Recently there has been some heated discussion in our office regarding overdrawn (debit) beneficiary accounts in a discretionary trust setting.
We have some clients who have historically implemented a “debt swap strategy” by taking a line of credit to pay business expenses and drawing out the free cash this has created via their beneficiary drawings account. So end result – CR LOC and claiming an interest deduction and DR Beneficiary Account. Although the actual purposes for borrowing the funds does have a nexus with earning assessable income, the resulting artificial arrangement doesn’t pass the smell test for me and I am concerned interest should be charged to the beneficiary on the overdrawn account (or converted to a loan).
Can anybody provide their thoughts or direct me to relevant cases or rulings on this arrangement?
I’m not fully following the sequence of events here:
Where you say “the client takes a LOC to pay deductible business expenses” is it the trust who takes a LOC, or the individual beneficiary?
– if it’s the trust, it’s prima facie deductible interest
– if it’s the individual, it’s not deductible
Assuming it is the trust with the LOC, the issue you may run into is proximity and matching of transactions. If there’s a clear scheme/strategy/arrangement to obtain an interest deduction for payments to beneficiaries, there is a risk being taken. Other than that though, I think it’s like any other trust with deductible debt and debit loans to beneficiaries.