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Discretionary Trust Basic Questions

Discussion in 'General Investing Discussion' started by BigStrawbs, 16th Oct, 2009.

  1. BigStrawbs

    BigStrawbs Member

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    I have recently established a Discretionary Trust with a Corporate Trustee. A couple of basic questions:
    1) I am paying all adhoc expenses via my personal credit card on behalf of the Trust with such reimbursing me on a monthly basis (I am using formal paper work for this). Is this OK?

    2) I assume it is OK for the Trustee to invest the money held in the Trust throughout the year with the earnings from such making up part of the Trust profit? There will be about $50,000 or so throughout the year waiting to be distributed to my wife in June, so the investment income will not be large but I am keen to get better than bank interest.

    3) Should the start-up capital (only $3500 as I am a service based entity) be a loan or
    gift? I see the benefits of a loan but seems allot of paper work for such a small amount

    Yes, my accountant should have answered these when setting things up…. So lets just say I will be finding a new Accountant!

    Cheers,
    BigStrawbs.
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    1. yes, this is how I do it too. Trust reimburses me for expenses I incur on its behalf.

    2. I'm not exactly sure I understand the question. Is is that you've earned $50,000 or so from some activity and this money is currently sitting in the trust waiting to be distributed at the EoFY - you want to invest that money in the interim to earn better than bank interest?

    If this is the case - I don't see anything wrong with investing it. Just be aware that you will be required to distribute all net income at the end of the year, so if your capital is tied up in investments, you may not be in a position to do so - although you could always do a "book entry" distribution with a loan directly back to the trust from the beneficiary, so no cash actually needs to leave the trust (the beneficiary still needs to pay tax on that distribution, even if they didn't get the cash, and they can legally demand the cash at any time).

    Also consider the time frame of your investments - if you are intending to distribute the whole amount at the EoFY, you've only got 6-8 months to make your returns ... you don't want to be investing in something risky which could see you lose some of that capital during that time. With such a short timeframe, cash might actually be the best option?

    3. Loans are good from a tax point of view since you can subsequently draw this money back out of the trust without paying tax on it (as opposed to a gift - you'll need to take a potentially taxable distribution to get that money back out again if you need it). The downside with loans is that it has asset protection implications - your loan to the trust is an asset you own, which your creditors could lay claim to if you personally get into financial difficulty. Not sure which would be better for such a small amount of money.
     
  3. BigStrawbs

    BigStrawbs Member

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    Thanks

    Thanks Sim, your reply is much appreciated.

    Apologies for not being clearer on Q2 but you certainly did answer the question I was (trying...) to ask.
     
  4. jrc77

    jrc77 Well-Known Member

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    Trust income net

    On a related theme ... Sim mentioned the net income needs to be distributed from the trust (or book entry put in to loan back).

    What is the net income in the following situation:

    Trust has outstanding loan (say $40,000) from one of beneficiaries.
    Someone works through the trust and the trust receives income of $150,000 from clients.
    The trust pays the employee $80,000 to provide the services for the clients.
    The trust pays $10,000 worth of expenses incurred in providing the services.
    The trust repays the loan ($40,000) during the financial year.

    Is the net income to be distributed:
    a. $150,000 - $80,000 - $10,000 = $60,000.
    b. $150,000 - $80,000 - $10,000 - $40,000 (loan repayment) = $20,000

    Regards,

    Jason
     
  5. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    It would be the first option ($60,000), since loan repayments are made out of capital and not income.
     
  6. ashwright

    ashwright Well-Known Member

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    On this note, is there any way of the trust to increase its capital? If it has to pay out all income (which includes capital gains).

    For example if in the example above the trust has $40K capital (in the form of a loan). And then has to pay out all income, it still has only $40K capital (and a 40K loan).

    Is the only way to increase the capital of a trust to either gift or loan money into it? It can't increase its capital on its own?

    Thanks,
    Ash.
     
  7. jrc77

    jrc77 Well-Known Member

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    The trust can hold assets that increase in value - hence increasing capital - shares/property etc. It's only the income (minus expenses) that needs to be distributed.

    Regards,

    Jason
     
  8. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Pretty much, yes.

    Loans can be from a bank, a beneficiary, or from any other source really.

    Increase in capital value of assets is nice - but it's only practical if you either borrow against it (ie a bank loan), or sell the asset and realise the capital gain - which must then be distributed and gifted or loaned back to the trust.