All Topics / Legal & Accounting / Discretionary Trust questions

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  • Profile photo of gomez109gomez109
    Member
    @gomez109
    Join Date: 2009
    Post Count: 12

    Hi,

    I have 2 questions on Discretionary trusts which I probably ought to know the answer to, but wanted to confirm my understanding was correct.

    1) My wife and I have a discretionary trust, with us both as benefactors. It owns property, but there’s not a lot of equity available to it. We want to buy another property in the name of the trust and we personally have enough equity to do this. It will be a cashflow positive property so all that the trust needs is money for the deposit / stamp duty / other costs.

    I understand that we can “gift” money to the trust with no tax implications but then we effectively lose the money from our personal savings. Is it possible to “lend” the money to the trust so that as the trust makes money off the property it will repay this money without it being treated as a distribution and hence incurring tax.

    For example, let’s say the trust needs $50,000. We lend the trust this money, it buys the property and in the first year makes $1,000 profit. Instead of distributing that $1,000 as income to my wife and I (which we would therefore need to pay tax on), can we take the $1,000 without paying tax, reduce the debt the trust owes us to $49,000 and have the trust declare no profit?

    If we do a loan like this, does the trust need to pay us interest? (Which obviously would be taxable).

    2) Can the trust own a property yet have the loan for that property in an individual’s name? (And hence the individual gains the tax benefit?) I thought the name on the loan didn’t matter, it was the entity that owned the asset that could claim the interest as a deduction (so in this case the trust and not the individual), yet a friend proposed this scenario to me yesterday and I wanted to confirm my understanding was accurate.

    Thanks!

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
    Post Count: 16,213

    1. Yes you can lend to your trust. The trust can pay you back out of the profit, but this would not reduce the income of the trust, just like you paying $1000 off your ANZ loan would not reduce your income by $1000.

    There is no need to charge your trust interest, but if you are borrowing from a lender and then lending to your trust your trust should probably pay you the same interest as you are being charged so it cancels out. Otherwise you would be left with paying interest to your bank and be unable to claim it.

    2. Yes loan could be in anyone’s name if the bank will accept it. But the individual couldn’t claim a deduction for ‘investing’ into a discretionary trust.

    If the trust was a unit trust the individual could borrow to buy the units. Because the units give a fixed entitlement to income the unit holder could claim the interest against their personal tax returns. This is not the case with a discretionary trust as there is no fixed entitlement. So if you borrow and invest in the trust there is no guarantee you will ever get a return because the trustee has discretion on who to distribute to.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of gomez109gomez109
    Member
    @gomez109
    Join Date: 2009
    Post Count: 12

    Hi Terry,

    That’s very helpful, thank you.

    I guess what I’m getting confused about in the first scenario is: If the trust has to distribute all it’s profit to beneficiaries then it will never have any money to repay the “loan”. The only way it seems to be able to get money is to have it gifted.

    So if it makes $1,000 and has to distribute it, there’s no money left to repay the loan. The only way I can see it repaying the loan then is by making money through non-cash deductions such as depreciation and amortising borrowing costs.

    So the property might have:
    – Rent $33,000
    – Interest $28,000
    – Depreciation & other non-cash deductions: $4,000

    So the profit would be $33,000 – $28,000 -$4,000 = $1,000, but the trust would still have $4,000 in cash once it’s distributed it’s profit. And it could use this $4,000 to repay the loan, correct?

    On your comment about the interest not being tax deductible, does that apply if the money comes out of an offset account?

    For example, I have a loan of $200, 000 and an offset account with $50,000 in it. I lend the trust $40,000 from the offset account. Is the interest now tax deductible?

    And finally, do I need to charge market interest rate for the interest the trust pays me to be tax deductible? For example, if the trust pays me 1% interest and I’m paying 7%, is that 6% difference tax deductible? (In which case the trust makes more profit, distributes this profit to my wife as a lower income earner and I get a tax deduction.)

    Thanks very much,

    Tim

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
    Post Count: 16,213

    The trust doesn't have to distribute all of its property, just its income (or if it doesn't the trustee is taxed). The trust will be holding a house, for example, and this will be growing in value. Eventually this could be sold or the loan will revert to PI and will gradually be paid off as rents rise.

    Your example
    – Rent $33,000
    – Interest $28,000
    – Depreciation & other non-cash deductions: $4,000

    The taxable income of the trust would be $33,000 – $32,000 = $1,000
    But the cashflow would be $33,000 – 28,000 = $7,000 this is because you can claim depreciation but not actually pay anything for it (its build into the purchase price).
    This $7,000 would be capital of the trust and could be used to reduce the loan or held onto.

    Not really sure what you mean about the offset account.
    eg. if you had a $100,000 loan on your PPOR and $20,000 in the offset account. You would be paying interest on $80,000 and this would not be deductible.

    if you were to take this $20,000 out for any reason the interest would be charged on $100,000 and you would still get no deductions. This would be the case even if you had lent the $20,000 to the trust. At 7% you would end up paying $1400 extra interest pa and not be able to claim it.

    Had you set up a separate loan of $20,000 and then on lent this to the trust then the trust would end up being able to claim the interest and reduce its taxable income by $1,400. It would then be in a position to distribute this tax effectively.

    If you borrow money at 7% and on lend it at 1% you would not be a very good business man as you would be losing money. This would be a non commercial transaction and the ATO would probably disallow it.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of gomez109gomez109
    Member
    @gomez109
    Join Date: 2009
    Post Count: 12

    Hi Terry,

    I appreciate that the asset will grow in value and when it is sold there will be a profit — but that profit will need to be distributed as a capital gain to the beneficiaries so cannot be used to pay off the “loan”. So the only real way for the trust to acquire capital seems to be through non-cash deductibles like depreciation.

    Sorry I was unclear about the question on the offset account. Your answer was very nearly what I had in mind, except I was envisaging an investment loan, not a loan on the PPOR.

    So, if I have an investment loan of $100,000 which is deductible, with $20,000 in the offset account and I lend the $20,000 to the trust from the offset account, my personal deductible expenses go up by $20,000 so I pay $1,400 more interest at 7%

    But the trust now has $20,000 more so doesn’t need to borrow this money, so it saves $1,400 in interest and makes $1,400 more profit for the year. Which it then distributes to my wife as the lower income earner, reducing our net tax bill.

    I’m assuming the ATO would disallow this scenario and force the trust to pay interest to me at market rates, negating this strategy?

    Thanks,

    Tim

    P.S. — I don’t suppose you’re a tax accountant who services the Sydney area are you? I could really do to have a good conversation with you, your answers on the forums are incredibly helpful!!

    Profile photo of TerrywTerryw
    Participant
    @terryw
    Join Date: 2001
    Post Count: 16,213

    hi Tim

    I am not an accountant, just a lawyer (sydney) with an interest in trusts, so I may be wrong, especially on the tax side of things.

    A trust could acquire capital would be gifting to it, and if there is capital growth of the trust assets.

    But I see what you mean.
    eg. $500,000 property. with a $500,000 loan. Property increases to $1,000,000 and the trust sells it, paying back $500,000 loan. It is left with a $500,000 capital gain which would be distributed.

    With your offset, the money in that is cash. You can do with it what you please. Go and bet it all on a camel race if you want and the extra interest incurred on your loan should be deductible as it is not borrowings. It is just cash temporarily parked in the offset.

    There is no requirement that you must lend money to someone at market rates unless you want to claim deductions. So in this case you could lend it to your trust interest free. This would assist the trust make more profit and thereby mean your tax position is enhanced.

    Good thinking

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of gomez109gomez109
    Member
    @gomez109
    Join Date: 2009
    Post Count: 12

    Hi Terry,

    Thanks very much for your thoughts. It’s always very helpful to bounce ideas off other people, particularly when they seem to be as well informed as you are!

    Cheers,

    TIm

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