ATO Taxpayer Alert on 'Hybrid Trusts'

[Terryw]

The ATO has just issued an alert which covers certain Hybrid Trusts:

TA 2008/3
Uncommercial use of certain trusts
http://law.ato.gov.au/atolaw/view.htm?DocID=TPA/TA20083/NAT/ATO/00001

From the end of the document:
The Tax Office considers that the arrangement outlined above may give rise to taxation issues that include:

1.
whether, and the extent to which, the taxpayer's borrowing costs are deductible under section 8-1 or section 25-25 of the Income Tax Assessment Act 1997 (ITAA 1997);
2.
whether a capital gain could arise under the capital gains tax provisions in Part 3-1 of the ITAA 1997 when trust interests are redeemed or new interests are issued;
3.
whether the taxpayer has 'created' a trust in which the taxpayer or their children have an interest, such that the trust may be subject to section 102 of the Income Tax Assessment Act 1936 (ITAA 1936); and
4.
whether the general anti-avoidance provisions in Part IVA of the ITAA 1936 may apply to the arrangement, on the basis that its dominant purpose is to enable the taxpayer to obtain a tax benefit.

 

[DavidMc]

I wonder what this means in English?

Can someone from Gatherum-Goss comment if my HDT is at risk?

 

[Mry]

All HDTs are at risk if the unit holders negatively gear income-only units that have no right to capital, or some sort of quasi-right to capital that doesn't relate to the underlying asset. It isn't a ruling, but a heads up.

GG's position is now that the units have a right to capital based on the underlying asset. Check your special income unit application page to confirm this.

 

[Terryw]

I think this means if your trustee has any discretion on who to distribute income or capital gains to, then the unit holder cannot commercially justify their claiming of interest.

 

[DavidMc]

That doesn't sound so bad then... I think?

In my trust 100% of the income is distributed to me because I am the own 100% of the units and I claim 100% of the interest on the loan for the units. I didn't think I could choose distribute income to my kids (if I had any). I thought that the trustee could only distribute income relating to the increased portion of the value of the units in a discretionary manner.

Have I got that right?

 

[Mry]

This Taxpayer Alert describes a non-arm's length arrangement under which a taxpayer uses borrowed funds to acquire an interest, such as units, in a certain type of trust, which uses the funds to purchase income-producing property. The arrangement seeks to provide income tax deductions to the taxpayer for all of their interest payments and other borrowing costs. The arrangement does not provide a sufficient connection between the expenditure and the production of future income and/or capital gains, which may be distributed to other beneficiaries of the trust, who may have a lower tax rate.

I suppose the HDT supporters will now claim that they have to go to court to prove they actually work because the ATO just shot them down. At this point, it is cheaper to own in your own name and sell to a DT later on.

The ATO has problems with HDTs that
1 - Do not entitle the unitholder to the capital gain from the underlying asset.
2 - Distribute profits to people while the unitholder is still negatively geared (you may have heard of people saying they can distribute profits from the 'growth' of the underlying property in the trust)
3 - Create interests to associates for no money down (eg where a person buys income units for say $400,000 and gives their spouse the capital unit for no money down)

The conclusions the ATO reach in plain english are -

1 - No negative gearing.
2 - Whether a full capital gain would be assessed to the taxpayer (it sounds like its either 1 or 2 for unitholders)
3 - Minor rates of tax in a trust (ie high)
4 - Penalties for seeking to avoid tax in what they consider to be a scheme.

 

[Mry]

I thought that the trustee could only distribute income relating to the increased portion of the value of the units in a discretionary manner.

Have I got that right?

No. Have a look at point 9.

9. Beneficiaries other than the taxpayer may, or may not, be entitled to trust income derived over the life of the investment. Where they are, the taxpayer's proportionate share of that income may be smaller than the proportion of the trust's capital which they funded using the borrowed money. In effect, this means that a proportion of the borrowed money is used to fund the production of income for other beneficiaries.

 

[DavidMc]

Thanks Mry.

Do you think it would be possible to amend a deed for it to comply or is the whole thing so fundamentally wrong it's not possible?

Say for example if it was amended so that no income or gains be distributed to beneficiaries (other than the taxpayer).

Do you think there are some HDT's that are fine and some that aren't or that all of them are at risk?

 

[Mry]

Do you think it would be possible to amend a deed for it to comply or is the whole thing so fundamentally wrong it's not possible?

Say for example if it was amended so that no income or gains be distributed to beneficiaries (other than the taxpayer).

Changing the deed around like that would mean a resettlement. You would need to pay stamp duty on the entire asset value of the trust and capital gains on the market value of the trusts's assets less their cost base would be incurred.

Do you think there are some HDT's that are fine and some that aren't or that all of them are at risk?

HDTs that issue units that have a right to the entire income and capital gains derived by a trust during the time of ownership and that have a capital gain on redemption equal to the market value of the asset that was funded by the units that were purchased should be ok.

It should be noted that the ATO are raising issues here that they could take a hard line on so you should speak to the person that sold you your deed to talk about what this alert means to you. They sold it, they told you how it worked, they can explain the mess they put you in.

 

[coastymike]

We haven't been using hybrid trusts for some time now and have moved to a different structure.

No disrespect MRY but the ATO does not reach those conclusions in that taxpayer alert. It raises concerns not conclusions and if you read the alert it does not provide an answer to the questions it raises.

A Taxpayer Alert provides taxpayers with concerns the ATO may have regarding arrangements and allows taxpayers to make informed decisions regarding entering into or considering entering into arrangements of the types discussed in an alert.

In fact PS LA 2005/13 states that an alert "As noted earlier, the publication of a taxpayer alert is principally intended to ensure that taxpayers and their advisers are informed that the scheme described is under risk assessment by the Tax Office. The subsequent publication of the ATO view in respect of a published taxpayer alert ensures that taxpayers and their advisers are further informed of the Tax Office's position in respect of that scheme. It is therefore anticipated that the need for a published taxpayer alert to be altered or withdrawn will arise infrequently. "

Alerts do not provide a definitive conclusion on the outcome. It informs people of the concerns that need to be addressed by the ATO as part of their risk review.

 

[Mry]

No disrespect MRY but the ATO does not reach those conclusions in that taxpayer alert. It raises concerns not conclusions and if you read the alert it does not provide an answer to the questions it raises.

I concede that to you coasty, but when the ATO uses the word 'purport' in their taxpayer alert, they are issuing an opinion in that area that they consider the scenario they are describing to be unworkable.

 

[Pat]

I wonder what this means in English?

Can someone from Gatherum-Goss comment if my HDT is at risk?

Hi David,

The trust deeds issued to GGA clients for negatively gearing through a HDT are an excellent document and comply with the law. Those promoters that say the discretion of the capital gain can be to lower income beneficiaries other than the unitholder while units are on issue, will find that the ATO will disallow such practice.

As Dale mentioned in his August 2007 article in API magazine and as I have in our Spring 2007 newsletter, the units will always be valued at their market price as they relate to the underlying value of the property.

Sleep soundly David.

 

[asdf]

I believe theres a few HDTs setup in recent years. Any forumites getting their HDT reviewed and/or fixed up where necessary? Private Ruling perhaps?

 

[JamesGG]

As Dale mentioned in his August 2007 article in API magazine and as I have in our Spring 2007 newsletter, the units will always be valued at their market price as they relate to the underlying value of the property.

Hiya,

I have deliberately stayed out of the accounting section of this forum for quite a few months now. However, I do not think it fair or appropriate for Dale to be misquoted, particularly when he is not present to clarify otherwise.

To confirm, he has never stated that unit values must relate to the value of the trust assets, in that article nor anywhere else.

Cheers

James.

 

[austini]

... The trust deeds issued to GGA clients for negatively gearing through a HDT are an excellent document and comply with the law. Those promoters that say the discretion of the capital gain can be to lower income beneficiaries other than the unitholder while units are on issue, will find that the ATO will disallow such practice....

Hi Pat,

Does this apply to "all" MGS HDT deeds sold to clients since around 2004? If what I heard is correct, about a year or so ago MGS added/changed a few clauses to their deed (and modified the Unit Application & redemption forms?) in relation to such things as restrictions on distribution of capital whilst Units are on issue etc. So although the newer MGS deeds (and related Application & redemption forms) available for the last 12 months or so may be somewhat more robust, what about those original MGS HDT deeds that were sold to clients before then when HDTs were all the rage?

I thought it would be worthwhile asking this as there was probably a lot more HDTs (using the original MGS deed) setup prior to the last year or so when it become apparant that some of the benefits originally promoted were no longer there etc.

Cheers - Gordon

 

[WASP]

Be nice to have Chris Batten drop in again as well

HDT's as always a hot topic on SS

 

[rodimus]

I just bought ahome + land package into my HDT. Should I sell it to my Unit Trust and Discretionary Trust while the building is still not complete? Save some stamp duty?

This is considering the uncertain future of ATO's view on HDT.....

 

[JIT]

"enabling the taxpayer's interest in the trust to be redeemed at face value, or face value, adjusted for inflation. "

I think this is the bit Batten may have been suggesting a unitholder might do (but I could be wrong), and which the ATO are now pointing out (without making a clear commitment as to where they stand it seems) in this 'TA'.

Is there a PBR on the way for the MGS Deeds??

The ATO are asking for them now?

 

[Twitch]

LOL, I've had laptops with a longer usable life than a HDT deed. Considering trust deeds need a shelf life of 80 years, that's a worry.

 

[Ebbie]

If what I heard is correct, about a year or so ago MGS added/changed a few clauses to their deed (and modified the Unit Application & redemption forms?) in relation to such things as restrictions on distribution of capital whilst Units are on issue etc.

Hi Gordon,

I have numerous MGS HDT deeds, the first was purchased in 2002 and the most recent in 2008.

The only clauses that seem to have changed include:

1) New clause inserted at 1.12 - definition of 'Social Security and/or Veterans'

2) New clause 1.21 - something about 'references to statute or statutory provisions' and 'legislation made under the relevant statute' etc.

3) New clause inserted at 6 (w) - allows trustee to appoint a power of attorney.

4) Clause 25 a, b & c rewritten - means-tested Centrelink and/or Veterans' Affairs is now called Social Security and/or Veteran's Affairs Payment. No mention of means-tested.

So in answer to your question I can't see any obvious changes to the actual deed regarding the distribution of Capital, but the following line has been inserted on the Unit Application form:

Clause 2 - CAPITAL: Apart from their entitlement under the heading of REDEMPTION in this application, the holders of Special Income Units....etc.

Hope this helps.

Regards, Ebbie.