Legal Tip 188: How to Fund a New Discretionary Trust

Who does trust A make presently entitled to the income?
Who does trust B make presently entitled to the income?

 

Hi Terry
Is that predetermined in the deed of Trust A and/or trust B? Or is that determination made in the distribution minute before the trust funds are distributed?

If that can be written into the distribution minute the i can ensure the Trust B is deemed presently entitled for the distribution from Trust A.

And in the distribution of the funds from Trust B i will establish that the beneficiaries are presently entitled?

The concepts of Trust and distributions are all new to me, so please excuse my ignorance / stupidity if i have got my understanding of 'presently entitled' mixed up.

 

The trustee will generally determine who is presently entitled to the income.

If Trust B is presently entitled to the income of Trust A it will need to make someone presently entitled to that income or it would be taxed at the top tax rate.

 

Okay- that is awesome. And i understand. If those conditions are sarisfied...

My question then is whether the distribution from Trust A could be made to a personal account, and that money moved into the account of Trust B- without the personal bank account holder (used to facilitate the movement from Trust A to Trust B) having to pay tax, because the initial payment was made into the personal account.

The distribution would ultimately be made to Trust B and the tax on the amount all paid, based on the distribution to the beneficiaries of Trust B paying the tax..

The only other consideration is that the personal bank account holder would also be a beneficiary to Trust A, as reflected in the deed of Trust A i.e. child of the primary beneficiary.

 

Yes that is possible but a lot of legal issues to consider and probably should be avoided.

 

Okay. I will take your advice for sure. For the sake of a couple of days, to receive the distribution earlier, i will wait until the bank account for Trust B is set up and ready to receive the distribution from Trust A.

I have one last question

From a taxation perspective, for a beneficiary of a trust, is it better to receive a tax free loan from the trust or a distribution?

The distribution would be taxed, but would income from an interest free loan? And if my rationale is correct what would the maximum repayment period for a loan?

Thank you for taking the time out to reply to me.

 

There is no tax on a loan but tax on income.

But where will the trust get the money to lend?

 

The trust (family trust) will receive a distribution in FY22. From that distribution it will loan a sum to one of the beneficiaries, where that beneficuary is also a director of the trustee company.
That loan will be tax free with a repayment period of 25 years.

So i guess the question is whether that process and action is valid/legal?

Are beneficiaries treated the same as shareholders or associates receiving a loan from an private entity (in terms of incurring a Div7A assesement)?

Or would the beneficiary be treated/viewed as an interposed entity, given that the director (and shareholder of the trustee company) is also a beneficiary?

And if the loans terms were based on a 4.52% interest rate, over a 25 year term (secured by a property) would that be better off as made by the trustee company to the director/shareholder?

And what documentation is required to evidence the terms, validate that mortgage is secured? Could it just ve a written notification appended to the deed? Would it have to be witnessed by a justice of the peace?

Thanks again Terry.

 

If the trust receives income from another trust it will need to make a beneficiary presently entitled to the income. This would likely eat up all the cash so will it have any cash left over to lend?

As to whether division 7A can apply to trusts - it can in some instances.

Tax Tip 181: Borrowing Money from Related Trusts and Deemed Dividends Tax Tip 181: Borrowing Money from Related Trusts and Deemed Dividends

 

Trust deed may limit distribution to Trust B ? eg Rule of perpetuities...breach of trust ? Is Trust B a pemitted beneficiary of Trust A (based on a Family trust election)
Are losses being utlised in trust B (if not, why bother)... Trust loss rules ? Why cant A + B each distribute ?
The fact Trust A has no bank account is a concern.

 

That loan will be tax free with a repayment period of 25 years ? There may be a scheme arrangement here as this does NOT look arms length. Other taxing provisions govern others who benefit from trust income eg s100A. This is a aspect of tax law that could treat the beneficiary borrower (who isnt a beneficiary) as...a beneficiary. The term "benefit" is not just distribution of income. S100A is presently subject to the Commissioner making broader rulings on what can be excluded. s100A concerns "reimbursement arrangements" that can be classified as a trust distribution. And the ATO are always happy to tax both s100A and actual distributions to others.

 

Hi Terry

if money was moved to a trust bank account without any documentation at the time of transfer to identify if a loan or gift, could the say a deed of gift be made up and backdated for the date of transfer? Or would it need to be dated the day of signing and the specific amount used to to identify which transfer it's referring to?

 

it would be fraud to back date a deed. You would need a deed on todays date to say that the transfer made x years ago was a gift.

 

Hi Terry,

1. For small regular "gifts" to the family trust, is it acceptable to just put in the internet banking reference as "gift for no consideration"? I don't know how difficut a deed of gift is to make each time..But a deed of gift for every fortnight/monthly to buy ETFs is going to end up with hundreds of deeds over years.

2. Is it ok to just BPAY (from personal bank) directly to the trust selfwealth account? Saves a step of transferring funds from my bank to the trust bank account and then bpay to the trust investment platform for ETFs.

 

You can do anything like these but the question you should be asking are what are the potential implications. A deed shows more evidence of intention.
2 increases the risk of a resulting trust being argued.

 

I'm guessing putting "gift" in the internet banking reference is better than nothing right? Do you think it's possible to do a deed of gift/stat dec once a year that includes all the gifts for the year?

 

its all possible but doing a deed after the fact doesn't show your state of mind at the time of the gift.

best to seek your own legal advice.

 

Would you say something like this is sufficient for a deed of gift? It's for UNSW but obviously would be adapted for the trust.

 

What happens if the loaned money has capital growth? For example, you loan $1m to the trustee. The trustee invests it all in shares. At death those shares are worth $2m.

1. Would the trustee then need to sell $1m of shares to pay back the loan to the estate?

2. I suppose this sale is a CGT event. Who pays the CGT - the beneficiaries of the discretionary trust, even though they don't get any of the capital gains?

3. In the end are we left with $1m of cash in the estate (that can pass into a testamentary trust) and $1m of shares in the discretionary trust?

4. What happens if the trustee doesn't have enough assets to repay the loan in full? I guess it is just partially repaid and the discretionary trust ends up with nothing?

5. Can the loan continue after death (not be repaid), and be held as an asset of the estate then pass into a testamentary trust? And then the trustee of the discretionary trust can choose when to repay it (e.g. when the discretionary trust gets income), and the repaid amount will become income for the testamentary trust?

6. If the goal is to get as much of the trust fund into your estate as possible, I believe you could gift to the trustee, and then at your death have the trust vest, transferring all assets to your estate. Any disadvantages of this compared to lending to the trustee?

 

1. That is up to the trustee really. They might borrow elsewhere, have capital of the trust they can draw on, or enter into a continuing loan agreement with the estate and beneficiary.

2. Trusts would generally make someone presently entitled to the income and that person would pay the tax. The trustee might also no do this and the trust pay the tax. If a beneficiary is presently entitled to the income they should receive it.

3. in that example yes.

4. If there is not enough to pay its debts the trust might be insolvent and the trustee personally liable potentially, the estate might have a capital loss.

5. Yes. a loan is a 'chose in action' - an asset.

6. Anti-avoidence provisions of Part IVA and s102AG. What would be the purpose of a trust suddenly vesting and paying a dead person be?