Strategy for Disc Trust to repay loan back to beneficiary

I would like to get some information on what is the correct way for Discretionary Trust to repay loan back to the beneficiary.

One way is Trust can borrow money and use it to repay loan. But what if the Trust is profitable and doesn't want to borrow. Trust usually distributes all income it earns after paying expenses to it's beneficiaries so there is no income left to repay existing debts.

Can the Trust use income earned to pay debts instead of distributing to beneficiaries? How does tax be paid on such income used to repay debt?

Hoping @Terry_w might be able to point me to one of his existing posts where he has already covered this topic.

Cheers,
Oracle.

 

Interest is an expense incurred by the trust and loan is it's debt. Both can be paid by the trust from income before distributions are made.

What are the terms of the loan? P&i or IO?

 

Thanks

Currently, Interest Only. Does that mean the trust can at the discretion of the trustee's decide not to distribute any income and use excess income to repay existing debt.

Cheers,
Oracle.

 

Ain't no expert by any means but are you referring to a Beneficiary Loan Account?

The one I'm presently involved in, but not for long, doesn't physically distribute the funds to each beneficiary but accrues within the fund as a liability. The beneficiaries are advised of any distribution (interest, dividends, franking, etc) to include in their personal tax return. Once advised it's available to them from the BLA on request at any stage.

Can get tricky managing cash/liability.

Probably the beneficiary could actually draw the funds and then lend back to the Trust (commercial terms?)

May also hinge on what the Trust Deed allows.

 

No

I am a beneficiary and have lent money to Trust on commercial terms with proper loan agreement drafted by lawyer. Trust pays interest at the end of each month which is income to me.

Cheers,
Oracle.

 

Ha, I see. Different scenario then.

 

Confusing cash flow and profit?

Trust profit becomes a present entitlement to the beneficiaries weather it is paid in cash or not.
So yes, you can use the money to repay Debt (balance sheet movement) and the net income is still taxable in the usual manner (though it’s not paid).

My understanding anyway. But I’m not an accountant.

Blacky

 

How is that possible. Let's say the trust has made $100 profit it can use that money to either pay off debt or pay beneficiary. I don't think it can do both as in pay off $100 debt and distribute $100 profit.

Cheers,
Oracle.

 

Think about it

if you borrow money from me and use income to pay it back will you be taxed on the income?

You might also have a home loan - do you pay it back with pre or post tax income?

 

And that’s the confusion. Trust is distributing all income and it’s the beneficiaries who pay their marginal tax rate on that income. So the trust has no post tax income to repay debt.

What am I missing?

Cheers
Oracle

 

The trust will have some asset which it used the borrowed money to buy. If this asset increases in value it might be able to borrow against it to repay the loan or sell the asset and pay the money back.

Say you lend me $1mil and I buy shares and i give you all the dividends - how would i give you $1mil back?

 

If Trust make a capital gain shouldn’t the trust be passing the CG to its beneficiaries who then pay tax on it?

My question is how does trust get post tax dollars to repay debt without selling any assets. Example would really help clear the confusion.

Cheers
Oracle

 

A gain would be taxable if it is income and this would only happen if the asset is sold.

How does anyone repay a debt when they spend all their income?
You either
cannot or
you borrow elsewhere or
you sell and asset.

 

Ok so if I am understanding this correctly. Trust usually will not have any post tax dollars from income earned to repay debt since it distributes all income to avoid paying highest tax rate.

So it can borrow from elsewhere and use that money to repay debt. But that’s just shifting debt not eliminating. To eliminate debt it needs to sell assets and use the proceeds to repay debt. It can then also pass CG from selling those assets.

Can the trust use gift money to repay debt?

Cheers
Oracle.

 

Yeah I can see the difficulty in trying to get your head around it.

You either 1. lend your after tax dollars to the trust to pay down the debt or 2. sell an asset to pay down the debt.

Ie say the loan is $1M and was used to purchase $1M of shares. After 10 years the shares are worth $2M, the loan is still $1M as was interest only for 10yrs. You sell all the shares, $1M is Capital Gain which gets distributed to beneficiaries and taxed at their marginal tax rates, $1M is used to pay off the loan. Simples

 

Yes
if hte trust has other assets it can use this to pay down the debt. Gifts received by the trust are an asset - corpus of the trust.

 

Thanks Terry

And the trust can use that assets (gift as cash) to pay any debt.

Cheers
Oracle

 

Yes.
You could also forgive the loan.

 

How a discretionary trust is able to repay its mortgage?
Say a trust collects $100,000 rent p.a., its mortgage repayment is $50,000 p.a. ($30,000 as principal and $20,000 as interest).
The trust net income is $80,000 as only the interest is tax deductible and the $80,000 has to be distributed to the beneficiaries.
How the trust is able to pay back the principal?

 

Using the numbers from BMS above, the 100k rent comes in 30k goes out to essentially manage the existing debt which is IO as mentioned in an earlier post. The trust can now do a range of things. It could distribute to beneficiaries in and way it wants that is best for their tax or it could pay it all to reduce debt or it could do a mix of both.
At the end of the day the trust is their to make money for beneficiaties. Each option does this in its own way. Ie direct payment, reducing debt for future better returns or a combo of both. Best option depends on tax situation. That's a different issue.
This seems right to me but if not I am sure the good people here will correct it in the usual way.
DoingOk