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

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

Generally, it is possible to borrow from a trust where the trust deed allows the trustee to lend and to lend to a related party. This can be an interest free loan where the deed allows and it can be interest free to a beneficiary.

With interest free loans there are generally no tax issues because there is no income incurred to the lender and no expense incurred to the borrower.


However, there can be significant tax issues if the trust has an unpaid distribution to a company. This can trigger division 7A of the ITAA36 which is designed to stop people simply borrowing from related companies and not paying tax. If the trust makes a distribution to a company but doesn’t pay that distribution and if a beneficiary borrows money from the trust it is as though they are borrowing money from the company.


Example

Simpson Family Trust makes a taxable income of $100,000 and the trustee makes a related company, Simpo Pty ltd, presently liable for the income – but doesn’t pay it. It is a UPE or unpaid Present Entitlement.

Homer then goes and borrows $100,000 from the trust. It is as if Homer borrowed the $100,000 from the company.

If the loan between the trustee and Homer is not on specified terms under Division 7A that $100,000 will be treated as if it were a dividend paid to Homer from the Company. And Homer will be taxed accordingly.

 

Okay, that puts taking a loan from the trust in a different category of consideration.

So that i am clear- when a distribution is made to a trust, the sending trust has to name a (or a nunber of) beneficiary to receive the distribution. In that case the receiving trust would be named as presently entitled?

Would the distribution received be treated as income?

As i understand it the process of determining how a distribution is allocated (in the receiving trust) is reserved for the trustees of that trust, and that only needs to happen after the trust receives the distribution, and in the financial period for which the distributuon was received?

Does all of the distribution received need to distributed to the beneficiaries?

If the full amount of the distribution needs to be allocated in the financial period for which it was received, and a loan to a beneficiary (deed permitting) was not paid back in full- in that reporting period, that then would result in a Div7 ruling?

However, if the distribution was made to the beneficiary for the outstanding loan amount, then that would make the Div7 ruling a mute point. Would that be accurate?

I guess the other questuon then, if my assumptions are correct- if the trust did not want to distribute to that beneficiary, and required the full amount of the loan be repaid (over a 10 year period for example) the trust would then need to distribute the loan amount to a shell (trading company - also a beneficiary of the trust), and the company issue the loan over the period required, and with the terms agreed.

Just trying to get my head around the period that money can stay in the trust, and how a beneficiary could receive a bonafide loan from the trust for a 10 year + period, interest free.

And am i correct in saying that a loan can only be made for a max 25 period if it is secured against property?

 

No.
Trustee of Trust A can make the Trustee of Trust B presently entitled.

It is then up to the Trustee of Trust B to make one or more of its beneficiaries presently entitled.

Not until they call for it.

The trustee would need to make someone presently entitled to the incurred in the same financial year as the income is incurred. If they don't they will be taxed at the top marginal tax rate.

But if they don't distribute the money and then lend it to someone else, they are really running a risk of the first person asking for their money which they no longer have as they have lent it to the second person.

Div7A won't apply to these situations, generally, unless they have an unpaid present entitlement to a company. if this is the case it would need to be a loan on Div7A terms, or held in bare trust for the company.

If the trust had no unpaid present entitlements there could be no div 7A unless it separately borrowed from a related company.

I have no idea what this means.

that is easy. The trust would have no present entitlements to a company and just enter into an interest free loan agreement with the beneficiary.
But there would still be tax to pay as the beneficiary would be presently entitled to the money - could they legally borrow $100,000 from the trust if they trust owed them $100,000? It would potentially cancel each transaction out. They might have to gift it to the trust first.

no.
But a division 7A loan has a 25 year max period if secured by property.

 

I think you might be thinking Trust A could distribute to Trust B and person X could use the funds without paying tax if the funds are loaned to person X by Trust B.

If so you are not taking into account that someone must be taxed on the income of the Trust B, which would be the distribution from Trust A.
If someone is taxed on it, say person Z, that person is owed the money by the trust.

Example
Homer controls Trust A and Trust B.
Trust A has $100,000 profit which is all taxable income.
Trust A makes Trust B the beneficiary of this profit.

Trust B has to make someone presently entitled - lets say Bart.
Bart doesn't receive the $100,000 as it is left in the trust. It is a UPE.
Bart has to pay tax on the $100,000 - lets say $47,000 which he pays using his savings.
Bart is still owed $100,000 by the trust.

Homer then causes Trust B to lend Lisa $100,000.
Trust B has no cash or assets left except $10.

Bart then asks the Trustee of Trust B for his $100,000.
He doesn't have it. So has to ask Lisa to return it....

 

For a capitol gains distribution it would seem the best option would be to receive the money into a personal account, assume the liability for the tax (as the presently entitled beneficiary), and then gift the money to a family trust.

That is in the absence of any beneficiaries who might offer some tax relief to money distributed to them, by virtue of their taxable income bracket.

With the CGT discount applied the taxable income, receiving the distribution into a personal account, is still less than if it were distributed directly from trust into a company beneficiary.

Would that seem like an accurate assesement? The trust then becomes more of a vehicle for asset protection than tax minimisation.

If that is the case, and once the trust distributuon paid into a personal account is gifted into a family trust does that sum (the full sum) carry a 'franked credit' benefit to any beneficiary who receives a distribution from that money gifted into the trust?

I dont think company beneficiaries of that trust would receive that benefit?

It just seems completely unreasonable to pay tax twice?

 

It will depend on the circumstances.

It could be better to make a company presently entitled to the capital gains for superior asset protection plus it could result in less tax overall too in some cases.

Its not the case, but there are no franking credits on gifts either.A gift to a trust is just a gift - without franking credits.

Where is the tax being paid twice?

You have some dangerous misunderstandings which could get yourself and associated entities into expensive trouble.

 

I would love to engage with your business, and i have completed the online forms to register my interest.

Perhaps we can take this offline, only if you would consider bringing on new clients - consulting engagements.

 

Hey Terry

I did want to clarify my 'taxed twice' assertion, and that was based on the scenario where a distribution is made into a personal account (of that beneficiary) who would then pay tax on the amount (less the CGT discount), and then gift that money (post tax) into a family trust.
If a gift carries no franking credits, then would that money (once distributed to the beneficiaries of the family trust) be taxed based on the tax regime applied to those individuals / entities that are beneficiaries of the distribution
Hence the money would be (1) taxed to initial beneficiary (2) taxed when distributed from the family trust.

I also dont get how paying the initial distribution into the trust and making a company beneficiary presently entitled would yield a better outcome if the company would need to 25% on the full amount (my understanding is that companies cant avail of the CGT credit) where a distribution to a personal account (or individual beneficiary) would be 48% of half of the distribution?

It makes sense to me know though that a distribution into a personal account and then into a trust is much more complex (potentially) and would have a negative impact on the other beneficiaries (if the money was gifted and franking credits didnt apply)

 

Is there any benefit to creating a trading discretionary trust VS a investment discretionary trust? In the eyes of the ATO that is? When apying for a TFN that distinction is made...

 

A distribution of corpus of a discretionary trust could generally be tax free.

This is how paying a capital gain to a bucket company could result in no tax payable:

Tax Tip 287: How Capital Gains Through a Company can be Tax Free Tax Tip 287: How Capital Gains Through a Company can be Tax Free

But it could also potentially result in 47% tax payable
Tax Tip 288: How you could end up paying 47% in CGT Through a Company Tax Tip 288: How you could end up paying 47% in CGT Through a Company

 

There is no such difference other than in a single field on the tax return and during TFN / ABN applocation. That use can also change. A trust can do more than one thing and may even do both. But I dont recommend it. I do sometimes see profitable trading busiensses ina trust who then have excess cash and they invest. The terms of the trust deed are generally exceptionally broad and allow the trustee to do most things.

There may also be merits to turning a pyramid on its head and having a trading company with shares owned by the trust (ie a passive investment along with financial investmnets). That is also good asset protection since individuals (Director ?) can be sued but shareholders cant be. (Trustee). This allows the company to pay a dividend to the trust. That can then be distributed in shares to beneficiaries with tax credits from franking if the company has paid tax on its profits. Or it may defer that and retain profits and pay a low rate (2021 26%)