Legal Tip 153: Using Personal Money to pay for Trust Expenses

Using Personal Money to pay for Trust Expenses



Lately I have seen a handful of people who are paying trust expenses out of their own money, usually for cash flow shortfalls of the trust owning property where the expenses exceed the income.



There are many legal and tax issues to consider in these situations.



Firstly you must remember you are not the trust and the trust is not you. In real life you don’t go around paying other people’s expenses do why do it with a trust. Most people think of the trust as ‘theirs’. This is wrong and has many issues



Blending of personal and trust assets. When you start paying trust expenses you are mixing trust and personal. This could be evidence that the trust is just your alter ego. Perhaps it is a sham or doesn’t exist.



Asset protection is weakened because it is unclear which are trust assets and which are personal. If you are paying all trust expenses is the trustee acting as trustee for you under a resulting or constructive trust?



Disputes over whether it is a loan or a gift often arise. If there is no documentation it could go either way – it could be a gift when you want it to be a loan and vice versa. Example you end up bankrupt – all the payments could be clawed back from the trust.



Keep in mind you only control the trust temporarily. Beneficiaries could apply to the courts to remove you, or you could lose mental capacity, become bankrupt, die etc



If all of the above doesn’t convince you, what about the tax savings might. Where you pay the expenses of a trust you suffer by diverting your cash holdings to another entity. If you have a non-deductible debt this means you are causing yourself to pay more interest on your home loan.



Example

X has a $200,000 home loan and pays around $10,000 per year in interest. He needs to earn about $20,000 to pay this amount.

X also operates a discretionary trust which owns property. It runs at a short fall, a loss, so X has been using his own money to pay for rates, insurances and other expense of the trust – about $6,000 per year.

This is actually costing X about $150 more in interest per year – which he cannot claim.

X decides to borrow and lend the trust the money – the trust doesn’t have the equity to borrow more from a bank.

X borrows $6,000 and onlends to the trust. The trust can now claim the interest on the loan and X has $6,000 more cash per year with which he can pay down his non-deductible debt.

The trust is now running at a higher loss, but that is a loss which can be carried forward to future tax years and that is when the trust will also benefit from tax savings.



Accountants and loans. Many say they will use their cash and leave it for the accountant to document. Accountants just records financials of the trust for the trustee. The trustee legally cannot delegate its decision whether it has borrowed money or not – but it can take advice. However even if a record is made that the money is a loan this does not legally make it a loan. A loan can only exist where there is a contract. Also just recording something as a loan does not show the terms of that loan – interest rate, if any, when it is due, interest only or PI etc.



Analogy

You and I go down to a book shop. You choose a pile of books. We go to the register, and I pay. Whose books are they? Mine or yours? What happens if I say I want my books back now. You might argue they are your books. What if I suddenly die? My wife comes to you and says she wants the books back to distribute via my will. You argue they are yours. She produces a credit card statement.

What if I say I want my money back now? You might say it was a gift.



With a trust situation like this people often say I don’t know what it was. I was just paying for things and will let my accountant sort it out.



Analogy continued.

Me and/or you have purchased the books. We get on the bus. A man says nice pile of books, whose are they? You say – you tell us whose they are! He asks whose books do you want them to be? You say mine, lets treat the payment as a loan. The man behind asks when do you have to pay the loan back? What are the terms of the loan? I say I want my money back in 2 days, you say I thought it was 2 years? I say the rate is 10%, you say I thought it was 5%.


I die (again). My wife, as executor, starts asking for the loan to be repaid including interest. She finds some notes that I have made and takes you to court to get the money back using the notes as evidence. You now have to sell some books to be able to repay me.

 

@Terry_w, another good post.

What about the case when one pay's a trust expense (say, paint at Bunnings), then one fills out an Expense Claim with the receipt and submits the Claim to the trust for payment. One is treated as a creditor of the trust until the Claim is paid.

Basically, the same process as when an employee incurs business expenses (eg a taxi fare, car parking, etc) on behalf of their employer, fills out an Expense Claim and gets the money refunded.

Does this approach have any merit? Does it overcome the issues detailed in your post?

 

I was going to put in something about reimbursements - but forgot.

Yes that is fine.

 

The beauty about reimbursements is the trust can decide when to pay its creditor. If the trust is a little short on cash, it can delay payment for a wee while until funds/rent is accumulated in its bank account.

Probably good practice to clear all such creditors by 30 June, if possible.

 

Its not good to leave it too long because of the issues above - a few days to a week.

 

Why does the reimbursement of expenses need to be paid promptly? What issues would it cause if it's delayed?

I think I read somewhere that if there are no documentation then it is taken automatically that a verbal contrac has been in place that it's a loan? Is this incorrect?

Where would "X" be able to borrow the $6k from if he's got no equity or borrowing capacity available to borrow from a bank that $6k?

 

The longer you leave it the more open it is to misinterpret. If you incurred expenses for employment how soon would you try to get reimbursed?

Yes this is wrong. It could be a gift. If I hand you $100 without any documentation you would think it is a gift.

If X cannot borrow then he cannot borrow from a bank etc. if the trustee cannot borrow then there may be issues too.
But X or the trustee may be able to use other strategies such as debt recycling, related party loans etc.

 

Would this time limit apply the same to an SMSF? Eg. you paid the accountant/auditor fee with personal fees then will reimburse yourself from the SMSF but forgot to do it until a year later.

Related party loans - Could your SMSF lend the trust directly the shortfall money in this case or is that a big no-no?

 

Not sure off the top of my head on SMSF rules for reimbursement.

A SMSF can't lend to a related party.

 

Hi Terry, is it the same for a company? Expenses should not be paid by a director or a shareholder? Thank you.

 

Even more important for a company. You would potentially be taxed more eventually when you get the capital returned.

 

Would it be treated as a sham as well like the trust?

 

not sure what you mean, but if you do the transactions yourself and pay for things while there is a company sitting in the corner doing nothing it would appear that you are the entity and not the company. The company may just hold legal title to assets as bare trustee for you.

as a real example I had a client who formed a company to do a business joint venture and then proceed as if the company wasn't there. there was a dispute so the other party to the joint venture sued him and his wife directly, and not the company.

 

Thank you Terry, That's what I wanted to ask.