Incorporating a Trust into a Strategy Recycling Debt

Not difference with the trust other than added flexibility

 

Yes that should of been 'cannot', if there is no net income the trust cannot pass franking credits.

 

Specific tax advice requires personal advice. It would be unwise to guess

 

Why would you loan the amount you want to debt recycle to the trust instead of just "gifting" the same amount to the trust?

Loaning would lose the asset protection provided by the trust set up.

If Lisa/Millhouse for some reason become bankrupt then the 100k loaned to the trust would be taken by the bankruptcy trustee. Whereas if you had gifted the 100k (provided you follow the claw back rules) then the 100k would be protected.

 

This thread is about debt recycling. If you gifted borrowed money to the trust the interest on the loan would not be deductible. If you gift cash to the trust you lose out on saving interest and reducing non-deductible debt. You would need to consider what you valued most, saved tax or asset protection.

 

Oh ok, I assumed you could gift it to the trust and still deduct the interest paid on the amount. I guess that was wrong, you have to loan it for it to be deducitble.

 

Hey Terry
Would the trust have to repay its loans when it sells the assets and gets a CG?

And then that loan split would be paid with nothing owing (loan closed?) But the CG part is then used to repay OO debt which is further recycled.

Have I got that right?

 

If an asset is sold and the loan is not secured by the asset then the loan could potentially be kept open, but the interest would not longer be deductible.
The trust would need to distribute the income to beneficiaries too so it would probably need to repay the loan in most cases. But this is part of the debt recycling strategy as that income could be used to reduce non-deductible debt and then reborrow for further investing.

 

Trying to understand the best way to lend money to a trust in this situation:
PPOR in my wife's name
Loans are currently in both names
I am the trustee of our trust

Can we create a loan split on the PPOR (loan would be in both names) but my wife enters into a commercial loan with the trustee (me) to buy shares in the trust?

Does the fact that my name is on the bank loan exclude my wife from lending me the money as the trustee?

 

Nope

 

No. However, the onlend from your wife to you in your capacity as trustee needs to be supported by a "loan agreement". A undocumneted loan would not likely satisfy the ATO. Also consider settlement of the borrowed funds and ensuring that this shows the use of the borrowed funds to produce income. Example of a concern could be the trust buys $30K of new shares on 3 June. On 4th June wife transfers $30K to trust. Trustee hasnt used borrowed funds to buy shares. This fails.

 

Hello

To expand on this point, is there any way to combine debt recyling with a trust and asset protection? I can’t think of a way, as ultimately the borrowing by the individual will always be an “asset” when lent to the trust, so if sued, then could claim against that asset and the result being the equity attributable to the loan.

Is the only way to potentially facilitate it be have Trust A lend cash to repay PPOR loan, and then have then if couple, have the “less risky” person (say wife) lend to Trust B for debt recycling?

That way you would have asset protection on the “risky” person (say husband who could get sued).

Not sure if that makes sense

 

Yes there are various ways to improve asset protection with this strategy

 

Hi Terry,

Apologies if this is a silly question however - what is meant by “the terms were not commercial”?

I am looking at implementing a DR strategy with a discretionary trust and corporate trustee (in the process of setting up now).

From what understand, the ATO could view this as a way to increase tax deductions and therefore Part IVA may apply.

Could it be argued that the dominant purpose is to increase cashflow to purchase another IP/build the portfolio? ie:
- by redrawing from the PPOR loan and lending to the corporate trustee the interest rate will be less for that portion of the loan compared to a commercial loan, therefore increasing cash flow
- lending to the corporate trustee to purchase (instead of purchasing as individual) improves asset protection
- redrawing the full purchase price saves time and costs that would required to apply for and set up a commercial loan

The dominant purpose could be either for future investing and/or asset protection, rather than to obtain a tax benefit (the fact that the interest is now deductible is a nice bonus however). Is this understanding correct? I appreciate there won’t be a clear yes/no answer as to whether Part IVA would apply or not but just trying to get my head around the ruling.

I hope this example and explanation makes sense, and apologies if I have used incorrect terms. More than happy to be corrected.

Thanks so much

 

I had one client who entered into a loan agreement with a related company with the interest rate listed as 'as agreed between the parties from time to time'. The ATO considered this, and other terms of the agreement, as not arms length - 2 strangers wouldn't agree to such terms.

 

Thanks for the reply Terry - that makes sense about the loan agreement.

Also I think I had over complicated things thinking about whether Part IVA applied. I asked an accountant today who explained it relating to my situation

 

There is nothing wrong with using different entities to hold assets - but there could be Part IVA issues if doing things artificially to divert income, such as gifting money and borrowing it back at high interest rates and claiming the itnerest etc.

 

Hi all

I'm having trouble understanding how it would be more beneficial to debt recycle in a trust rather than with an individual.

With an individual, the interest paid gets reduced by the individual's marginal tax rate i.e. if interest expense is $5k and the person is on 37% tax bracket then interest expense goes down to $3,650.

However in a trust, the whole interest expense gets ($5k) deducted from the profits. Hence there will be less profits to distribute. Am I missing anything?

 

Yes.

It is not about the deduction it is about the income and other aspects such as estate planning and flexibility.

The shares would be positively geared so there is no tax difference if the income is distributed to the person who would have otherwise held the shares. But if the income is distributed to someone on a lower tax rate then there would be tax savings.

If the shares would be negative cash flow there are a lot of issues to consider though.

 

Thanks Terry would this mean that we should be investing on dividend ETFs to ensure that it will be positively geared?

What can be done to make sure that it stays positive geared? sometimes dividend distributions / interest rates can be out of our control.