Charging interest to a trust

Hello Tax experts,

Say if a director and sole beneficiary of a discretionary trust (set up with ACN) takes out money from LOC or equity to loan the trustee (which is the company in this trust) with a loan agreement document in place to charge interest rate on this funds at what ever rate the bank is charging to the LOC or used equity. When the trust pays back interest money to the director, will this be treated as taxable income or just interest paid back by the trustee as part of the loan agreement to reimburse for the interest bill charged by the bank for the funds loan to the trust ?

Is having a loan agreement document drafted by a solicitor sufficient to have the above arrangement or will some other documents be required to set up ?

Many thanks

 

Yes, interest received on your loan is taxable income to the receiver and deductible expense to the payer (assuming used for investment purposes).

And yes, loan document by you or soli is fine.

 

Yes interest received is income. But interest paid to your bank may offset the interest received

Solicitor drafted agreements is all that is needed but you need to consider the terms of the agreement too.

 

Thanks Terry, so if interested received from the trust is income, will the director have to pay tax on this?

And whatever interest bill paid to the bank for equity or loc extract for funds used to lend to the trust is then tax deductible to the director?

 

Thanks DT!

So individuals can write the loan agreement up themselves without going through a solicitor ?

Can this still be done after settlement has completed?


The scenario is:
-Director borrows from loc or equity to lend the trust to buy a rental ip
-trust pays director interest at same rate charged by the bank

So if the trust pays back less than total interest bill the director incurred from bank as rental outgoing exceeds rent income then will the shortfall received by the director becomes tax deductible?

 

Worth all the money its printed on. I would never recommend such an agreement to any client.
Most lawyers would assist with reflecting the terms of a verbal agreement in formal terms after the event but the longer this is left the greater the concern.

Also importantly the accounting for the loan must be maintained and the loan physically paid on arms length terms too.

 

the recipient of the interest will have to add this income to their other income and they may have to pay tax on this.

Can you lend money after settlement? You can lend it anytime, but there are various consequences. If you had already lent the money the ATO may have some issues.

 

Hi Terry, So if trust repayment on loan interest charge is taxable then is the interest charge from loc/equity incurred by the director from the bank also tax deductible? This loan is used to lend the trust ,( passing on interest charge ) to buy an IP.

Most likely there will be shortfall in payment from the trust to the director if total outgoing exceeds rent income. If the director pays the bank more interest rate than what the trust pays him/her back then will this shortfall be tax deductible to the director?

 

The lender may be able to claim the interest if the money has been lent to the trust on arms length terms.

No.

 

What is lent on arms length terms? And how can this be set up?

 

Thank you Paul

 

You will need to get legal and tax advice. Something that binds the parties and will hold up in court as well as charging a market rate of interest. Need to consider rate, security, term etc.

Once set up the parties should transact according to the terms - interest payments made on time etc.

 

Many Thanks Terry !

 

If a trust borrows money from a Director (ie a back to back loan) then the Director may well have a assessable amount equal to the deductible. The trust incurs the deduction. Take care if the cost is greater or less than the actual bank interest as this could also give a tax benefit to someone and be considered a scheme.

Ideally the trust should pay the Directors loan and the agreement reflect that basis.

 

Also consider what could happen on the death of incapacity of the lender and/or director and/or appointor.

 

Hi Paul,

Yes the loan interest from the director to the trust should be at whatever interest rate the bank charges the director on the funds.

If the trust pays the Director's loan directly and its total income is not enough to cover all outgoing then wouldn't the director have to inject more funds into the trust to cover the shortfall ?

Can a trust actually incur a net income loss ? Wouldn't someone who has an interest in it, say a director will have to pay any shortfall as bills have to be paid ?

When this happens can these extra funds provided to the trust to cover bills be considered as loan top up from the director to the trust ?

Many thanks

 

Yes this is important too

 

The trust can suffer a loss, but bills need to be paid so the trustee may need to borrow more money to pay the shortfall.

 

Or in some cases the trust income for distribution purposes will be less than the available cash and the cash will be used to repay the loan. These issues reflect in a change to the value of the Directors loan account v's the bank loan.

The key concern is for a ungeared unit trust and unitholder loan accounts. Redemption or issue of new units may be needed to clear that account to ensure Reg 13.22C and D are compliant. You have no idea how many times I have seen a non-compliant Reg 13.22 C trust for this reason.

eg Unitholders draw the loan repayment as an advance on the expected final year end trust distribution. At year end the non-cash deductions like depn and CA mean taxable income is lower than interest lets say. So the unitholder has borrowed from the trust and owes the trust. Solution is unit redemption at market value to clear this. A very minor CGT issue usually occurs but doesnt change the % between unitholders.

It is essential the the accountant for trust strategies knows these strategies backwards or errors will arise.

 

Many thanks Paul!