Tax Effectively Giving to Your Children at Christmas

With Christmas just around the corner, many families in business are talking to their Perth tax accountants about how to give money to their children tax effectively.

Is it a gift or a loan?

When parents decide to transfer money to their children, it’s crucial to determine if the transfer is a gift or a loan. In Australia, giving cash gifts to your children is free from any taxation or legal restrictions. However, it’s important to note how such gifts might affect eligibility for certain Centrelink pension benefits, as they might be considered when assessing assets or income. This consideration extends to not just cash gifts but also to paying off debts for your children or transferring assets like houses or cars at below market value.

For international fund transfers, it’s essential to be aware of the regulations in the country involved. The absence of reporting or income tax implications for cash gifts in Australia doesn’t automatically apply globally. Different countries may have varying rules regarding such transactions.

If it is a loan

After determining that the transferred funds constitute a loan rather than a gift, the crucial next step is to ensure accurate documentation. This is important irrespective of how the funds are used or the nature of the lending entity. Documenting the loan amount and terms is vital because disputes over whether the funds were a gift, or a loan are standard in the Family Court.

In situations of relationship breakdowns, the Family Court needs to ascertain whether the funds were gifts or loans to assess the asset and liability pools properly. Often, funds transferred between parties are not adequately recorded as either a loan or a gift, leading to potential issues of perceived unfairness in dividing assets. Therefore, regardless of the loan’s purpose or the lender’s identity, written documentation is always beneficial and can prevent future complications.

We have seen loans take on many forms.  One option is for the loan to be a limited recourse loan when the loan is only repayable on say, the sale of a property or the death of the parents.

Additional loan considerations

When a family business entity makes a loan, there are several vital points to consider:

  1. Compliance with Division 7A Rules: Check if the loan falls under Division 7A, which mandates a maximum term of 7 years for unsecured loans or 25 years for secured ones, along with an ATO benchmark interest rate (currently 4.77%). If your business is subject to these rules, ensure the loan’s terms to your children align with or are more favourable than these requirements.
  2. Consequences of Non-Compliance with Division 7A: If Division 7A applies and its conditions are not met, this could lead to unfavourable results, such as the necessity to declare dividends for minimum repayments and possible tax liabilities.
  3. Consideration under Corporations Act Section 260A: If the loan is for purchasing an interest in the business, it might be viewed as a ‘provision of financial assistance’ under Section 260A of the Corporations Act 2001. Ensure compliance with this section, including resolutions, general meetings, and lodging forms with ASIC.
  4. Impact on Retirement Planning: When helping a child buy into the family business, this should be integrated into retirement planning. Seeking specialised advice on how government benefits like Centrelink can impact such cases is advisable.
  5. Effects on Business Cash Flow and Solvency: The loan should not adversely affect the business’s ability to meet its debts. If the loan leads to insolvency, it might be considered a preferential payment subject to recovery. Additionally, any asset bought with the loaned funds might have to be sold to repay creditors.
  6. Estate Planning Considerations: When lending funds to one child, it’s essential to consider how this will affect the overall estate plan and balance the net asset distribution among other children. This requires careful planning to ensure fairness and address all parties’ interests.

Understanding the implications of lending money from your family business to your children is critical. Making informed decisions, ideally before the transfer of funds and with proper documentation, is essential from financial, taxation, and legal standpoints.

Taxation on gift-giving

While most Perth tax accountants will tell you that Australia does not tax gifts from parents to their children, the nature of the gift given can attract taxation.

If you are giving an asset like a house, the transfer of the asset will attract transfer duty and possibly capital gains tax.  The Australian Tax Office will deem the home to be sold for total market value.  The fact that you are not receiving the sale proceeds and the fact that you are transferring the house to your family member and not to an outside person will have no impact.

The ability to gift tax-free money to your children is not shared worldwide.  Many countries like Germany or the UK have a gift tax, which effectively comes from persons attempting to avoid a death tax So, if your family have offshore assets, talking to a Perth tax accountant with a worldwide network of tax advisors like GGI Global is important so your overall position is considered.

Family trust and gift-giving

A family trust also allows you to gift income not yet taxed from your business or investments to a child.  If the child is on a lower (or zero) tax rate, you can potentially gift more income to that child than if the gift is done from your after-tax income.

If your trust allocates and gives $20k in income/cash to an adult child who is not earning income, that $20k of allocation (gift) will be tax-free.  However, if that same allocation of income went to a high-income earning parent and were then paid to the child, the ultimate cash payment would only be $10,600.

The law surrounding family trusts is complex, and your Perth tax accountant needs tax advice to get it right.

Giving money to your children’s super fund

If you transfer money directly to your children’s superannuation fund (or self-managed superannuation fund), you cannot enjoy a tax deduction for the contribution.

One option is for you to give the money to your children, who then make a personal concessional contribution to their superannuation fund.

The contribution of monies to your child’s superannuation fund will still be subject to tax laws that restrict (or penalise) excessive contributions to a superannuation fund.  A Perth tax accountant can give tax advice on the maximum amount you can contribute to your child’s superannuation fund without triggering excess concessional or non-concessional contributions tax.

Giving money to your children when you die

With many people’s lives extending, the concern about giving away “too much” is genuine.  Most families will maintain a comfortable nest egg that will only be given to the children on death.  Otherwise, the gift might leave the parents financially vulnerable later.

What is a testamentary trust?

Testamentary trusts, created through Wills, and with the guidance of your Perth tax accountants allow trustees to determine which beneficiaries may receive distributions from the trust periodically. These trusts are advantageous when included in Wills.

After a Will-maker’s death, their assets are allocated to the testamentary trust’s trustee(s), who manage these assets on behalf of the named beneficiaries. This arrangement means the assets are not given directly to beneficiaries but are held by a trustee in a trust fund for their benefit.

These trusts are tailored for optimal flexibility, enabling tax-efficient distribution of assets’ capital and income. They also offer enhanced asset protection compared to direct asset holding by beneficiaries.

How is a testamentary trust tax effective?

Under an ‘ordinary’ trust, if a beneficiary takes their inheritance in their name, they must pay tax on the income generated at the top marginal tax rate. If a child under eighteen receives over $416, they must pay the associated tax at the maximum marginal rate.

However, under a testamentary trust, children under eighteen are taxed as ordinary taxpayers, commencing at the lower tax rates. Compared to distributions made directly or under family law trusts, this results in considerable reductions in the total tax payable when distributions are made to children and grandchildren (until they reach the age of eighteen).

Capital gains realised on assets held by a testamentary trust can also be streamed to one or more beneficiary’s tax-effectively. Where one or more beneficiaries have a low income in the year of distribution, distribution to this beneficiary allows them to take better advantage of the five-year averaging rate of capital gains and tax losses. Tax payable on capital gains on realised assets can be considerably reduced.

Taxation of children’s Christmas investments

If you give an investment to a child as a Christmas gift, the income from that investment is taxed differently. 

When a bank account is opened in a child’s name with an adult as the signatory, the accounting of the income from this account is determined by the circumstances. If the account’s funds originate from the child’s sources, like gifts received on Christmas and birthdays, earnings from a part-time job, or pocket money, and are exclusively used by the child, then the income is considered the child’s income. In this case, taxation of that income is taxed at ordinary marginal tax rates.

However, if the account is owned and funded by parents, other family members, or friends, withdrawals are made for the child’s expenses (or other purposes). The income generated from this account is attributed to the adult signatory. This income must be declared in their personal income tax return.  Alternatively, if the account is held by the child and is funded by the parents, the child will pay tax on that income at top marginal tax rates.

Some investment advisors will also recommend insurance bonds for children, which can be tax-advantaged.

Insurance bonds are considered ‘tax paid’ investments because the life company pays taxes on earnings at a 30 per cent rate before distributing returns. Depending on the bond’s assets, the effective tax rate might be lower than 30 per cent due to factors like franking credits from shares and other permissible deductions.

While the 50 per cent discount on capital gains tax doesn’t apply to gains within the bond, these investments can still be financially efficient, particularly for individuals with higher incomes, compared to unit trusts or fixed-interest investments.

Holding bonds for over 10 years allows for tax-free cashing in, as any growth is not included in the investor’s taxable income when withdrawn after this period. Withdrawals before the eighth year result in the growth portion being taxed at the investor’s marginal rate as part of their assessable income. For withdrawals between the eighth and ninth year, two-thirds of the growth is taxable, and if withdrawn between the ninth and tenth year, one-third of the growth is considered taxable income.

In this instance, getting clear investment advice from a licensed investment advisor or financial planner is essential.  You could easily have two insurance bonds with the same tax outcome – but one has excellent investment returns, and the other has mediocre returns.

Getting it right

The desire for a successful family in business to support and extend the next generation is often a primary reason why the family created the family business in the first instance.  And given that taxation can effectively half the gift to your children, getting clear strategic tax advice from your Perth tax accountant is vital to ensure that your success plan and gifting strategy are done well.  At Westcourt, we have one purpose: to help families in business become great.  And given our proven tax expertise, deep global connections through GGI Global and local service focus, we are the clear choice for families in business looking to take control of their affairs – so why not give us a call?

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