Gift Or Loan: Why The Paperwork Matters

A topic that frequently arises when meeting with clients is that of advancing funds to children during lifetime and how this should be approached especially if there is disparity as to the value being gifted to each child. The first consideration should always be what the intention of the advance is; is it an outright gift or is it a loan? The second consideration is how it is going to be documented? Whether the advance is a loan or a gift has very different consequences on death and can be the cause of great dispute if not recorded accurately during lifetime.

Gift or Loan

Lifetime gifting to children is common place as part of someone’s inheritance tax planning and an outright gift of a sum of money is often seen as an effective measure to reduce someone’s inheritance tax burden . How that gift is dealt with upon death and the treatment of it for inheritance tax purposes will depend upon the value of the gift, the type of gift and how long ago the gift was made . The important distinction here is that a gift does not require to be repaid to the estate upon the death of the transferor, whilst a loan ordinarily does unless there is agreement to the contrary.

Loans are often seen from a parent to child; it may be a lump sum of money to assist the child getting onto the property ladder or to buy their first car. If the loan is not repaid during the parent’s lifetime, technically upon the death of the parent the loan is due to be repaid to their estate.

Documentation

The parent making the advance to their child during lifetime may think that it is obvious as to what the intention of the advance is and may feel that properly documenting it is not required. However, when the transferor dies and their executors are going through the transferor’s finances, whether it was a loan or a gift may become more hazy and the lack or records may become problematic especially if there are difficult family dynamics or disparity in the amount advanced to each child during lifetime. Thus proper documentation of the gift or loan is of paramount importance.

It does not necessarily have to be anything complicated to document the position; to a degree anything written down is better than nothing at all. The gold standard would be a document signed and witnessed by both parent and child, however a note by the parents documenting any substantial payments made to their children would also be taken into account and would be better than no records at all.

Issues arising on death

If there is no documentation behind the payment the starting point is that if an advance is made it is treated as a loan as there is a presumption against donation under Scots law. However, where someone makes a payment to another and there is a natural obligation to support and provide for the recipient, such as a parent and child, this presumption no longer applies and instead the starting point is that it is assumed to be a gift and the onus to displace the presumption that the payment was a gift lies with the donor and not the recipient.

On death, executors need to be able to wind up someone’s personal affairs and part of this is establishing whether any gifts or loans were made in lifetime. The executor does not always have the personal insight from the deceased and will not necessarily know the intention behind every advance that person made during their lifetime. It can become very costly and stressful if a dispute arises as to whether a particular payment was a gift or a loan and may ultimately end up in court to determine what the nature of the advance was. This can be avoided if the payment is properly documented at the time of making the payment.