Tax Tip 200: Claiming Interest on a Loan from a Bucket Company

Where a company lends a shareholder, or an associate of a shareholder, money it will be deemed a dividend, and taxed as such, unless the loan meets certain conditions such as a maximum term and minimum interest rate – Division 7A loans these are often referred to. I have discussed this in more detail here

Tax Tip 158: Borrowing Money from a Related Company (Div7A) Tax Tip 158: Borrowing Money from a Related Company (Div7A)


One strategy for companies and trusts is to build up income into a bucket company as a company pays tax at 30%, and then reinvest the money. But because a company investing won’t obtain the 50% CGT discount on the eventual sale of the asset the bucket company itself may not be a good investment vehicle.


The way around this is for the bucket company to lend another entity money to purchase either shares or property.


If a taxpayer borrows to buy income producing property or shares the interest will be deductible under s8-1 ITAA97. So, the interest paid to the Bucket company by a trust borrowing to buy shares is deductible to the trust.

The interest received by a taxpayer lending money is income and may be taxed. So, where the bucket company lends money to the trust and receives interest this is income which is taxed.


Example

Bart sets up the Simpson discretionary trust through his lawyer. The trust invests in shares using money loaned by Bart to the trustee. This produces good income which Bart, as controller of the trust, causes to be distributed to SimpBucket Pty Ltd which is a new company set up with the sole purpose of receiving trust distributions, i.e. a Bucket Company. Bart sought advice on carefully structuring this company beforehand.

Let’s say that $100,000 in dividends is distributed to the Simpbucket Pty Ltd, this includes $70,000 in dividends at $30,000 in franking credits. Simpbucket Pty Ltd ends up with $70,000 cash after tax.

This $70,000 is lent to the trustee of the Simpson Discretionary Trust under a Div 7A complying loan agreement. The trust uses this money to buy $70,000 worth of shares and pays about $4,000 in interest to Simpbucket Pty Ltd.

The trust can claim $4,000 in tax deductions. Simpbucket Pty Ltd has $4,000 more income which is taxed at 30%.

This builds up more money in the company which could then be lent out to the trust in the next financial year.


Example 2

Lisa is in a similar situation, but Lisa wants to buy a property in her own name. She simply borrows 25% deposit and costs of the property from Simpbucket Pty Ltd and borrows the rest, 80%, from Westpac so she gets a property with 105% loan and no cross collateralising of securities. Interest is paid to the company which is deductible to her, perhaps at 47% and taxed to the company at 30%.

Keep in mind these are complex situations so both tax and legal advice should be sought before doing anything.