too.
“I would say it’s like interfering with Capital Gains Tax on the sale of a family home. If the same people are perceived to be hit all the time for various tax raising measures, it would be viewed as a step too far,” he explained.
“And besides, all that would happen is that the parents would end up paying it.”
Surely there’s a societal fairness argument there?
And this is the nub of the issue.
There’s a cohort who can afford to get a loan from parents and then there are those who can’t.
There’s a well-documented shortage of housing and those who can afford to top up their offer for a property with parental cash (while those without are restricted by lending caps) are sure to get the keys to the house or apartment at the end of the day.
And at a time when nest eggs are attracting no gain from the banks – and may even be in line for a charge in the form of negative interest rates if they’re large enough – there’s a built-in incentive for parents to give the money to children.
This must be contributing to property price inflation?
“There’s no question that it’s impacting prices,” Michael Dowling said.
“If you’ve 3 or 4 people bidding on the same house at €400,000 or €500,000, and one can take €50,000 out of the hat to make the difference, that’s going to impact prices. And once another house in that area comes up for sale, the benchmark is going to be set at the price that first house went for,” he added.
And the loans are getting bigger all the time.
“I’m 30 years in the business and over the past few years €10,000 to €30,000 was the level you’d be seeing. Now, €50,000 to €60,000 is quite common and €100,000 wouldn’t surprise me,” Mr Dowling explained.
He cited some examples of buyers essentially getting an advance on their inheritance with a gift, as opposed to a loan, up to the current maximum lifetime threshold of €335,000.
Figures are not available on the aggregate amount that’s out on loan to children from family but Michael Dowling estimates that it could up to €1 billion a year.
Is this the end of the road for this issue now?
The inclusion of the measure in the Finance Bill without having been flagged in the budget last month took many by surprise.
No reason was given by the Minister for Finance for rowing back on the plan, other than that it needed further examination.
“The Minster has decided not to proceed with section 62 of the Bill relating to the tax treatment of interest-free or low interest loans as he believes greater consideration needs to be given to the proposal,” the Department said in a statement in which the Minister welcomed a number of Government amendments to the Finance Bill, which may suggest that at least some resistance had emerged at a political level.
As to whether it will form part of next year’s budget or Finance Bill, after ‘greater consideration’, it may well do so.
One approach that would not require any legislative change is for Revenue to ensure that such loans are being paid back and are not effectively gifts from parents to children.
“Revenue can seek proof that a loan is being paid and is not a cash gift,” Norah Collender explained.
“They have the power to question any transaction that has tax implications. For example, with all of the CAT exemptions for business relief and agricultural relief, Revenue have tightened up on those over the last number of years,” she added.
In this way, they’re getting greater oversight of transactions and putting the onus on both parties that gift or inherit to prove that they are compliant.
A similar approach could be applied to the use of family loans to ensure that they do indeed constitute such a transaction and that they are being paid back or, if not, that they are being declared as gifts that can be offset against the lifetime inheritance/cash gift tax free threshold which is currently set at €335,000.
It’s fair to assume that we haven’t heard that last of this just yet.
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