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Ruling
Subject: Trust - Interest Deductions
Question 1
If a capital distribution is made to the beneficiaries, would all of the interest still be deductible in the family trust and assessable in the Will trusts, if paid to the Will trusts on the loan?
Answer
No.
Question 2
If interest is in fact charged does it need to be physically be paid across to the Will trusts from the family trust within the income year?
Answer
Not applicable.
Question 3
If interest is charged could it be accumulated in the Will trust loan accounts to be paid at a later date and still be deductible/assessable as incurred?
Answer
Not applicable.
This ruling applies for the following periods:
30 June 2012 to 30 June 2017
The scheme commences on:
01 July 2011
Relevant facts and circumstances
The settlor operated a Family Trust in their lifetime. They were the appointor of the family trust as well as a director of the trustee company. They have recently passed away.
On their passing, the will stated that specified beneficiaries would become the appointors of the family trust. They are in the process of appointing a new trustee company with the beneficiaries as directors and shareholders.
Prior to their passing the settlor liquidated some superannuation fund investments and loaned to the family trust an amount of money. With this money the family trust placed the bulk of it on term deposit and a smaller amount into an investment.
The settlor amended their will in relation to the superannuation amount. It stated that the amount was an interest free loan to the Family Trust which was:
"repayable on thirty days notice given by me to the Trustee or Trustees. In the event of my death whilst such monies or any parts thereof are owing, the monies so owing shall be repayable by the Trustee or Trustees of such Trust to my Trustees within 30 days of the date of my death or as any of such monies invested on term deposits falls due under the terms of such deposit whichever is later".
The Will at subclause X(b) went on to state that the debt was to be assigned proportionately to the Will Trusts set up for each of the beneficiaries.
The loan to the Family Trust was inherited by the beneficiaries through separate Will trusts as loans owed by the family trust.
It is intended to charge interest on this money by each of the Will Trusts with a deduction claimed by the Family Trust, creating assessable income to the Will Trust. It is intended that the beneficiaries would then distribute the interest money from their Will Trusts to themselves or their children.
The beneficiaries of the Family Trust are considering withdrawing the term deposit and paying the amount out of the Family Trust via a capital distribution, rather than a repayment of the loan. They would use this money personally to pay their mortgages etc.
This would leave a small amount invested with the whole of the original amount owing by the Family Trust to the Will Trusts.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
Summary
The interest is not deductible to the family trust where the money borrowed is not for income producing purposes.
Detailed reasoning
Section 8-1 of the ITAA 1997 provides a taxpayer with a deduction for a loss or outgoing to the extent to which it is incurred in gaining or producing the taxpayer's assessable income. A loss or outgoing is not deductible to the extent that it is:
§ a loss or outgoing of capital or of a capital nature;
§ a loss or outgoing of a private or domestic nature.
In this situation the loan to the Family Trust is an interest free loan from an individual which under the terms of the Will passes to the Will Trusts of the beneficiaries in equal proportions. If the Will Trusts each enter into agreements with the Family Trust to loan the amount as a loan with interest then this is a new loan arrangement.
Whether the Family Trust can deduct the amount of interest is determined by the income use of the money during the year, it does not matter how it was previously used. When the money is withdrawn from the fixed term deposit and returned as capital to the beneficiaries of the Family Trust there is no nexus between income producing purposes and the interest deduction. Therefore no deduction is available for the interest charged on this amount.
It is possible however that the smaller amount invested in a company could have interest deductions for the Family Trust and therefore be income of the Will Trusts. Without the loan agreement between the Will Trusts and the Family Trust it is not possible to answer questions 2 and 3 in regard to this amount.