The Administrative Appeals Tribunal (“AAT”) have determined once again that when an individual borrows money from a bank, and then puts the money into their discretionary trust, a tax deduction can not be claimed for the interest expense if they haven’t dotted their i’s and crossed their t’s.

Discretionary Trusts are Discretionary

This is because no individual has any fixed entitlements to receive income distributions from their trust.

Which is pretty much the whole point of a discretionary trust, being that you want to have “discretion” each year to decide where the income goes, and therefore where the tax gets paid.

Loans in Individual Names Easier to Secure

Of course as many CapitalQ Community Members will know, it is much easier to get a bank loan in your personal name, and then put those funds into your trust for your trust to invest, be it in to a business or other potential income earning assets.

So, what can be done?

Avoid Cutting Corners

The answer is the individual must have a formal loan agreement with their trust, and must charge market interest on the funds placed into the trust.

The result is that in the individual’s name, they have interest income (from the trust) which is offset against the interest expense paid to the bank on the bank loan.  Net result in the individual’s name is therefore nil.

However, in the trust, it now has a tax deductible expense, being the interest paid to the individual, which it can offset against the income the trust earns on its business or investing activities.

Problem solved.

Latest Reminder

But as the AAT have once again confirmed in Chadbourne v FC of T [2020] if you cut corners and don’t implement a formal loan agreement with your trust, and you don’t recognise the interest in the right place, then your deduction will be denied every time!