Trust fund to trust fund - income tax?

Hi all,
First post here, but have had a look through quite a way back and can't seem to find anyone with the same question.. Apologies in advance if the answer is obvious..!!

My partner and I operate a business as follows:
We are directors of Company A (equal shares)
Company A is corporate trustee for Trust A
Trust A trades as a retail business, and is a discretionary trust, with myself and partner as listed beneficiaries (clause also allows related parties/companies/trust to benefit)

Trust A provides our sole source of income as beneficiaries, neither of us have PAYG wages.

We hope to purchase our first property - PPOR - this financial year. As such i've started to do some reading, and can't find anything to contradict what seems to be a HUGE gap in the tax system. I can't really find anyone saying anything similar, in fact, so can't help but feel like i've missed some fundamental element here!

Plan to purchase said PPOR:
Establish Company B, as corporate trustee for Trust B.
Trust B is discretionary or family trust, and 'trades' only in purchase of PPOR.
Trust B becomes a beneficiary of Trust A, receiving enough funds to service home loan (and as much more as possible, within Trust A's earning/profit capacity)
Remainder (or as required to cover our living costs) of Trust A's profits distributed to ourselves or other beneficiaries.

Profits transferred as a benefit from Trust A to Trust B are used completely to purchase Trust B's asset (PPOR). Trust B therefore does not make a profit for that year, and does not need to distribute to tax paying entities ie, no tax. (?!)

The intent is to buy and hold, passing on to future generations through trust. Therefore we buy asset, but don't see a gain on that asset (in our lifetime) therefore do not pay tax....?
I completely dismissed the idea at first as I thought there's no way it would be possible, until I considered that our retail business (Trust A) buys assets (trading stock) and may not necessarily make a profit on that stock (it does, but beside the point ) in that financial year, or subsequent years, instead carries over a loss - so how is it any different for Trust B to purchase our PPOR as 'long term' trading stock?

This to me reads that the 100k (or whichever figure you want) per annum sent from Trust A to Trust B as benefit to pay for this asset is not subject to income tax, 'saving' 30k per annum on what would have been 30% income tax (apply whatever tax rate and figures you want - but get my drift)... And only limited to your businesses success/profits..

Surely I've missed something.

(Could also complicate things further by suggesting that to truly qualify Trust B as trading, Trust A pays market rent to Trust B for PPOR, or portion of as business premises - home office etc - offsetting any potential loss from expenses such as interest on loan, rates....? Or am I well off the beaten track here?)

Hi

I think you have missed something!

but first, let me try to summarise what you are asking.....

Trust A has a profit of $100,000 in one tax year. You want to distribute this profit to trust B - thinking trust B will buy a $100,000 house and therefore have no profit and no tax.

If this is the case you must realise that a house is a capital asset and therefore not claimable in full. Depending on when it was constructed you (or the trust actually) may be able to claim depreciation on the building at the rate of 2.5% pa and depreciation on fittings. The trust could also claim council rates, insurance etc. So there would still be a huge profit there which would need to be distributed.

Also the rent should be factored in. Since you are third parties you may have to pay rent to your trust. If you don't claim rent you may not be able to justify claiming the deductions as it is not a commercial arrangement.

There are also fiduciary duties of a trustee to maximise the profits of the trust. The other beneficiaries may not appreciate the trustee, or directors of the trustee, staying there rent free - but this will depend on the wording of the deed etc.

And then there is the general considerations of buying your PPOR in the trust. This is not usually recomened because:
- you pay land tax
- you will not be utilising your CGT free status
- In the long run you may need to pay more tax as rents rise

If you bought under your own name then no land tax, CGT free and no income tax as you are not paying rent to yourself. But there is no asset protection.

And, why have 2 directors in your trusting company? This just doubles the risk. If the business goes down both of you going down. I would consider having just 1 director and keep the other person free for the future.

Terryw
Finance Broker

Thanks Terry,
Have tried to do some more reading before coming back more confused than before..!

Potentially a stupid question, but you say that the house will be a 'capital asset' - does this mean its taxed differently... as if it were a cash profit...? (I'm guessing - trying to understand what you mean)

Stripping it right back -
Trust A distributes 100k to Trust B during financial year,
Trust B uses whole of 100k to pay off mortgage, ending up with an asset, rather than a net profit at the end of financial.

I guess what we're trying to figure out (related issues aside) is - what exactly does the trust pay tax on at the end of financial year? We understood it was profit, not assets? (Otherwise, how does the trust hold assets normally - a lot of double taxing?)

No profit = no tax? Or not so simple?

Hi Kaatje

I think you misunderstand tax a bit.

Just remember that only interest on a loan is deductible, not the principle.

Maybe, ignore the fact that it is a trust. Think of it as a person holding the house.

If you buy a house for $100,000 you cannot claim a $100,000 deduction. You can only claim the interest on the loan (and other deductions). Even if you paid $100,000 cash for the house, you cannot claim a $100,000 deduction.

This is because it is classed as a capital asset. You can claim depreciation of the asset (depending on how old it is etc) and interest on money used to buy the asset, but not the full price of the asset.

Same if you buy some machinery for your business, or a photocopy machine etc. You cannot, usually, claim the whole amount, just a portion of it over a number of years.

Now, substitute the trust in the above example. The trust B can receive $100,000 income from trust A, but if will still have a large profit even if it purchases a house as only depreciation, interest, council rates etc will be claimable, not the full price of the house.

Terryw
Finance Broker

Also if Trust B has a taxable income of $100,000 (received from Trust A) and does not distribute this, Trust B will pay income tax on the undistributed income.  You haven't found a "HUGE gap in the taxation system" - you have not done enough reading.  Tax law is indeed an area where a little knowledge is dangerous. 

Yes, and at top marginal tax rates too!

Terryw
Finance Broker

Crj - maybe a bit rough, don't you think? I'm asking a legitimate question, which is my understanding of what these types of forums are for.
I've read quite a bit but hard to get any further when I can't figure out what i'm looking for.

Terry - thank you. Treating it as a person makes sense that way. I wasn't sure that a trust was treated the same way as a person, however - if the purpose of a trust is to 'hold' assets, it therefore needs to acquire them to be held, and didn't think it would make sense for them to be taxed in that aquisition if they'd already been taxed.. eh. ie, I can't 'give' something to be held in trust, I'd have to 'sell' it to the trust.

Anyhoo - in the end - I may lack the knowledge on this subject, although would never start the process without checking with a qualified accountant. I'm not a complete idiot.

Kaatje

You can gift things to trusts. Though this shouldn't change the tax aspects.

Terryw
Finance Broker