Another Blow to Hybrids

[julia]

Is this the final straw for Hybrids or will this PBR be challanged.

http://www.ato.gov.au/rba/content.asp?doc=/rba/content/66298.htm

Basically says that you only get a deduction for the interest equal to the amount of income received. Seems to cover typical Hybrid arrangement but there are many variations.

 

[davea]

Very basic cals

Interest 180k
Estimated Value of Property (interest rate 8%) - $2,250,000
Rental Income - $60,000

Yield 2.67%

Seems to be a fairly low yield for the property. Maybe it is a comerical property and not residential. (I noticed it said something about residential in the later part)

Be interesting to see what the pros say about this ruling...

 

[geoffw]

This may be why Chris Batten has previously suggested that the jury is still out on the Hybrid Trust- and that the wording of the deed is all important.

 

[alexlee]

Ouch. I still need to read the judgement in detail but the first page seems pretty clear. Are these rulings retrospective? i.e. how does it affect past tax returns done for HDTs and individuals who deducted the full amount of interest?
Alex

 

[julia]

Geoff,

I think it is a catch 22. If your deed is flexible enough to allow you to shift to the discretionary beneficiaries when it is positively geared or sold for a gain then you will not get a full deduction for the money borrowed by the high income earner for the units.

 

[alexlee]

Very basic cals

Interest 180k
Estimated Value of Property (interest rate 8%) - $2,250,000
Rental Income - $60,000

Yield 2.67%

Seems to be a fairly low yield for the property. Maybe it is a comerical property and not residential. (I noticed it said something about residential in the later part)

Actually it's not unrealistic. 4% yield (not uncommon, esp in Sydney), less agents fees, council rates, insurance, etc and DEPRECIATION (here it works against you) and it may very well be only a 2.5% net yield. Yields on commercial are usually higher (especially as many leases state that tenant pays all outgoings) so negative gearing is less prevalent with comercia. Irrelevant in this case as the ruling specifically states that the rental propety will be a residential property.

The size of the numbers aren't as important. It's the FACT that you can't claim more deductions than the net income that's important. What the ruling says is that you CANNOT claim interest such that you achieve negative gearing with a HDT. Prima facie, this makes the HDT no better than an ordinary discretionary trust.
Alex

 

[julia]

Alexlee,

The ruling is the ATO's interpretation of the law and does not contradict anything else they have said so it does not change the law in anyway. This is how the ATO will apply it to the past returns you have lodged.

 

[alexlee]

Alexlee,

The ruling is the ATO's interpretation of the law and does not contradict anything else they have said so it does not change the law in anyway. This is how the ATO will apply it to the past returns you have lodged.

I see. The usual idea of 'just because we've never explicitly considered this against the rules in the past doesn't mean previous returns lodged were legit'. I'm sure people will challenge this in court, though?
Alex

 

[GreatPig]

This is because your motives for purchasing units in a trust where the capital return is discretionary include the private purpose of asset protection.

I fail to see how discretionary distribution of capital gains implies a private purpose of asset protection. What do capital gains have to do with asset protection?

Their argument of no obvious commercial explanation is more logical though.

GP

 

[julia]

Alexlee,

I see. The usual idea of 'just because we've never explicitly considered this against the rules in the past doesn't mean previous returns lodged were legit'. I'm sure people will challenge this in court, though?

That is why we have a private ruling system. Did you get one before you entered into the arrangement?

Dale is going to write an article for API as soon as things are a bit clearer.

 

[GreatPig]

What the ruling says is that you CANNOT claim interest such that you achieve negative gearing with a HDT.

It doesn't say that. What it says is:

An interest expense is not fully deductible in those cases where the expected return from the units, both income and capital growth, does not provide an obvious commercial explanation for incurring the interest.

If capital gains are not distributed to the unitholder - or rather, if the unitholder has no right to capital gains - then this would likely be the case where the income return is less than the loan interest.

If capital gains are also distributed to the unitholder, then I think there would be an obvious commercial explanation, provided of course that the likelihood of capital growth and income exceeding the interest rate was good (as it typically is with real estate).

GP

 

[alexlee]

I fail to see how discretionary distribution of capital gains implies a private purpose of asset protection. What do capital gains have to do with asset protection?

Putting something in a trust IS for asset protection. If you write the deed such that capital growth of an asset can be distributed in a discretionary way, that means your creditors can't get at it if they sue you personally because you have no claim to the CG.
Alex

 

[alexlee]

If capital gains are also distributed to the unitholder, then I think there would be an obvious commercial explanation, provided of course that the likelihood of capital growth and income exceeding the interest rate was good (as it typically is with real estate).

GP

But if you write the deed so that the unit holder has a claimable right to CG, aren't you also destroying the asset protection benefits? i.e. if I hold units that have a legal right to both income and capital (as opposed to where CG distribution is discretionary) then if someone sues me creditors can legitimately claim the CG from the trust, in the same way as creditors can call in loans I have made to other people?

In that case I might as well just hold the asset in my own name.
Alex

 

[julia]

In that case I might as well just hold the asset in my own name.
Alex

Yep and a lot cheaper too.

 

[GreatPig]

if someone sues me creditors can legitimately claim the CG from the trust

Actually this introduces another issue: if the unitholder is entitled to CG, then that must impose some restrictions on unit redemption. If the trustee can always redeem the units at face value, then effectively the unitholder has no guarantee of receiving CG, as the trustee could redeem the units before selling the asset.

So it seems to me that unless the trust deed also states that units must be redeemed for the market value of the asset, then there would be a loop hole to get around the CG distribution, even if the units did entitle the holder to capital growth.

And the trustee might also be able to just refuse to ever sell the asset.

GP

 

[julia]

I think it is a catch 22. If your deed is flexible enough to allow you to shift to the discretionary beneficiaries when it is positively geared or sold for a gain then you will not get a full deduction for the money borrowed by the high income earner for the units.

And if it isn't that flexible there is no point in having the HDT.

 

[alexlee]

Actually this introduces another issue: if the unitholder is entitled to CG, then that must impose some restrictions on unit redemption. If the trustee can always redeem the units at face value, then effectively the unitholder has no guarantee of receiving CG, as the trustee could redeem the units before selling the asset.

So it seems to me that unless the trust deed also states that units must be redeemed for the market value of the asset, then there would be a loop hole to get around the CG distribution, even if the units did entitle the holder to capital growth.

And the trustee might also be able to just refuse to ever sell the asset.

That's another unresolved issue. If the trustee redeems the units at FV:
1) Will the ATO deem the units to have been redeemed at market value, making the individual liable to tax, and
2) How will the courts look at the value of the units in the case of a bankruptcy proceeding?
Alex

 

[GreatPig]

How will the courts look at the value of the units in the case of a bankruptcy proceeding?

Another question is can the courts force the trustee, who would not be the bankrupt by that time, to either redeem the units or sell the associated asset?

GP

 

[DaleGG]

Hi

As Chris batten has stated, we should all know reasonably soon what the tax office are thinking abt in terms of HDT's.

The important thing to remember here is that it is a PBR. That is, a Private Binding Ruling that applies ONLY to the person who asked for it and based on their particular circumstances and their particular trust deed.

So, a different trust deed or different circumstances may bring a different answer.....

Lastly, this ruling is merely the tax office's opinion and does not constitute law.

To be honest, whilst these PBR's do concern me in general, I am waiting on more definite answers to come from the discussions and submissions made by Batten before I make any decisions.

I will keep you posted.

Dale

Ouch. I still need to read the judgement in detail but the first page seems pretty clear. Are these rulings retrospective? i.e. how does it affect past tax returns done for HDTs and individuals who deducted the full amount of interest?
Alex

 

[Rolf Latham]

Im thinking some application of the principles in a court will bring some clearer resolution, in the meantime, its business as usual.

while its wise to be "careful" ..........if we put off making structure or investment decisions every time the ATO or a regulator sneezes no one would get anywhere.

One BIG issue with the tax office in Australia is that they are a law unto themselves, and whats ok this week might not be next week.

As we all know, the ATO can reverse and obliterate its own decisions, or change the date of an event or preted that it never happened, without any real regard to the impact of the tax payer.

This really sucks where you are an investor or you are in business because you never ever have a solid foundation to go forward on............a decision you make today might kill you in the future, because the ATO has reversed a decision...

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