Help me understand the finance side of trusts

[eggnog]

So I've got tonnes of detailed questions around trusts. Thought id start a thread and get a discussion going as im sure there will be many readers who would find it very educational.

First question on my list is, should you loan money to the trust or gift it. What are the pros and cons and under what situations should gifting and loaning be done.

 

[D.T.]

Ive been looking into this a fair bit lately myself as ive reached landtax threshold and need trust to continue.

For sake of simplicity say a $100k purchase;
Personally id spend say $10k on buying 10k $1 units (and then that $10k moves from personal bank account to trust bank account)
Then, take out a $90k loan in my name, with which I buy 90k $1 units and simultaneously trust buys a house for $100k.
End result is that vendor has $100k and no house, trust has a house and dave has 100k units.

Note where I say 'trust', obviously trustee has to do things on its behalf and act for it, but I assume you already know this part.

 

[eggnog]

I think for unit trusts its pretty straight forward as you are purchasing units or shares which is how the trust gets the capital to purchase property. But what happens with discretionary/family trusts. Do you loan to them or gift it to the trust?

 

[Terry_w]

First question on my list is, should you loan money to the trust or gift it. What are the pros and cons and under what situations should gifting and loaning be done.

That is such a broad question which is impossible to answer without reviewing the deed and your situation.

Where is the cash coming from that you want to inject into the trust?

If it is being borrowed you need to factor in the interest you will pay.

If it is cash you need to factor in the terms of the trust, and can you get that money back at some stage in the future. a gift is non refundable.

Remember you may control a trust, but this is only temporary.

 

[Peter_Tersteeg]

I'd say take advice from an accountant on this because the correct answer does depend somewhat on the specific circumstances of the individuals involved.

My observation is that most people do it via some sort of interest free loan, it's usually a book keeping entry.

There's a lot of threads on discretionary trusts on this site. Any questions you've got have almost certainly been covered before.

 

[danwatto]

And if the loan to the trust from yourself is not interest free, can you claim it as a tax deduction? Probably not because there is no definite nexus to income because it is Discretionary?

 

[coastymike]

Interest free loans ? Why would you do that ? Interest deductibility will be capped up to amount of interest income see Flethcher v FCT.

Interest free. Non commmercial loan so asset protection pretty well destroyed. I cant see any reason for an interest free loan over a gift to a DT.

 

[Terry_w]

And if the loan to the trust from yourself is not interest free, can you claim it as a tax deduction? Probably not because there is no definite nexus to income because it is Discretionary?

If A borrows money and then on lends money to B, A could only claim the interest on the money borrowed if the terms of the loan were commercial.

 

[Terry_w]

If A had, say, $100,000 cash, A could make an interest free loan to the trust. But the money lend would remain an asset of A. If A were to go bankrupt the $100,000 would fall into the hands of A's creditors.

If A had, say, $100,000 cash, A could gift that money to the trust. If A were to go bankrupt the cash would not imediately fall into the hands of creditors, but could possibly be clawed back as an undermarket value transaction. How long this could be clawed back would depend on how the transfer was structured. Generally first 4 years would be at high risk, but the longer ago the transfer was the harder it will be to claw back. However if the transfer was done to defeat creditors (or 'asset protection') the money could be clawed back indefinitely - under both bankruptcy act and relevant state legislation such as s37A Conveyancin Act NSW.

If A later wants the money gifted back A could request the trustee make a capital distribution. The Trustee will need to determine if it has the power to make this distribution. Another option may be for the trustee to lend money to A. Trustee also has to determine whether it has the power to make this loan, and if so under what terms. It may even be able to to be done at 0% interest. Trustee may also want to take security.

If A borrowed $100,000 and then lent this money to a trust the interest that A pays on the loan would not be deductible. that would be around $5,000 pa at market rates.

 

[Paul@PFI]

Lending funds to a DT is the preferred method HOWEVER it is imperative that the loan is sound and commercially maintained.
- Loan agreement
- Loan security may be contemplated
- Rate is arms length and there is no scheme in play
- No compounding interest etc

Many of these related party loans get challenged when the terms are not maintained. I'm a big fan of maintaining a back to back loan facility. Think of this....Dave and Mabel have a LOC on PPOR. They draw $300K down on this and lend to the trust etc...The bank loan account is replicated so that the Trust pays that same interest and the trust makes the repayments. This is ideal as it ensures that the loan is clearly real and on full arms length terms etc. So Dave and Mabels loan from the bank is the same as the loan to the Trust. This also means D&M have income which has identical outgoings so no personal tax concerns arise.

A loan agreement needs to be prepared between the lender (Dave and Mabel) and the Trustee which is on terms such as the "CBA Variable rate incurred by D & M on loan account no 123456789 from time to time without any margin"...A lawyer can facilitate this. The lawyer will also address the issue of either Dave or Mabel dying.

 

[Eug]

First question on my list is, should you loan money to the trust or gift it. What are the pros and cons and under what situations should gifting and loaning be done.

The alternative is for the Discretionary Trust to borrow the loan from a lender. Lenders tend to require an individual to be a Guarantor to the loan for them to accept the risk of lending to a trust. I recently went through this process myself and there was certainly a steep learning curve in the process where lenders require the Guarantor to get Financial Advice and Legal Advice certificates as part of the lending criteria so that the lender is comfortable the Guarantor is aware of their obligations on the loan. If possible, try to get the certificates waived by the lender to save cost and time.

Of course, its best to speak to a mortgage broker knowledgeable in lending for trusts for details.

 

[danwatto]

Thanks Terry & Paul

Have you ever seen a situation where the individual lends to the trust for less interest than they are paying, thus creating a negative gearing situation in the individual name? Or does this make it non commercial terms?

 

[Terry_w]

Thanks Terry & Paul

Have you ever seen a situation where the individual lends to the trust for less interest than they are paying, thus creating a negative gearing situation in the individual name? Or does this make it non commercial terms?

non commercial

 

[coastymike]

Private Binding Ruling 38919 makes it clear that the interest will not be deductible for funds on-lent interest free to a discretionary trust.

https://www.ato.gov.au/rba/content/?ffi=/misc/rba/content/38919.htm

 

[eggnog]

Thanks for the replies all. Looks like this and all my followup questions are best saved for a lawyer.

 

[danwatto]

One more question:

Say a couple have a discretionary trust, and the beneficiaries are not named beneficiaries but are "partner" i.e. girlfriend or wife or whatever.

They have all prior properties in single names, no joint properties, and require to borrow against these in single name for a long time in the future to buy more properties.

But to borrow jointly in the trust will compromise future equity draw borrowings from the properties held in single name because of joint and several liability etc.

To get around this, can the borrowings for purchases in the trust be done in single names?

i.e. for each purchase, can you choose which director of the trustee that you want to give the personal guarantee for the loan? Or does the lender force ALL directors to give personal guarantee?

If not - is it simple enough to just resign/appoint directors as needed for serviceability, and still keep loans only tied to a single not joint borrowers? I see this as one of the advantages of a trust.. having shared property but without the downside of joint & several liability stunting your growth, and being able to change who the servicer for future serviceability is without affecting ownership. Is this correct?

 

[eggnog]

Interesting point Dan. What happens then when you need to refinance the property held within the disc. trust to draw down on more equity or change banks?

 

[danwatto]

Interesting point Dan. What happens then when you need to refinance the property held within the disc. trust to draw down on more equity or change banks?

That part would be easy, the same director who signed on the original loan signs again.

I'm more concerned with drawing equity from the ones outside the trust once the trust gets big. I don't want joint assets/loans to be taken into account for single borrowing assessments, so want to only have one guarantor for each trust loan..

This is just an idea I have, have not setup a trust or received advice yet but maybe this will work or there is a better way. Wondering about the experts opinion and how others do it?

 

[Terry_w]

i.e. for each purchase, can you choose which director of the trustee that you want to give the personal guarantee for the loan? Or does the lender force ALL directors to give personal guarantee?

If not - is it simple enough to just resign/appoint directors as needed for serviceability, and still keep loans only tied to a single not joint borrowers? I see this as one of the advantages of a trust.. having shared property but without the downside of joint & several liability stunting your growth, and being able to change who the servicer for future serviceability is without affecting ownership. Is this correct?

Each commercial lender will want a personal guarantee from all directors of the trustee company. Some lenders will even want a guarantee from named beneficiaries of the trust.

Changing directors of a company with a mortgage would generally be a breach of the mortgage agreement with the lender unless their permission is obtained.

Why not set up a trust controlled by A and a trust controlled by B. Safer for asset protection if the trustee is sued - e.g. tenants.

 

[danwatto]

Thanks Terry, having two trusts is a good option. But I was hoping to be able to minimise the number of trusts due to cost.

At least we can still both be beneficiaries, just only one director per trust.