Discretionary distribution of property income?

[Harriet]

Hello,

I have three IPs owned within a hybrid family trust.

The unit-holding structure is 50/50 between my husband and me. There is debt on all three properties.

My accountant is telling me that any income derived from these properties can ONLY be distributed according to the unit-holding structure.

That is, we cannot discretionarily distribute any of the income from these properties to other family members.

I am really confused, as I thought this was the whole point of having a hybrid trust?

Or does the restriction she is describing only apply while there is still debt owing on the properties?

Can someone explain for me, please?

Thank you.

 

[Harriet]

Here are her words:

Because the property income is distributed in accordance with unitholding structure, there is no discretion for property income distribution.

 

[Terry_w]

It all depends on the wording in the trust deed.

If you the unit holders have been claiming all the interest then it is likely that only the unit holders can receive distributions of the income and capital - otherwise the interest would not be claimable in full.

 

[Scott No Mates]

Is it a unit trust (with defined distribution) or a discretionary trust (allowing the distribution at the discretion of the trustee)?

 

[alexlee]

Is it a unit trust (with defined distribution) or a discretionary trust (allowing the distribution at the discretion of the trustee)?

That's supposedly the idea of the hybrid trust. It's a unit trust when there are units on issue, but turns into a discretionary trust when units are redeemed.

 

[Harriet]

Hello,

Yes, we have been claiming all the interest between husband and me.

It is a hybrid trust (unit plus discretionary).

When and how are units "redeemed"? In lay terms, is that what happens when the debt is paid?

Thanks.

 

[alexlee]

When and how are units "redeemed"? In lay terms, is that what happens when the debt is paid?

What was your understanding of how these things work before you put 3 IPs into it?

 

[Terry_w]

Hello,

Yes, we have been claiming all the interest between husband and me.

It is a hybrid trust (unit plus discretionary).

When and how are units "redeemed"? In lay terms, is that what happens when the debt is paid?

Thanks.

You will have to read the trust deed to find out. A trustee can only do what is allowed by either legislation or the trust deed. The deed contains the rules the trustee must follow and if the trustee breaches these rules they could be committing a breach of trust. this can lead them to be personally liable and/or court action to remove them as trustee.

 

[Harriet]

Hello,

My understanding, initially, was that we could distribute trust income, from any source, even if under debt, in any way we wanted (among family).

That was the big drawcard when hybrid trusts were all the rage in the early 2000s (and when we established ours).

I then took it to mean that if property in the trust was under debt, the income - and associated loan interest - had to be split according to the unit-holding structure. But that discretionary distributions would be possible when the debt was paid off.

Seems I may be wrong about that last sentence as well?

I'm not blaming anyone but myself here. I assumed too much.

 

[Harriet]

Thanks, Terry W. I will look at the deed.

 

[Terry_w]

To be able to claim the interest the deed must 'force' all of the income and the capital to the unit holders who are claiming the interest. It woulldn't be commercial for someone to invest in income producing units only to have the trustee give the income and/or capital to someone else. e.g would you buy ANZ shares if there was a clause which allowed ANZ to give any income and capital growth to someone other than you?

You could still invest in such units but would not be able to claim the interest in full - maybe partiallly depending on the set up or maybe not at all.

So to get the deduction the deed has to essentially be structured like a unit trust. The units could then be redeemed or bought back by the trustee in part of full and this would turn the trust into a discretionary. It is probably a unit trust while units are on issue and then a discretionary later.

If you have debt and are claiming the interest the debt would have been incurred in your name for the purpose of buying the units. Once the units are redeemed you could no longer claim the interest on any loans. However the trust itself could have debt still.

 

[Harriet]

Hello Terry W,

Thanks. That all makes sense, and I am pretty sure it's the structure we have.

Loans are in our names. We used these loans to buy income units.

How does the redeeming process work? (Not that we'll be ready for that any time soon!)

Cheers.

 

[alexlee]

Most likely you sell the units back to the trust. This will probably have to be at market value, triggering a CGT event to you.

 

[Terry_w]

Hello Terry W,

Thanks. That all makes sense, and I am pretty sure it's the structure we have.

Loans are in our names. We used these loans to buy income units.

How does the redeeming process work? (Not that we'll be ready for that any time soon!)

Cheers.

This will be specified in the deed too.
Probably one of 2:
1. Trustee asks unit holders to redeem
2. Unit holders as trustee to redeem.

Does remeption have to occur? Maybe not, depending on the deed.
How to start - usually by writing to the trustee or the unit holder making a request
how much - probably needs to be market value. How to determine market value should be in the deed too.

And just because it may seem silly to send yourself a letter doesnt mean it shouldn't be done. failure to do something required in the deed may mean that the action could be invalid - and deemed never to have occured. e.g. a recent case involving a Sydney lawyer - the appoint for x number of years turned out not to have been the valid appointor beccause documents were not served on the trustee as required.

 

[Harriet]

Thanks for your input.

 

[Paul@PFI]

What was the source of the Hybrid Deed ?? Many hybrid trusts fail to comply to the ATO views in TD 2009/17. The ATO already has issued notices to major deed providers and know who has what hybrid deed. They havent acted (yet)

Many of the comments here are consistent with the ATO views in TD 2009/17 and its accompanying "compendium" of examples.

Generally a hyrbid trust is settled with a discretionary element then further "special units" are issued to unit holders. The ATO view is that both the unitholders AND the disc element all share in income proportionately. This is subject to the deed AND trust minutes. No minutes can be a very dangeorous tax problem. Further the way the borrowers obtained their loan and settled the units MUST comply. Thats the common mistake......eg Dad and Mum borrow $100K and Dad gets issued 20,000 units and Mum gets 80,000. That fails. This is the "benefits others" problem that the ATO expressed in the Determination. That and later trying to pass capital gains through to a diferrent beneficiary. If the deed contains "trustee discretion" clauses I would seek some advice. Just cause you havebeen doing this for three, five etc years doesnt mean it complies.

In respect of redemption there are a large number of technical issues that must be satisfied for the unitholders to be considered to be in receipt of a entitlement to income AND capital:
- redemption RIGHTS (Trustee discretion may fail)
- Valuation rules...many deeds do not contain the clauses the ATO expect. (It should also address the discretionary settled funds too)

The ATO have been very good at allowing non-compliant hybrid deeds to be amended to remove many concerns. I woundnt just ignore the problem.

 

[Paul@PFI]

Quote : buy "income" units
this sounds like its already failed.

The accountant saying all income is between yourselves may not be right.

A compliant hybrid shouldn't be capable of issuing income or capital units without a concern. A unit should give entitlement to both. In the same %. You cant disregard the settlement sum (discretionary) either. It may be $50 or it may be $5m.....Yes there were schemes that addressed that exact issue.

 

[Harriet]

Our trust is fully compliant. It has been updated a few times since we set it up (due to ATO rulings).

 

[Harriet]

PS If I had my time again, I wouldn't have used a family trust to invest in property. We live and learn . . . And some mistakes are expensive.

 

[Terry_w]

PS If I had my time again, I wouldn't have used a family trust to invest in property. We live and learn . . . And some mistakes are expensive.

But you are not using a family trust - it seems it is a hybrid trust. Things would be very different in a family trust - maybe better. I have never set up a hybrid trust for a client.

What about your land tax, what state are the properties in and what is happening with that?