Tax Tip 89: Borrowing and onlending Interest Free to a Discretionary Trust

Discussion in 'Accounting & Tax' started by Terry_w, 2nd Dec, 2015.

Join Australia's most dynamic and respected property investment community
  1. Rob G

    Rob G Well-Known Member

    Joined:
    16th Oct, 2015
    Posts:
    966
    Location:
    Melbourne
    FC of T v Total Holdings (Aust) Pty Ltd

    On-lent interest-free to a wholly owned subsidiary to assist it to become profitable and start paying dividends and interest.

    In the present circumstances, if the unit holder has indefeasible entitlements to all income and capital gains then the interest expense may be traced to their assessable income.
     
    Terry_w likes this.
  2. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    23,319
    Location:
    Sydney
    Ummm....In the highlighted part. I dont follow. The deduction reduces assessable income (ie net income). If the trust in B had not paid interest the trust income would be $80K. In B you must consider who the trust pays interest to. If its a bank then OK. If its to Bob then Bob has $70K of net trust income AND $10K of assessable interest.

    So if Mrs Bob had lent the $ to the trust rather than Bob and she has no other income perhaps it has a tax benefit also.
     
  3. Phase2

    Phase2 Well-Known Member

    Joined:
    14th Jul, 2016
    Posts:
    1,289
    Location:
    Perth
    I think you're tying yourself in knots and confusing yourself here. In example B the deduction is applied within the trust. On a very simple level, the trust generates the income, and it incurs the expenses. It can only distribute net income. It cannot distribute it's expenses or losses.

    If you hold a negatively geared property in a DT, the losses are "trapped" within the trust.

    The tax advantages of a DT are mostly to do with being able to distribute to a beneficiary with a lower taxable income (individual) or tax rate (holding company).
     
  4. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

    Joined:
    18th Jun, 2015
    Posts:
    41,672
    Location:
    Australia wide
    in B the trust is claiming the interest which reduces its taxable income just the same as in A.
     
  5. jay.

    jay. Active Member

    Joined:
    22nd Oct, 2016
    Posts:
    38
    Location:
    Canberra
    Thanks Terry, this makes sense now.

    Now let's add franking credits to the equation.

    Bob Discretionary Trust has $800 expenses against two equal lots of dividends totalling $1400 dividends and $300 franking credits.

    After expenses deducted, how are the franking credits distributed?
     
  6. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    23,319
    Location:
    Sydney
    I know the answer to that one and it depends.....on the beneficiary.
    Jay dont get me wrong but isnt this a sign you need help ?

    45 day rule, streaming, beneficiary residency, proportionate entitlement, TFN credits etc..Then you dont invest in shares but invest in Trusts and ETFs and have to deal wit foreign income, foreign credits, CGT discounts etc..All issues you may encounter.
     
    Perthguy and Terry_w like this.
  7. keentobuy

    keentobuy Member

    Joined:
    26th Jun, 2015
    Posts:
    14
    Location:
    Canberra
    What if George borrowed $10k from LOC @ 5% and provided unsecured $10k loan to discretionary trust at commercial rate of 10%. And assuming loan was properly documented and repayments made.

    The income (or profit) from the loan arrangement would presumably be added to taxable George's taxable income. Would this also make George's LOC interest deductible given George has entered into loan arrangement to generate income?
     
  8. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

    Joined:
    18th Jun, 2015
    Posts:
    41,672
    Location:
    Australia wide
    If someone is borrowing and lending money and not scheme is involved interest incurred would generally be deductible with income received as income.
     
  9. keentobuy

    keentobuy Member

    Joined:
    26th Jun, 2015
    Posts:
    14
    Location:
    Canberra
    Thanks Terry.

    Does ATO stipulate or provide advice on what an appropriate rate of interest would be in the example above?

    Or should George just base it on advertised unsecured loan rates from the banks?
     
  10. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

    Joined:
    18th Jun, 2015
    Posts:
    41,672
    Location:
    Australia wide
    No
     
  11. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

    Joined:
    18th Jun, 2015
    Posts:
    41,672
    Location:
    Australia wide
    Perthguy likes this.
  12. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    23,319
    Location:
    Sydney
    TD 2017/D4 is draft...So take care.

    I question the capacity of most disc trusts to make a early irrevocable resolution to distribute. The very nature of the deed typically grants the trustee broad discretion however many prescribe what income is. A trustee could determine specific income up to a point in time however but the drafting required to make a irrevocable resolution would require legal advice and amendment to the terms of most deeds. Anyone contemplating such a issue probably should be seeking a loan agreement that deals with the interest from the outset in any event.
     
  13. Netninja

    Netninja New Member

    Joined:
    28th Mar, 2018
    Posts:
    2
    Location:
    Melbourne
    I have a twist on this one.
    If I have a disc trust and I am the trustee and I provide a loan to the trust from personal funds (no loan from institution), I have a basic agreement stating the funds are a loan and payable back monthly with at say an interest rate of 5%, can the trust claim a deduction on the interest?
     
  14. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

    Joined:
    18th Jun, 2015
    Posts:
    41,672
    Location:
    Australia wide
    At law you cannot contract with yourself. but if you have borrowed for the trust then the trust may be able to claim the interest depending on the situation.
     
  15. Netninja

    Netninja New Member

    Joined:
    28th Mar, 2018
    Posts:
    2
    Location:
    Melbourne
    Ok that makes sense. What if the loan came from another beneficiary such as my wife and I am some trustee?
     
  16. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

    Joined:
    18th Jun, 2015
    Posts:
    41,672
    Location:
    Australia wide
    Yes you could contract with a different person.
     
  17. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    23,319
    Location:
    Sydney
    But the basic agreement doesnt say that ? Seems a sham attempt to fix a problem. If funds came from your bank account to trust then a agreement with your wife may still fail if you advanced the funds. A sham.

    Its the minor details that create problems
     
  18. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

    Joined:
    18th Jun, 2015
    Posts:
    41,672
    Location:
    Australia wide
    PBR Authorisation Number: 1012502598156

    RBA Content
     
  19. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

    Joined:
    18th Jun, 2015
    Posts:
    23,319
    Location:
    Sydney
    Thats a ruling with a lot of technical issues and other taxpayers need to exercise caution.

    The loan agreement may be 0% but the technical issue is....the terms of the loan agreement require the trustee to distribute an amount equal to the interest the taxpayer incurs on the external loan plus a margin.

    The loan agreement is still the relevant matter. A hybrid form of interest or a form of fixed entitlement to income

    Im currently seeking a ruling for legal costs to be deductible vs trust income in a similar manner. The legals solely incurred to produce a fixed entitlement to trust income that would otherwise not be available and it provides a fixed right that prevails over discretion. The uncertain timing of it governed by Steeles principles. The deed of agreement for income rights act as a form of right to income or agreement to lend.
     
    Last edited: 14th Jun, 2018
    Terry_w likes this.
  20. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

    Joined:
    18th Jun, 2015
    Posts:
    41,672
    Location:
    Australia wide