If a discretionary trust wants to lend money, it must first determine whether the terms of the trust permit it. If the trust deed is silent on the matter, the trustees may have implied authority to lend money if it is in the best interests of the beneficiaries. However, the trustees must exercise caution when lending money, as they may be held personally liable if the loan is not repaid. They should also consider the tax implications of the loan, as any interest earned on the loan may be subject to income tax.
Trust Powers and Lending Authority
A discretionary trust, also known as a flexible trust, is a type of legal arrangement that gives the trustee broad discretion in managing and distributing trust assets. While the specific powers granted to a trustee may vary based on the trust document, in most cases, a discretionary trust will include the power to lend money.
The power to lend money is a valuable tool that can be used by a trustee to generate income for the trust, support the beneficiaries, or achieve other investment objectives. However, it’s important to note that the trustee must always act in the best interests of the beneficiaries and comply with the terms of the trust document.
When considering whether to lend money, the trustee should carefully evaluate the following factors:
- The purpose of the loan.
- The amount of the loan.
- The terms of the loan, including the interest rate, repayment schedule, and collateral (if any).
- The creditworthiness of the borrower.
- The potential risks and rewards of the loan.
If the trustee determines that a loan is in the best interests of the trust, they may proceed with the transaction. However, it’s important to document the loan carefully, including the terms of the loan, the security (if any), and the repayment schedule.
| Advantages of Trust Lending | Disadvantages of Trust Lending |
|---|---|
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Tax Implications of Trust Loans
Discretionary trusts can lend money, but the tax implications of these loans must be carefully considered.
- Income tax: Interest earned on a loan from a discretionary trust is generally taxable in the hands of the lender (the trust). However, if the loan is made to a related party (such as a family member), the interest may be subject to special tax rules.
- Capital gains tax: If the loan is repaid in full, the lender may be liable for capital gains tax on the difference between the amount of the loan and the amount repaid.
- Land tax: If the loan is used to purchase land, the lender may be liable for land tax on the land.
The table below summarises the tax implications of trust loans:
| Loan type | Income tax | Capital gains tax | Land tax |
|---|---|---|---|
| Loan to a related party | Interest may be subject to special tax rules | No | No |
| Loan to an unrelated party | Interest is taxable in the hands of the lender | Yes | Yes |
Discretionary trusts are commonly used for asset protection and tax planning. However, they can also be used to facilitate lending arrangements.
Repayment Arrangements
- Repayment Schedule: The trust deed or a separate loan agreement should specify the repayment schedule, including the frequency and amounts of repayments.
- Interest Rate: The loan may be interest-free or charge a fixed or variable interest rate. The rate should be commercially reasonable to avoid tax implications.
- Term: The loan should have a fixed term, although it may be renewed or extended if agreed upon by the parties.
- Default Provisions: The loan agreement should clearly outline the consequences of default, such as late payment penalties or the right to enforce security.
Security
Security is an important consideration to protect the trust’s assets in case of default. Common types of security include:
| Type | Description |
|---|---|
| Personal Guarantee: | A guarantee from an individual, typically the beneficiary of the trust, promising to repay the loan if the trust defaults. |
| Charge over Assets: | A legal interest created over specific assets of the trust, such as real estate or investments, to secure the loan. |
| Security Interest: | A lien or encumbrance on specific assets of the beneficiary of the trust, such as a shareholding or personal property. |
Ethical Considerations for Trustees
When a discretionary trust lends money, the trustee has a fiduciary duty to act in the best interests of the beneficiaries. This means that the trustee must:
- Consider the potential risks and benefits of the loan before approving it.
- Ensure that the loan is made on commercial terms.
- Obtain independent legal and financial advice if necessary.
- Monitor the loan and take steps to protect the trust’s assets if the borrower defaults.
| Duty | Description |
|---|---|
| Duty of care | The trustee must exercise the same degree of care and skill as a prudent person would in managing their own affairs. |
| Duty of loyalty | The trustee must act in the best interests of the beneficiaries, even if this means sacrificing their own personal interests. |
| Duty of impartiality | The trustee must treat all beneficiaries equally, even if this means that some beneficiaries receive less than others. |
If a trustee breaches their fiduciary duty, they may be held personally liable for any losses suffered by the trust.