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

Thanks Terry, yea that's what I meant, the Homer-Barney loan would initially have started off to mimic the Homer-bank loan, being same term, repayments, rate etc. If Homer pays down his bank loan (which would be the case I think in my mixed loan example above) then that amount would need to be added back the Barneys loan, meaning Barneys repayments to Homer will no longer match homers repayments to the bank because these would be slightly reduced. That's what I was understanding

 

Thanks for the above Paul, those points help me understand, sorry for rambling

if the Homer-Barney agreement allowed extra payments by Barney, say he paid Homer $5k above the minimum, Homer would then pay $5k to his bank loan so his CBA liability is reflected the same. BUT let's say Homer has a mixed loan of 100k with the bank (50% was personal, 50% was for on-lent for investment to Barney)

As any repayment Homer makes to this would need to be apportioned to both portions, if Homer paid down the loan by 10k, that would mean that 5k would pay down the liability to CBA relating to Barneys loan (both loans are reflected the same now) and 5k would be attributed to paying down homers personal portion. - now Homer would be able to further lend 10k of new borrowings from this loan account if he wishes. Further mixing of the loan issue aside, does this way pose any other tax issues?

 

2019 Vacant Land Deduction Exclusion scenario:

Lets say Homer wants to build a new IP. He purchases the land and organises the build contract through a trust (discretionary/hybrid) and takes out a loan and onlends it to the trust interest free as described in the first post.

Would it be fair to say that, as Homer has invested in the trust (as opposed to directly in vacant land), his losses associated with the loan are tax deductable as they occur outside the trust and avoid the 2019 vacant land deduction exclusion even though the vacant land is held in a discretionary/hybrid trust which is subject to the exclusion?

The losses that occur inside the trust (e.g. council rates) would still be non-tax deductable but would form part of the capital costs.

 

No

 

why would the interest on the funds lent interest free to the trust be deductible ?

 

I accidentally refered to a discretionary trust instead of fixed trust. I was assuming the trust and loans had been set up as described earlier in the thread such that the interest would be deductible when the IP was available for rent. See this post:

 

are you asking if an individual borrows to acquire units in a fixed unit trust where the trustee of the unit trust will hold vacant land will the interest be deductible to the individual?

Interesting question and the answer is maybe,
s26-102 ITAA97 denies deductions for expenses associated with holding vacant land for some entities in some situations.
But here the taxpay is the individual who will be owning units in the trust. This section won't prohibit that interest being deductible but there has to be an expectation of income for the interest to be deductible and if the trust holds vacant land where is this income coming from?

 

Yes! Thank you for managing to translate my thoughts into English.

My interest in this tip is the ability to neg gear by running the losses outside the trust. You have a post about it (see link) but only talk about unit trusts. I understand you can also do this for fixed interest trusts too (correct me if I am wrong).
Unit Trusts and the 2 methods of Borrowing

Profit in the trust would come from future rental earnings and capital gains once a house has been built on the vacant lot (e.g. house and land package). Earnings would likely not be realised for a number of years.

If this structure does allow tax deductions on an IP during construction, you will make me a very happy man.

 

This is something you should seek specific tax and legal advice on. You wouldn't want to select ownership structure based on being able to claim a one off extra $20k for example.

 

Question which I believe is inline with this threads topic.

Situation. An individual lends money to a corporate trustee of a discretionary trust which is used for investment / income producing purpose. The loan from the individual is interest free.

Individual would like a return of some of the funds lent to the trustee / trust. If trustee then borrows money from another entity such as a bucket company on terms complaint with div 7a and repays the loan to the individual is the interest payable on the money borrowed from bucket company to repay said individual tax deductible?

In essence the trustee is replacing the borrowed money from individual with borrowed money from bucket company. The purpose of the original borrowed funds are still invested and producing income for the trust. Does the fact that the original loan from individual having no interest terms matter?

 

It could be if it is just refinancing one loan with another.
But need to consider Part IVA

 

Thank you at @Terry_w .

Yes it would be considered a simple refinance of loan from the individual to the bucket company. The fact that the individual loan was not charging interest and the new loan from the bucket company is, doesn’t change the purpose of the loan.

Looking at part IVA, I would say that I have gained a tax benefit by refinancing the loan from individual with no interest attached to the bucket company which has interest costs. But I don’t believe it’s at odds with standard commercial arrangements and the purpose of the scheme is not for the purpose of tax avoidance.

Will have to run it past my accountant to be sure before I do anything, but I don’t see it being an issue in such a scenario.

 

I may have covered this topic here

Tax Tip 348: Borrowing from a Related Company and Refinancing Investment Debt Tax Tip 348: Borrowing from a Related Company and Refinancing Investment Debt

 

Thank you @Terry_w , Much appreciated.