Incorporating a Trust into a Strategy Recycling Debt

Discussion in 'Accounting & Tax' started by Terry_w, 4th Sep, 2017.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Incorporating a Trust into a Strategy Recycling Debt

    It is possible to incorporate a discretionary trust in a strategy of recycling debt. This can even speed up the process by saving tax.

    How
    The individual would pay down the non-deductible loan, split it, and then reborrow and lend the money to the trustee. The terms of the loan would allow for the charging of interest at an amount of at least the same rate the individual is paying their bank. The trust would then invest the money, pay the interest on the loan, and any profits would come back to one of the beneficiaries as income.

    The beneficiaries could then use this money to pay down the non-deductible debt further. The enables further money to be lent to the trust.

    Example
    Lisa and Millhouse have a main residence debt of $800,000 with $200,000 in their offset account.
    They set up a discretionary trust to invest.
    They then split their main residence loan into 2 portions
    a) $700,000 with offset attached
    b) $100,000 with no offset
    They then take $100,000 from the offset and pay down the $100,000 loan to nil – making sure they loan will not be closed.

    Then then redraw this, which is new borrowings, and lent it to the trust. They charge the trust 5% interest or $5,000 per year. Lisa and Millhouse declare this as income but they can deduct the interest they pay their bank, so their tax position is nil.
    The trust is able to claim this interest as an expense as it uses the borrowed money to invest in income producing assets.
    Let’s say the trust makes a 7% return on its investment. This would mean it makes $2,000 profit. This profit would then be distributed to the beneficiaries of the trust – Millhouse is a stay at home dad, not earning any income, so he pays no tax on this, but uses it to deposit into the offset account on the $700,000.

    After a short while Lisa’s wage has held them build up the offset to $200,000 again and they do the same thing. Split the loan by $100,000 and borrow to lend to the trust again.

    They don’t use the full $200,000 as they want to maintain a good cash buffer in case they need it for emergencies or unexpected expenses.

    Periodically the trustee of the trust sells its investments and distributes the capital gains – to Millhouse again. Millhouse uses this to pay down the non-deductible debt further and then splits, borrows and lends to the trust again.

    Pretty soon their whole non-deductible loan is fully paid off, but they still have a debt of $800,000 – but now the whole of the debt is deductible to the trust. They can then decide whether to start paying down this debt themselves, of causing the trust to start paying down its debt to them and they then pay off the bank.

    Please don’t try this at home without legal advice – including tax law advice as there are many issues to consider.
     
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  2. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Part IVA antiavoidance would be a specific concern. Especially if the trust doesnt exist and have existing arrangements. A strategy of debt recycling may well be a Part IVA concern for the non trust taxpayers
     
  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Not a worry if set up properly. That is why advice is needed.
     
  4. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Not a worry?
    When will you post the ruling ? Until then its a possible scheme.
     
  5. Hamish Blair

    Hamish Blair Well-Known Member

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    If times have been good for our dear couple, and they could borrow more than the $800k their current mortgage is, could they set up a separate loan secured against their PPOR and on-lend this to the trust in the same way? Trust pays them interest but its a wash against the additional interest?

    Technically not a recycle but perhaps could be coupled with the above strategy?
     
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  6. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Specific advice is needed. Its always a possible scheme.
     
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  7. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    And I definitely agree that those even contemplating it really need tax AND legal advice. Invariably a loan agreement (etc) as a minimum is needed along with advice....
     
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  8. NewGuyACT

    NewGuyACT Active Member

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    Hi Terry,

    I have had financial advice suggesting a similar approach - legal and accounting appointments to come. But before I meet with them I am interested in a couple of questions that you might be able to answer.

    The specifics of how the equity release was 'lent' to the trust wasn't covered with the financial adviser (I'll reach out to confirm). However, how does that play out in reality? I'm concerned that if I release the equity into an offset account against my PPOR, even for a day or so before transferring it to the trust that it might become mixed purpose. Does the equity release get deposited directly into the trust? And therefore the trust needs to exist first - then release the funds? Does it really need to be formally lent? Wouldn't the fact the loan was for business purposes and the income from the trust just equal each other out... ?

    Thanks!
     
  9. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    See my tax tip 1

    Need a written loan agreement with the trusty too
     
  10. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Trustee
     
  11. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Does it need to be formal. Hell yeah. Its a legal issue.
    If the trustee is you there may be issues as you cant lend to yourself.
     
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  12. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    And I had the ATO deny a deduction for deduction for interest even with a written loan agreement where the terms were not commercial. The loan agreement was from an online document service by a law firm. We had to get them into a new loan agreement which was then accepted
     
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  13. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Yeah some online things are rubbish and just encourage bad outcomes

    I encountered case recently taxpayer has lent $$$ to spouse (not to them jointly) who is also co-owner of the same property at a rate that was so non-commercial. Loan agreement was a online doc provider...But copied and with a SAMPLE watermark across it with whiteouts. I asked for evidence of actual loan payments - Ummmm not really its all sortof mixed up among how we pay the bills and move money around etc. Current loan balance ? - Of course it was IO. Evidence the $$$ was advanced and what it was for....For management fees paid to spouse to manage the property which is also agent managed - $25K a year for the property.

    Yeah. No.
     
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  14. NewGuyACT

    NewGuyACT Active Member

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    Thanks Terry & Paul,

    I have a meeting with a solicitor in a couple of weeks, but what I'm picking up is:

    - Try and get the split loan dispersed directly to the trust and not detour via any other account. Failing that, ensure it has a redraw facility, put it straight back in and then wait until the trust is ready.
    - I need a loan agreement with commercial terms between the lender (me and my wife) and the trustee. I only want these terms to be same as my bank loan so I end up in a net neutral position. I don't know what would be an issue here?

    - Paul, what do you mean if I'm the trustee as well? I was planning on being the trustee. I understand lending to yourself isn't allowed, so how is this viable since I imagine almost everyone doing this would be in my situation? Until writing this response I actually thought I was lending to the trust itself, not the trustee...
     
  15. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    You cannot contract with yourself. The trust is not an entity, it cannot contract. The trustee would borrow
     
  16. Big A

    Big A Well-Known Member

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    Hey @NewGuyACT ,
    I am not an expert in this field by any means and have used @Terry_w myself for professional advice on my own trusts. But myself I have a corporate trustee rather than myself as an individual. That way you can lend money from yourself to the trustee being a company. You can be a director of that company. Having a corporate trustee has a number of benefits.
    Well worth having an expert guide you on setting this up correctly as I have experienced first hand the pain of not having it done right the first time.
     
  17. NewGuyACT

    NewGuyACT Active Member

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    Ok... so in the scenario presented in the original post, Lisa and Millhouse set up a discretionary trust to invest and are both beneficiaries - but neither can be the trustee? Who would they actually use in this scenario?

    Hey Big Al, thanks! That's great info. I do have a meeting with the solicitor in a couple of weeks and fingers crossed he's all over this. Just doing research in advance so I'm a bit more knowledgeable.
     
  18. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    They may or may not be the trustee. It depends on the circumstances. You cannot enter a contract with yourself, but someone else can. Actually, you can enter a contract with yourself, but it would fail at law. It might be held up in equity. It at least shows which capacity you did things
     
  19. PandS

    PandS Well-Known Member

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    Instead going via you, can the trust borrow directly from the bank? and you guarantee the loan?

    I have a corporate trustee trust no debt, all in shares in the stock market that generates a lot of dividend and capital gain.

    I was thinking of taking on some extra debt and invest in the trust, the dividend will more than enough to covered any interest expenses.
     
  20. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    A trust is not an entity so cannot borrow from a bank or anyone. It is the trustee that must borrow.
     

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