Ask Ban Tacs Question
I’ve recently released some equity from my home and want to invest in the stock market via my Discretionary Trust (Family Trust) of which I am the sole beneficiary and director of the corporate trustee. I’ve got some general questions around this:
- What is the best way to get the cash into the Trust? Do you just transfer it? In general is it best to make transfers to the trust bank account and then the brokerage or can you transfer it directly from your personal to the brokerage account? In terms of documentation what is the wise thing to do (i.e. documenting the transfer from yourself to the trust)?
- If the cash is sitting in a redraw account how does this work in terms of tax implications
- If the cash is sitting in a offset account how does this work in terms of tax implications
- If you transfer the cash back to yourself (i.e you never invested it) is this considered ‘income’ or is this simply ‘corpus’ i.e. no tax payable (with the exception of any interest you earn). If it is considered income are there ways to mitigate this.
- If you transfer the cash, then invest it in stocks and then sell the stocks to cash and transfer the cash back to yourself, is this considered ‘income’ or is it corpus i.e. no tax payable (with the exception of any gains you make).
- Can you carry forward losses? I’m assuming this cant be offset against income you make from your employment?
Thanks
Answer
Thank you for a great question and making it available to our notice board as it will give other readers a chance to understand the fundamentals of a reasonably common situation.
The first point is that the trust is a completely separate entity from you even though you have set it up for your benefit and control it. You say it is a discretionary trust but you are the sole beneficiary. If there is only one beneficiary then it is a fixed trust. The difference between a fixed trust and discretionary trust is a lot when it comes to who gets to deduct the interest. In a fixed trust you have a fixed right to income so the interest on borrowings you take out to invest in the trust could be tax deductible in your own tax return. But in a discretionary trust you have no fixed right to income so interest on money you borrow to invest in the trust does not have the nexus of a cost of earning you income. Therefore not deductible in your tax return.
I expect that yours is a discretionary trust and you are the primary beneficiary. The deed probably includes a discretion to distribute income to your relatives. So for the interest on the borrowings to be tax deductible – a cost of earning income – you will need to on lend the funds to the discretionary trust and charge at least as much interest as you are paying the bank. This will mean the trust will deduct the interest it is paying you and your tax return will include interest received from the trust offset by interest paid to the bank. Effectively cancelling out the interest in your tax return and moving the deduction to the trust, which can be a nuisance if you have a negatively geared investment property in the trust because trusts cannot distribute losses but in the case of shares you should receive enough income to offset the interest. Make sure you set up the loan between you and the trust in writing. Loan agreements are available on google, here is an example https://legalvision.com.au/documents/loan-agreement/
Not that I am making any recommendations. The trust could try and borrow the money itself direct from the bank but it is a painful process and probably a higher interest rate.
Note if these shares receive franking credits (which is usually the case) those franking credits will be lost unless the trust makes a profit for both trust law purposes and tax law purposes. A profit for trust law purposes cannot include the value of the franking credit. This is probably best explained by example:
Let’s say the trust held $100,000 worth of shares purchased with $100,000 worth of borrowings at 5% so the interest for the year was $5,000. The shares may also have returned 5% plus franking credits of say 2% and then there are accounting fees of $1,000
The taxable profit would be $1,000 from $5,000 cash dividend plus $2,000 franking credit less $1,000 accounting fees less $5,000 interest. That $1,000 would be distributed to you for tax purposes and you would have to pay tax on it without utilising the franking credits, which because the trust made a loss for trust law purposes are lost for ever. Trust income does not include franking credits. The loss for trust law purposes is $1,000, it is made up of $5,000 cash dividend less $1,000 accounting fees less $5,000 interest.
As a result it is dangerous to borrow all of the money you are investing, you need to try and keep that interest bill down to ensure there is a profit for trust law purposes but you must charge the trust at least the interest rate you are paying.
The next barrier to utilising the franking credits is the 45 day rule. A discretionary trust cannot satisfy the 45 day rule because there is no fixed ownership interest in the shares. This problem is solved by making a family trust election but it will restrict future distributions to only your relatives.
Now to offset accounts and the like. You could take the money back out of the trust and reduce the loan therefore the interest bill that you are on lending and that is fine because the trust now owes you less money. But it can’t go into an offset account instead, this messes with the nexus. An offset account is just your personal savings account. If say you took half the money back out of the trust and put it in the offset account then the loan would have been half used to on lend to the trust and the other half put in your savings account ie private use so only half the interest would be tax deductible. Now you might say at this point but it is only now half of the interest that is being charged due to the amount in offset. It does not matter only half of the funds were used to lend to the trust so half the interest whatever it be based on is tax deductible. This would not change when you take the money back out of the offset account and again lend it to the trust because the nexus is now you lending the trust money from your savings account. Now without the offset you are back to full interest charges but half of them are now not tax deductible. A redraw facility would be different, you could take the money out of the trust and pay off some of the loan then redraw from the loan to lend back to the trust, that is like fresh borrowings. Start all over again with a new loan agreement.
Always put the funds into the trust bank account first before you invest. Also be very careful to take the funds direct from the loan into the trust bank account. If there are any detours along the way say into your personal account or an offset account then the nexus is broken and the funds are considered used for private purposes.
It is important that a trust distributes all its income to you or your relatives, if it retains any it will have to pay the maximum tax rate on it. It is not so much a question of the cash you actually receive from the trust but the profits the trust makes that goes in your tax return. When you do receive cash from the trust there are no tax consequences as tax has already been paid on any portion of that that is taxable. What you have to be careful about is making sure any cash you receive in excess of your profit distribution and the interest for the loan is paid back into the loan, not used for private purposes otherwise the original loan becomes partly for private purposes because you owe the bank more than the trust owes you.
If the trust makes losses it can carry the loss forward but the franking credits are lost so your strategy should be to be very careful to make a profit.
If a gain is made on a sale of shares the gain is distributed to you for tax purposes and you pay tax on it. That gain if you wish can be distributed to you in cash but not the original purchase price if the share was bought with the borrowed funds else a portion of the interest on the borrowings would not be tax deductible because some of that money is now being used by you for private purposes.
I am a little concerned from the wording of your question that you may have already drawn down the loan and put the money in an offset account, thus breaking the nexus. If this is the case you need to put the money from the offset account back into the loan account and then redraw the funds putting them directly into the trust bank account.
