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

My accountant said there would not need to be a loan agreement under the assumption I was the director of the company that was corporate trustee. - true?

EDIT: so I would be the director and a beneficiary, so I was 'related to'/'associated with' or some words to that effect, the way he explained it

 

This is a dangerous thing for an accountant to say. Certainly not the case if you will be charging interest and it shouldn't be an oral contract for estate planning reasons. How will you get your money back on death?

 

Sorry Terry, were you talking about an individual trustee here, or a corporate trustee? If the latter, why would you decide to utilise a bucket company over just including the corporate trustee as a beneficiary to absorb some income?

 

Individual trustee.

 

Legal and tax advice is wise. The legal aspects are more relevant.

 

Thanks Terry, so say if generally the individual beneficiaries maintained tax rates above the corporate rate, and the intention was to utilise the corporate tax rate in a trust with corporate trustee, would the options be
A) have the corp trustee as a beneficiary, that way they can hold funds for future investment within the trust, or
B) have an additional bucket company as a beneficiary, in which case a loan agreement would need to be made to get the funds back into the trust for investment.

Are there some other pros and cons for each/ things to consider? Thank you for your help

 

I wouldn't advise distributing to the corporate trustee.
This is something you need legal advice on.

 

Would the fact that Homer is the director of the company that is the corporate trustee affect the loan agreement between the trustee and Homer, or interest deductibility?

Wouldn't the loan agreement show Homer's signature twice? Once for him signing as director of company in its capacity as trustee and also as himself?

 

No issue as the company is a separate legal enty to it's directors and shareholders

 

And thats why proper legal drafting of such an agreement is important. Non-arms length loan terms may, or may not, be a concern. If Homer were to engineer a high rate because he has no other income and wants to engineer tax free income that covers his tax free threshold this could be a Part IVA concern. If Homer was to borrow and onlend at a similiar rate this may not be a concern.

 

With the Commercial Tenancy Relief Scheme happening again in Vic, this topic appears very
relevant & applicable for affected DT landlord to fund holding costs gaps due to rent relief given to
tenant.

The issue is going to be, if I borrow and onlend to my DT landlord, which is struggling to pay for
all its commitments due to rent relief given to tenant, is there a minimum monthly amount DT must
pay to the onlender (ie me) so interests on the amount I borrow and onlend can still be
deductible?

 

You can charge the trust any amount really. But you will only be able to claim your interest in fully if the trust pays you at least the same amount. If less is paid you would only be able to claim up to this amount.

e.g. If you borrow $100,000 at 3% and lend to the trust at 2% you would only be able to claim $2,000 in interest and suffer a $1000 loss which isn't deductible.

 

Boy o boy don't you love a loss trapping DT ;-)

 

Hi Terry.

I have a question relating to paying back an on-lent loan, let's say an individual borrowed from the bank and on-lent to their family trust with a loan agreement in place. Can this loan be paid back by the individual and if so would this need to be accompanied by a deed of forgiveness or similar ..
or would the amount need to be first gifted to the trust in order for the trust to make the payment into the loan

 

think it through. If Homer lent Barney $100,000 repayable in 20x $5,000 installments. Could Homer make the payments on that loan?

 

There would be the agreement between Homer and bank to make the 20x $5,000 for his loan as well, if Homer wanted to pay this off, being it's his loan he has in his name with the bank. Im confused how that affects the Homer - Barney loan agreement : does it cease to exist or stay in place, or this is fully dependent on how the agreement is written.

If it would cease to exist then a deed of forgiveness should probably be made up for the Homer - Barney loan prior to Homer paying out his loan?

EDIT: I think the same concept would apply even if Homer didn't fully pay off his loan to bank but rather paid extra into it.. this could have the flow on effect in reducing Homer - Barney loan interest as well which may require additional documentation?

 

If you borrowed $100,000 from CBA and then lent this to me and then I didn't pay you but you paid CBA. would I still owe you $100,000?

 

If Barney and Homer agreed for Homer to borrow $100K from a bank and advance this to Barney the agreement may need to provide for Barney making paymnets to Homer or directly to Homers bank. The agreement may even support that the accounting for the indebedness will at all times be the sum payable as noted by CBA Account 12345678. But.....

There is a inverse...Lets say Barney paid $20K to Homer and Homer didnt pay back CBA and used that $20K to buy a new car does that then mean Barney still owes $20K more ? And then the scanrio as contemplated by Terry occurs. Extra interest ?

The agreement may be best that Barney and Homer agree that all repaymnets made by Barney and no other amount will credit the CBA account and that Homer will do all things to ensure that the CBA Account at all times reflects both Homers liiability to CBA as well as Barneys accounting for his liability to Homer. However....lets assume that Barney stops paying as he is in a coma. Homer pays the loan. How will that work ? A additional clause may need to consider that a new accounting for the Barney - Homer loan then occurs which will be different to that of the Homer-CBA loan.

 

Thanks Terry and Paul, making sense now. thinking it would definitely stay in place, as the terms of the Homer- Barny loan may be dependent on the Homer - bank loan, any deviation to this loan cannot carry over to the Homer- Barney loan. Eg. If Homer pays his loan down from $100k to $50k (or puts 50k in an offset), his repayments to bank will drop, but the original repayments should be maintained by Barney, so a spreadsheet or something should now be used to track this as it no longer just matches the bank transactions.

My question has stemmed from a similar choice I am facing

If Homer had partially paid back a personal bank loan, then redrew this to on lend to Barney - Homer now has a mixed loan which he is tracking. - Ideally a loan split should have occurred.

Barny needs more money urgently.

Homer was thinking rather than gifting Barney more money, he could pay down another amount into the mixed loan and redraw for Barney. - Homer understands it's not as efficient without splitting because he would now be paying down a portion of already deductible debt. - this issue aside, there is also the issue because Homer is paying down a portion of Barneys loan, - this will need to be added back for the accounting of the Homer -Barney loan, so now the Homer - Barney loan principal will be higher than the Homer - Bank principal by that apportioned amount and repayments will be reflected in the same manner - would that be roughly correct?

 

No I dont think so. Homer wouldn't be paying down Barney's loan.