Interest Deduction in a Family Trust

[NickM]

Ref: TD 2003/D4

There has been questions on this forum in relation to this matter which is why i have brought it to everyone's attention.

If a Family/Discretionary Trust has an investment property which is subsequently revalued upwards eg $100K then if the trust borrows that $100K can it claim the interest incurred if that money was then paid out of a revaluation reserve to a beneficiary.

In short - the ATO view in this draft ruling is NO.
There must be sufficient connection with the production of assessable income for the interest to be deductible.

Unrealised revaluations of assets are not considered to be in regarded as an income producing operation of the trust.

Bear in mind that this is a draft ruling and is the ATO's opinion only.

However I must say that this is a view that i have also taken in the past.

NickM

 

[geoffw]

Nick,

Not sure of the implications here.

If I read you, you're saying that Cap growth in the trust's IP cannot fund private expenditure (so could not be used to fund cashbonds for instance).

But presumably the cap growth could be used to but another property in the same trust?

Or even in another trust?

 

[NickM]

Geoff
Basically addresses the issue of private expenditure by a beneficiary of the trust

I dont see a problem in using the money to fund a property in the same trust as that is to be used in the income producing activities of the trust

Depending on the circumstances you may be able to lend it to a new trust but i wouldnt want to commit on that without knowing the facts

Nickm

 

[DaleGG]

Hi

Nick & I spoke about this off list and he has allowed me a moment of glory to post this . . .

Whilst that ruling does certainly say that the tax office will not allow interest as a tax deduction in the circumstances quoted. I have a couple of "alternative" thoughts:

It is a "draft" ruling and so is open to discussion and considerable change before being finalised.

It is only a ruling which means that the decision does not have the backing of the law, and so it may well be wrong;

The decision does allow opportunities for the interest to be claimed under paragraphs 3 & 5;

The ruling is at odds with the courts decisions in the Roberts & Smith court case of about 10 years ago to do with refinancing. Further, I believe that companies being able to borrow money to pay dividends to their shareholders and still claim a tax deduction.

May I suggest that each person consider their own circumstances and seek advice from their advisors. I do not think this a clear cut matter and personally believe that the tax office is clearly wrong at law.

Damn! More confusion. Just what you wanted in tax law . ..

Dale

 

[always_learning]

Originally posted by geoffw
Nick,

Not sure of the implications here.

If I read you, you're saying that Cap growth in the trust's IP cannot fund private expenditure (so could not be used to fund cashbonds for instance).

But presumably the cap growth could be used to but another property in the same trust?

Or even in another trust?

Couldn't the trust borrow money (eg from a LOC) for the purpose of purchasing an annunity (cashbond) for the trust, which pays the income into trust, and the income of this annunity is then distributed to the benificaries. Surely this would be on very stable legal ground?

 

[NickM]

Originally posted by always_learning
Couldn't the trust borrow money (eg from a LOC) for the purpose of purchasing an annunity (cashbond) for the trust, which pays the income into trust, and the income of this annunity is then distributed to the benificaries. Surely this would be on very stable legal ground?

I havent spoken to Steve about how his cashbonds operate, however based on what you state i see no problem.

The key is that there should be a nexus between the interest expense and the income.

In your example the loan is taken and then invested in a cash bond which in turns generates income. Thats fine.

NIckm

 

[Ultra]

Hi Dale

You write:
"The decision does allow opportunities for the interest to be claimed under paragraphs 3 & 5;"

Can you give example situations where interest could be claimed legitimately under these paragraphs?

Thanks
Pam

 

[strangep]

Hi all

Just a question I'd like to raise on Point 6. of TD 2003/D4.

I don't understand how they can make a distinction between beneficiaries of fixed trusts and beneficiaries of discretionary trusts who settle amounts to be used in the income producing activities of their respective trusts.

Surely, if, as a beneficiary of a discretionary trust, I give an amount to the trustee to be used in the income producing activities of the trust, eg. money to purchase a property to generate rental income, unless I state that this money is a gift I can ask that it be repaid, the same as the situation would be if it was a fixed trust being considered. Or is it automatically assumed that money settled on a discretionary trust is a gift??

In Point 6. they are indicating that this MAY be a situation where...

...the interest expense paid or payable in respect of the borrowed funds may have the requisite connection with the production of assessable income.

Any thoughts or am I looking at this the wrong way??

Thanks

Paul

 

[NickM]

Paul

the difference is that under a fixed trust you get a fixed entitlement to income. Like say a managed fund

if i borrow money and lend it to your discretionary trust i have no rights to income so i cannot claim a tax deduction on the interest

if i borrow money and purchase units in your unit trust i can claim the interest as i have a fixed entitlement.

take a step back and look at it as if it were an independant trustee.

does this help explain it ?

regards
NickM

 

[strangep]

Nick

Thanks for the reply but I'm not sure you answered the question I asked.

I understand that if I, as an individual beneficiary, borrow money and lend it to a fixed trust, then as I have a fixed entitlement to income from the trust, I can claim the interest as a deduction. I also appreciate that if I borrow and then lend money to my discretionary trust, as I'm not entitled to any income at all, I am therefore probably not able to claim interest on the borrowings as a deduction.

However, what I believe Point 6. of TD 2003/D4 deals with is the issue where a TRUSTEE borrows money at interest to pay back or refund a sum that has been LENT to the trust for the purpose of producing income for the trust.

I'm assuming that as a beneficiary of a trust who has LENT money to the trust and the trust has used that money to produce income, I am entitled to ask for that money to be repaid regardless of whether I have received any of that income or not.

If the sum that I've asked to be repaid (the sum of all monies that I have LENT to the trust over a period of time) is substantial, it is likely that the trust won't have the entire sum sitting in its account and so it will have to borrow money, probably from a bank, to finance the repayment.

What pt 6. says is that (with regard to fixed trusts)

"...in these types of cases, the interest expense paid or payable in respect of the borrowed funds may have the requisite connection with the production of assessable income...."

and therefore the interest may be deductable by the TRUSTEE against the TRUST'S income.

What I don't understand is why this wouldn't automatically apply to discretionary trusts as well??

Further to this, if the trust has to borrow money to repay a debt as in the situation I've described above, why couldn't it borrow the money against a revaluation of an asset??

Am I way off base here or is this a reasonable question??

Thanks

Paul

 

[Jackass]

Hi Paul.

It is my understanding that the interest would be deductable to the trust regardless of whether the trustee borrows the money to repay a beneficiary in a discretionary trust or a unit holder in a unit trust.

I think you will find the trustee using the revaluation of an asset as security for the loan is what normally happens in this case.

THE JACKASS.