Ask Ban Tacs Question
I am about to draw just under $200k in equity from my home. I intend to instruct the mortgage broker to split the loan. There will be two offset accounts. There will be the existing home loan which will be linked to one offset account. There will be a second loan linked to the other offset account. I am terming the second loan a ‘investment loan’ as I intend to transfer the money to my Discretionary Trust (I am the sole beneficiary) so that I can invest the cash in a share.
- Should I have two offset accounts? Or should I only have one or… two redraws, one redraw?
- Do I LEND the money to my trust and THEN transfer?
I intend to claim the interest on the investment portion on my personal tax return – I can do this right? This one is kind of time critical so if you could answer it ASAP i would be forever grateful!
Thanks
Answer
Please have a read of this question https://taxquestions.com.au/discretionary-trust-investing-in-shares-with-borrowings/#:~:text=But%20in%20a%20discretionary%20trust,deductible%20in%20your%20tax%20return. As it covers very well the issues around borrowings in a discretionary trust. Possibly pointing out further traps.
I would also like you to read this blog because reading between the lines of your question I am concerned you may be having a hybrid pushed onto you https://www.bantacs.com.au/Jblog/hybrids-are-being-spruiked-again/
Now to answer your question:
If you lend money to a discretionary trust you cannot claim the interest on your borrowings as a tax deduction because they are not a cost of earning income because you do not have a fixed right to the income of the trust. By definition the trustee has the discretion to decide each year who gets the income from the investment. This differs if it is a loan and the trust pays you interest then you have a fixed right to income.
Now I make this statement on the basis that you say it is a discretionary trust. This is contradicted by the fact you say you are the sole beneficiary. How can it be a discretionary trust if there is only one beneficiary, how can the trustee be considered to have discretion if there are no other possible beneficiaries? I think what is really the case is that you are the primary beneficiary and the deed gives the trustee the discretion to distribute profits to you or your family.
So as this is a discretionary trust deed if you want the interest to be tax deductible you will need for the trust to borrow it direct from the bank or you borrow it from the bank and then on loan it to the trust as the same interest rate you borrowed at. You can’t charge less than what you borrowed at, you will only be allowed to claim as much of the interest that you pay, as a tax deduction, as the interest payment you receive from the trust. It is less complicated to borrow in your own name and on lend but what will need security outside the trust which you appear to have. If it was going to be assets owned by the trust that are the security then the trust will probably have to do the borrowing. Either way the real interest is not going to be deductible in your in your tax return. If you borrow in your name where will be interest income and interest expense that offset each other but the real deduction which ever way you borrow will be in the trust. Trusts cannot distribute losses so if the deductions exceed the income the loss will just sit there waiting to be offset against future gains. Further, if the trusts earns franking credits but makes a loss those franking credits are lost forever. A loss in this regard is a loss for trust law purposes which means that the franking credits do not count towards the profit, so it is not that hard to end up making a loss. This is covered in more detail in the first link above. I am just stating the fact here.
Now a little more about having a fixed right to the income of the trust. If this was the case the deed would have no discretion, there would be a very clear right to all the income and capital gain ie 25% fixed between 4 or 100% if you are the only beneficiary. Generally, you would buy units in the trust. The units determine your fixed right. The trust invests the money you give it for the units. You can borrow the money to buy these units and claim the interest as a tax deduction in your personal tax return provided it is expected that the trust will give you income. This is the case even if the interest on the borrowings is more than the income. But you have got to ask yourself why you would do this. There is no asset protection from your creditors as the units can be taken by creditors. There is no flexibility of distribution. So why not just own the shares in your own name and save a lot of accounting fees?
You say you are going to use your home to secure the loan so I will proceed now assuming you are going to borrow in your name and on lend to the trust. Yes, you draw up a loan agreement and transfer the money direct from the loan into the trust bank account then use the money to purchase income producing assets. The trust pays you the interest and then can distribute any remaining profit to any of the beneficiaries of the trust. There is no opportunity to negative gear. Be very careful you could lose your franking credits. To be able to distribute income to beneficiaries there must be a profit before franking credits are added to the income. If you can’t distribute a profit to a beneficiary you cannot get the franking credit out of the trust so it is lost forever. Let’s assume your interest rate is 8% and for some very strange reason there are no other expenses in the trust. If the shares return 10% including franking credits you would think great you have made a profit yet will still get some of your franking credits back. Not so because if these are fully franked shares the cash dividend would be 7% and the franking credit 3% so there is a loss of 1% before franking credits. Profits can’t be distributed and the franking credits are lost for ever. If the shares were in your own name you would make a 2% profit, 10% dividends less 8% interest = 2% as the tax on that 2% is going to be a lot less than the 3% in franking credits there will be a nice fat refund. Too good to miss out on.
The worry of lost franking credits and not being able to offset losses when earned is avoided by just investing in your own name, though at least discretionary trusts do give you some asset protection and flexibility.
Also note that your trust will need to make a family trust election if any beneficiary is claims more than $5,000 in franking credits in their tax return, this includes franking credits they receive from other investments. Basically because of the 45 day rule they will not be entitled to utilise any of their franking credits to pay their tax unless the trust makes a family trust election.
As for the offset accounts on these loans. I see no point in offsetting the deductible borrowings, offset your private debt with any spare cash. With the deductible loan it is better to have a redraw facility so that you are technically paying down the loan each time and then redrawing for fresh investments. You see if you are taking money from the trust that represents your share of profits then it is ok to put in against your private debt. If you are taking money from the trust because you have sold shares at a profit then the original borrowings for those shares must be repaid off the loan used to originally buy those shares. When you buy new shares you can redraw.
In direct answer to your question:
- Should I have two offset accounts? Or should I only have one or… two redraws, one redraw? Offset for private debt redraw for deductible debt
- Do I LEND the money to my trust and THEN transfer? Yes, set up a loan agreement and transfer money direct from the loan into trust bank account, no detours.
I intend to claim the interest on the investment portion on my personal tax return – I can do this right? Yes if the discretionary trust pays you at least that much in interest, ie no negative gearing.
