Loans to discretionary trusts

[JIT]

Hi there,
If I loan funds to my discretionary trust, and the trust uses this money to invest in shares for instance, I understand that the trust has to pay me interest on this loan at market rates.
But does this payment of interest on the loan have to actually physically happen from the trust's bank account to my personal bank account every month?
Or is this just an accounting entry at the end of the financial year?
Also, if it works out that the trust makes a loss in one financial year (ie. dividends are less than interest costs), can this loss be offset against income (ie. dividends) and realised capital gains of the trust in subsequent financial years?
Thanks.

 

[Terry_w]

Hi there,
If I loan funds to my discretionary trust, and the trust uses this money to invest in shares for instance, I understand that the trust has to pay me interest on this loan at market rates.
But does this payment of interest on the loan have to actually physically happen from the trust's bank account to my personal bank account every month?
Or is this just an accounting entry at the end of the financial year?
Also, if it works out that the trust makes a loss in one financial year (ie. dividends are less than interest costs), can this loss be offset against income (ie. dividends) and realised capital gains of the trust in subsequent financial years?
Thanks.

You can loan money at what ever rate you want. But there could be important asset protection and tax issues.

Either way you should have a written loan agreement. Interest should be paid as per the loan agreement. Treat the trust as a third party.

Failure to do things properly will dramatically decrease asset protection and could create a big administrative mess. Imagine you died at some stage - whoever takes over the trustee position would need to go through the trust accounts and possibly chase interest from your estate. (make sure you know what happens to the control of the trust on your death - most people don't)

 

[eggnog]

Couldn't you just gift it to the trust. This way there is no financial link back to you that creditors can target and no obligation for the trust to pay back the capital or interest for the capital

 

[JIT]

Also the funds I am lending are coming out my personal LOC, so it incurrs interest for me.

 

[JIT]

You can loan money at what ever rate you want. But there could be important asset protection and tax issues.

Either way you should have a written loan agreement. Interest should be paid as per the loan agreement. Treat the trust as a third party.

Failure to do things properly will dramatically decrease asset protection and could create a big administrative mess. Imagine you died at some stage - whoever takes over the trustee position would need to go through the trust accounts and possibly chase interest from your estate. (make sure you know what happens to the control of the trust on your death - most people don't)

Thanks Terry, I have a loan agreement written by my solicitor.
From a practical point of view how does it work though - trust pays interest owing to me from it's bank account each month or at the end of the financial year, or is this just an accounting entry and there is no actual movement of funds between accounts?

 

[coastymike]

What does the loan agreement say ?

 

[Terry_w]

Thanks Terry, I have a loan agreement written by my solicitor.
From a practical point of view how does it work though - trust pays interest owing to me from it's bank account each month or at the end of the financial year, or is this just an accounting entry and there is no actual movement of funds between accounts?

There should be actual movement of funds - otherwise it is a sham.

And as Coasty says when you pay will depend on what was agreed to by the parties.

 

[Terry_w]

Couldn't you just gift it to the trust. This way there is no financial link back to you that creditors can target and no obligation for the trust to pay back the capital or interest for the capital

There is still financial links and creditors can still target these funds if the giftor goes down. See s 120, 121 Bankruptcy act.

 

[Paul@PFI]

Interest

On the issue of interest rate and loans I'm not sure I agree with Terry_w for tax reasons. I'm not suggesting doesnt work but some fail....

If you incur interest (from LOC) and "onloan" funds to the trust under an agreement there are no issues as long as its on arms length terms. Thus the interest rate should also be arms length. Back to back may be sensible and prudent. But thats only a tiny part of the issue. It needs more thought than just the loan.... If a tax benefit occurs or benefits others ATO could deny the interest deduction under Part IVA anti-avoidance rules.

I have seen instances where "dad" has loaned $$$ to trust. The trust makes a profit from investments and after interest it makes a distribution to "mum" who has a low tax rate. Dad receives no distribution. Mum gets all the income (at her lower marginal tax rate). Property used as loan security is in joint names. So is the loan. But the onlending is in Dads name only. Dad has undertaken a scheme to shift income to mum....Probably without even thinking it through that way.

ATO raised this issue in their Hybrid DT rulings and its a recurrent theme. "Benefits other people" is their arguement. Then use Part IVA and you have to fight it. They will argue isnt a scheme to split income. Of course if its millions the benefit magnifies doesnt it ?? So what is the limit where ATO arent worried?? Truth be told. I have no idea and neither do they. So all the accountants are saying ..."But Paul the Part IVA is easy to address since the "predominant purpose wasnt a tax benefit"...Sure valid point. Good luck with the delays and cost of fighting it is my experience. ATO allow you to worry about that fight...Object, appeal, lose maybe?

So can the trustee borrow from a bank you say ?? Possibly NOT. Name a bank the does unsecured loans?? A secured loan ok then... Loan on the shares is a margin facility. That works as the security = trust property. But the loan you didnt wanst like that so that argrument is lost.

I know you are all saying what I have long argued...Mum & Dad do this with IPs all the time. Loan to mum & dad is joint but tenants in common 99/1% ...Agree, and the ATO are also reviewing this as a potential problem concern too.

To avoid this tax benefit arguement I advocate back to back loans that never provide a tax benefit / issue for the lender. Also if a sizeable $$ is being loaned a Private Ruling is prudent.

 

[Paul@PFI]

Trust Loans / Capital

That is a valid point...However it comes with a tax concern.

So family put some $$ into the trust and it increase trust capital or "corpus". Several years later trust makes payment to clear a beneficiary loan account. Worse still trust lends it to someone etc. ATO will call it trust corpus. They will claim its income of the beneficiary. Yep. Taxable. But as trust resolutions didnt address that payment its assessable at top rate to trustee.

You better have awesome trust resolutions and records that clearly identify this arrangement. Problem is few accountant do. They use a "loan account" like a kitchen waste bin and pile stuff debit and credit into the account/s. They teach their clients that is all on "loan accounts". ATO look at the net ins and outs and consider there is:
- No agreements in writing
- No security perhaps
- No interest
- Infrequent paymnets so its not in charecter of loans
- Too hard. They call it all unexplained deposits = income and as the trust resolutions dont address the s95 ncome then its assessable to trustee.

So do "gifts work"....No. They require very diligent documnets and I argue retain proof of where $$ were paid/received from too. The gift arguement might fail if it comes from a business and you call it a gift from MR Jones for example. Aasset protection ??? Its getting harder with Family Court and Bankruptcy trustees increasingly given better ower to look back and look through. With time sure they are often OK. A gift prior to seperation won't work. Terry_w is sort of guy for that advice.

Is your accountant a trust "specialist"???
- Trust resolutions should not refer to grossed up amounts such as franking credits.
- Trust resolutions should explains all movements on loans !!!!
- Unpaid present entitlements ?? What was the advice?

Couldn't you just gift it to the trust. This way there is no financial link back to you that creditors can target and no obligation for the trust to pay back the capital or interest for the capital

 

[Terry_w]

I have seen instances where "dad" has loaned $$$ to trust. The trust makes a profit from investments and after interest it makes a distribution to "mum" who has a low tax rate. Dad receives no distribution. Mum gets all the income (at her lower marginal tax rate). Property used as loan security is in joint names. So is the loan. But the onlending is in Dads name only. Dad has undertaken a scheme to shift income to mum....Probably without even thinking it through that way.

Paul, you make a very good point here!

 

[JIT]

Thanks for the replies. I've checked the loan agreement and sorted this out.

If you incur interest (from LOC) and "onloan" funds to the trust under an agreement there are no issues as long as its on arms length terms. Thus the interest rate should also be arms length. Back to back may be sensible and prudent.

Thanks, this is what I am doing, no net tax benefit to me.