Using a discretionary trust

[DanielB]

I have recently undertaken a restructuring exercise with my discretionary trust whereby the trust gained a new trust deed that I wanted tweaked a little after reading most of Kevin Munro's and Chris Batten's publicly available material. I also put in place a corporate trustee as the former trustees were self+spouse. I was unsure about hybrid trusts so I did not have the 'special units' clauses inserted inthe wording of the deed.
I am wanting to invest through the trust but, of course, any losses are locked in the trust until such times as these can be offset against income.

The trust deed allows the trust to borrow and also to guarantee the liabilities of the beneficiaries (all standard fare with discr. trusts).
Can anyone see a problem with:
1) me personally taking out a loan,
2) I then on-lend the funds to the trust for the purposes of purchasing an IP via a written contract between myself and the trust
3) the trust purchases the IP and provides the bank the security for the loan
4) the trust passing the profit of the IP to me after deducting the normal IP expenses (management fees, rates, insurance etc)
5) At the end of the year, I include the trust's income in my personal income tax and claim the bank interest deduction.

I am aware that this is very similar to the operation of a hybrid trust but why do units necessarily have to be issued?

I must be missing something!

cheers
Daniel

 

[DaleGG]

HI

Congrats on taking the step towards getting your financial house in order.

The courts decided some time ago that if you borrow money and then on lend it to the trust, you cannot claim the interest as a tax deduction simply because the trust is a discretionary trust. This means that you have no entitlement to the income.

So, I am sorry to say you cannot do what you were thinking of.

Dale

Originally posted by DanielB

The trust deed allows the trust to borrow and also to guarantee the liabilities of the beneficiaries (all standard fare with discr. trusts).
Can anyone see a problem with:
1) me personally taking out a loan,
2) I then on-lend the funds to the trust for the purposes of purchasing an IP via a written contract between myself and the trust
3) the trust purchases the IP and provides the bank the security for the loan
4) the trust passing the profit of the IP to me after deducting the normal IP expenses (management fees, rates, insurance etc)
5) At the end of the year, I include the trust's income in my personal income tax and claim the bank interest deduction.

I am aware that this is very similar to the operation of a hybrid trust but why do units necessarily have to be issued?

I must be missing something!

cheers
Daniel

 

[always_learning]

Lets say the trust borrows 100K from you. And the trust needs to pay you back the capital plus reasonable interest? ie. 100K at 6% interest, the trust returns $106K after 12 months.

Is it really the position of the tax office that says that I personally have to pay tax on the $6K profit? But I am unable to offset this $6K profit against my personal costs to obtaining those funds eg from a 100K LOC secured against my PPOR? (eg. at 5.9% interest). ie. my personal profit is in fact only (6.0-5.9) .1% of 100K or $100, not $6000.

Confused

 

[DaleGG]

Hi AL

If the trust and you enter into an agreement where the trust agrees to pay interest on the loan at commercial rates, then, the interest paid by the trust will be tax deductible.

However, that interest will also be income to you which you can use to offset against the interest that you pay. If you pay the bank 8% and receive 6% from the trust then the tax office will not agree to the deal, so, you need to be careful.

Even then, the tax office could argue . . .

It is still better for the trust to borrow the money, or, for you to use a hybrid trust.

Dale

Originally posted by always_learning
Lets say the trust borrows 100K from you. And the trust needs to pay you back the capital plus reasonable interest? ie. 100K at 6% interest, the trust returns $106K after 12 months.

Is it really the position of the tax office that says that I personally have to pay tax on the $6K profit? But I am unable to offset this $6K profit against my personal costs to obtaining those funds eg from a 100K LOC secured against my PPOR? (eg. at 5.9% interest). ie. my personal profit is in fact only (6.0-5.9) .1% of 100K or $100, not $6000.

Confused

 

[DanielB]

Dale,
Thanks for your reply. OK, I now have the choice to either stick with the existing discretionary trust and have the trust borrow the funds (will need to analyse the cashflows of prospective IPs carefully in order to ensure that I don't carry forward too much of a loss). Or change the trust (again!) to a hybrid trust.

Hmmmmm....

thanx again,
Daniel

 

[always_learning]

Lets say the trust borrows 100K from you. And the trust needs to pay you back the capital plus reasonable interest? ie. 100K at 6% interest, the trust returns $106K after 12 months.

Is it really the position of the tax office that says that I personally have to pay tax on the $6K profit? But I am unable to offset this $6K profit against my personal costs to obtaining those funds eg from a 100K LOC secured against my PPOR? (eg. at 5.9% interest). ie. my personal profit is in fact only (6.0-5.9) .1% of 100K or $100, not $6000.

Confused

 

[Terry_w]

Lets say the trust borrows 100K from you. And the trust needs to pay you back the capital plus reasonable interest? ie. 100K at 6% interest, the trust returns $106K after 12 months.

Is it really the position of the tax office that says that I personally have to pay tax on the $6K profit? But I am unable to offset this $6K profit against my personal costs to obtaining those funds eg from a 100K LOC secured against my PPOR? (eg. at 5.9% interest). ie. my personal profit is in fact only (6.0-5.9) .1% of 100K or $100, not $6000.

Confused

Yes, you have made $6000 in interest income.

If you borrowed from a LOC and lent this to the trust you could claim the interest incurred if you are lending at the same or higher rate (depending on the circumstances).