Trust Makes A Profit. Then what?

[ok180]

Hi all,

I have been reading a lot about trusts lately and was wondering what happens when a trust makes a profit but you dont distribute that money to its beneficieries? For instance say i had a loan of 100K @ 7% interest but the trust has an income of 10k, thus 3k profit. How is this profit taxed? Could i just pay off some of the loans principal?

thanks!

[The Y-man]

Hi OK180,

in the case of a discretionary family trust, my understanding is that all (net) profits MUST be distributed and can not be retainded.
The income will be taxed at the personal tax rate of the beneficiary receiving the income. Therefore, it one of the advantages of having the trust is being able to decide which beneficiary to distribute to.

Hope this helps.

Cheers,

The Y-man

[ok180]

Thanks Y man,

If that's true though how could the trust ever pay off it's 100K debt? :confused:

It's probably a simple answer but i wouldn't have a clue :p

[DavidMc]

Why pay it off? Use the money you were going to pay if off to fund new asset purchases.

[ok180]

ermmm cause eventually the asset has to either increase in value or you have to service some debt so you can borrow more....


im assuming the asset isnt appreciating in value much at this stage.

[redwing]

OK

If you haven't already got it, I'd suggest getting DaleGG's Book "Trust Magic". NickM's site at Strategic Wealth also has some good information as does Chris Battens..

REDWING

[ok180]

ok thanks for that. :)

How does the trust pay down it's loan though? Is there a tax involved?

[Peter 14.7]

As I understand my trust, it can a nominal distribution but the fund can be retained in the trust. That is tax is paid at the nominal rate but the funds stay to be used for further investment.

The advantage is the funds cannot be attacked in a legal situation.

I could be wrong this is my first year.

Peter 147

[ok180]

Maybe i should re phrase the situation...

Say the trust was running a company, for instance "zxycorp" if zxycorp had a turnover of say 200k then payed wages of say 100k to it's employee's and had exspenses of 50k. This would leave 50K sitting in the trust. Now surely you couldnt just distribute 50k to the beneficieres at the end of the year cause the company needs some money to function no? So how is this profit taxed?

[handyandy]

Another option is to also have a company as a beneficiary. The company pays a flat 30% tax and can retain the income.

You can then use this income as valid dividends to with a 30% imputation credit or you could rake up legitimate company expenses (pre tax) and spend the money before tax.

I am intending to use this concept to achieve my aim of not paying any personal tax. Company will pay 30% tax and pass on the imputation but will still run cars etc through company so not personal expense.

Cheers

[Peter 14.7]

Maybe i should re phrase the situation...

Say the trust was running a company, for instance "zxycorp" if zxycorp had a turnover of say 200k then payed wages of say 100k to it's employee's and had exspenses of 50k. This would leave 50K sitting in the trust. Now surely you couldnt just distribute 50k to the beneficieres at the end of the year cause the company needs some money to function no? So how is this profit taxed?

Handy Andy is right.

Assuming the Company is owed by the trust it can pay 30% tax and retain the profit or hand it over as dividend to the trust. If it does the trust can distrubte with 30% franking creidt to those working so if the beneficary has no income they get the 30% back = no tax.

This is general only and should seek accountants advice for clarification

Peter 147.

[redwing]

The money has to be 'distributed' to the beneficiaries..look at the ways how..

REDWING

[The Y-man]

ok thanks for that. :)

How does the trust pay down it's loan though? Is there a tax involved?

Again from my very basic understanding....

Your "profits" would still need to be distributed and taxed (your P/L events). However, the trust may also pay back all or part of the capital invested in it, in which case this should be a non-taxable event (a balance sheet event).

So in your scenario, if your trust made a net 3%, this must be distibuted and taxed. It may also return the 100k to you, but this should not be taxable.

(I am not an accountant - so don't trust me!)

Cheers,

The Y-man

[DaleGG]

Hi

Yes, the trust must distribute its profit to the beneficiaries. If it does not, then the trustee will pay tax at 48.5% on the undistributed profit.

When distributing the profit, the trustee can distribute the profit to any of the beneficiaries and this may be to some who will not pay tax at all; and/or some who will pay a lower rate of tax than the highest rate.

To answer your question though:

The distribution may be by a book entry. This means that the money stays in the trust bank account and the account does a journal recording the distribution as if it happens. At that point, the trust effectively owes the distributed profit to the beneficiaries and will need to pay out that loan at a later date.

Does this help?

Dale

[gekko_99]

How does the loan get paid down?

If the trust has a loan of say $10,000 and at the end of a year made a net profit after interest and before tax of $2,000 how does it reduce the loan balance without losing tax benefits.

I can only think of 2 ways.

1. If it used the $2,000 to reduce the loan balance and did not pay out to a beneficiary, etc, I would think that this represents an unpaid distribution which would be taxed at the full rate.

2. If it distributed it out to beneficiaries as best it can for tax purposes through a book entry with funds being retained within the actual account and then the recipients gifted it back to the trust it could pay down the loan balance.

I imagine that 2 would be the way to go.

Or 3 I think I just cottoned onto Dale's comment, it makes a distribution via a book entry to the beneficiaries but keeps the $2,000 to pay down debt. The cash retained builds up as money owing to the beneficiaries which I assume might have a 0% interest rate and can be paid out of future profits once the loan has been paid out.

[Peter 14.7]

Correct.

BTW this post shows how trusts assist to redice tax but legally there is no way to avoid tax being assessed and apaid as required.

SO if the trust makes $50k it can nominally distrubute to say the 2 beneficaries and hane them $5K each to cover the tax. The remaining $40k can be invested in paying down the capital so eventually the turst has a debt free asset which it can sell to liquidate and pay without tax to the beneficaires it owes the money to.

Why do this?

The money cannot be attacked it is safe in the trust. Who gets it and how much can be changed each year to suit your personal situation.

Peter

[GreatPig]

The money cannot be attacked it is safe in the trust
I think that depends on who's being attacked. The beneficiaries who received the distributions as book entries have lent the funds back to the trust. I would think that if they were attacked, those loans might be able to be called in, although I don't know what obligation the trust would have to pay them back before it wanted to (which would be never in that case).

Ultimately the funds are the beneficiaries' capital, and I don't know that just lending the money to the trust provides much asset protection.

However, I'm certainly no expert and this is just my interpretation.

Cheers,
GP

[see_change]

If you have a trust that is profitable , you can ( to the best of my knowledge ie my accountant has no problems with us doing it ...) ) have another trust which has " negatively geared " and the profitable trust can distribute funds to the negative fund to make up any short fall in cash flow .

Effectively negative gearing within a trust without having to use a hybrid trust ( though not accessing negative gearing with personal income ) .

See Change

[ok180]

The distribution may be by a book entry. This means that the money stays in the trust bank account and the account does a journal recording the distribution as if it happens. At that point, the trust effectively owes the distributed profit to the beneficiaries and will need to pay out that loan at a later date.

Does this help?

Dale

Yes it helps :) Thanks to everyone else also!

So if the profit is distributed via a book entry does the beneficiary pay tax on that income in that financial year or when the loan is settled down the track?

[The Y-man]

Yes it helps :) Thanks to everyone else also!

So if the profit is distributed via a book entry does the beneficiary pay tax on that income in that financial year or when the loan is settled down the track?

In that financial year I believe....

Cheers,

The Y-man

[Peter 14.7]

I think that depends on who's being attacked. The beneficiaries who received the distributions as book entries have lent the funds back to the trust. I would think that if they were attacked, those loans might be able to be called in, although I don't know what obligation the trust would have to pay them back before it wanted to (which would be never in that case).

Ultimately the funds are the beneficiaries' capital, and I don't know that just lending the money to the trust provides much asset protection.

However, I'm certainly no expert and this is just my interpretation.

Cheers,
GP

The loans can only be called in if the funds exist. If the trust has no finds because it distrubutes it to others then the cupboard is bare. Essentially "doing a bondy" ala ALan Bond.

I'm also no expert and this is just my interpretation.

Peter 147