In our 'Restructure Series', we focus on various structures throughout the lifespan of a business from setup to growth to exit and how to restructure a business to achieve that purpose.
In this tax tip, we focus on a strategy of building wealth from a business through property investment, whether you operate your business through a family trust or a private company.
Trading Trust
Client A operates a business in Trust T.Trust T's excess profits are distributed to Corporate Beneficiary D.
Trading Company
Client A operates a business in Company C.
Company C pays dividends to Family Trust F.
Family Trust F distributes excess funds to Corporate Beneficiary D.
Wealth Building Strategy
In either case, Corporate Beneficiary D has funds which it can invest.
One strategy could be for Corporate Beneficiary D to lend those funds to Investment Trust I to purchase real estate.
Tax Tip
The loan from Corporate Beneficiary D is subject to Division 7A, however the loan terms can be for 25 years if:
1. the loan-to-value (LVR) ratio is 10/11 (being 90.9%) which includes all borrowings that are secured over the real estate (e.g. from third party financiers); and
2. the security provided is a registered mortgage - thus the strategy applies to real estate.
In the scenario where the proposed real estate purchase is the only security, the Investment Trust can borrow up to 90.9% of the purchase price and apply the 25 year arrangement to its borrowings from Corporate Beneficiary C. If the Investment Trust wanted to borrow the remaining value of the purchase price and transaction costs (such as stamp duty, legal fees, government fees) from Corporate Beneficiary D, those borrowings are subject to the 7-year arrangement.
Worked security example:
purchase price $1M
borrowings from third-party financier (e.g. bank) - registered mortgage - $800,000
borrowings from Corporate Beneficiary D - 2nd registered mortgage - $109,090 under 25 year arrangement as both secured borrowings reach 90.9% LVR
borrowings from Corporate Beneficiary D, $90,910 plus transaction costs under 7 year arrangement
Alternatively, if other real estate security could be provided for the remainder of the purchase price and transaction costs (if Client A has equity in other investment real estate and/or principal residence), then the borrowings from Corporate Beneficiary D, representing the remainder purchase price and transaction costs, can apply the 25 year arrangement.
Worked security example:
Real estate purchase
purchase price $1M
borrowings from third-party financier – registered mortgage (e.g. bank) - $800,000
borrowings from Corporate Beneficiary D – registered 2nd mortgage - $109,090 under 25 year arrangement as both secured borrowings reach 90.9% LVR
Existing real estate
value - $0.8M
borrowings from third-party financier - registered mortgage – $0.5M
90.9% LVR equity - $227,272 (being $0.8M x 90.9% minus $0.5M)
borrowings from Corporate Beneficiary D – registered 2nd mortgage over existing real estate - $90,910 plus transaction costs, to a limit of $227,272, under 25 year arrangement
Proposed changes to Division 7A mooted in 2018
In 2018, Treasury mooted targeted amendments to Division 7A which included changing all Division 7A loans to a single 10 year arrangement and this would include changing the 25 year arrangement. It was also mooted 25 year arrangements would be offered a transitional period of 2 years and, thus, in effect any existing 25 year arrangement would have a 12 year remaining lifespan.
Those changes were mooted over 4 years ago and it appears they are not a top priority for the government. Nonetheless, even if the changes become law soon, or in the future, it would be better to have an existing 25 year arrangement in place now and be availed of the 12 year change because if the proposed changes become law then any new Division 7 arrangements are limited to 10 years.
LGA Lawyers’ view is that a 25 year arrangement is appropriate and the government ought not change it given the security is a registered mortgage and the risk to revenue is low given the 90.9% LVR meaning a sale of the property would, in the vast majority of cases, yield sufficient sale proceeds to repay the Division 7A.
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