Discretionary trusts are generally started with just $10 or
$20. Mostly trusts are established for a trustee to hold shares or property for
the benefit of a beneficiary, so how does the trustee get the deposit or money
to do this?
There are basically just 3 options to consider:
A gift is an irreversible transfer from one person to another.
It is better than a loan for asset protection against
bankruptcy because if the gift giver goes bankrupt generally the gift will not
be available to creditors (but the claw back laws need to be considered).
Gifts to discretionary trusts may not be ideal though
because when you die the gift will not form part of your assets and cannot be
passed via your will.
If the gift giver is borrowing money to gift to a trust the
interest will not be deductible.
Gifts should be documented with a deed.
2. Loans with interest
A loan can be made with interest accruing. However, interest
is income to the receiver. Interest may be deductible to the trust if it is
using the borrowed money invest, s 8-1 ITAA97.
The interest rate could at market, under market rates or
higher than market rates. Each has different consequences.
But a person cannot contract with themselves, so you could
not lend to yourself if you are the trustee.
Generally, someone borrowing money to lend to the trustee
should consider charging interest to the trust. This interest would need to be
at least the same interest that the bank is charging you. But the question you
should be asking is if the bank has a first mortgage security over real
property and charges say 4% to you, if you lend to the trust at 4% without
security would this be a market interest rate? Are there any Part IVA
A loan should be documented with a written loan agreement which would be either a contract or a deed.
3. Interest free loans
Many like to make interest free loans to trusts because
there are no direct tax consequences and the loaned money would generally come
back to the lender at death and therefore form part of their estate and can
then pass into a testamentary discretionary trust.
But a major issue with loans is the various state
limitations acts. This could cause a loan to become unenforceable if there has
been no activity with a loan for 6 years (NSW law). So, a loan made say 7 years
ago which is interest free and no transactions have happened will not be
recoverable if the borrower refuses to pay back. You might think that you are
not going to sue a related trust, but you must remember that if you set up a
trust you are just in control temporarily. If you lose capacity, go bankrupt or
die the control of the trust will pass to someone else.
Interest fee loans should be documented in the same way as
loans with interest.
Which method should you use?
You should all get specific legal advice from a lawyer, but
as a guide:
- If you have cash and are concerned about
bankruptcy a gift might be worth considering
- If you are not concerned about bankruptcy and
have cash, then an interest free loan may be worth considering
- If you are borrowing and on-lending the money to
the trust a loan with interest may be worth considering.
If you do make a loan you must adhere to the terms of the
loan for it to be effective.