final ruling on hybrids

The underlying issue seems this:

34. A loss or outgoing is not deductible where it is incurred to gain or produce benefits for other persons

Many people keep on arguing the point that a trust is a "different entity" just like an "other person" , and not themselves, so they are getting what they wished for.
But I think somehow many people won't be happy about this though...
 
Do I read this correctly. Let's assume that Paul is the primary income earner. If all income and expenses are attributed to Paul, is this saying that if you're willing to forgo the ability to distribute to other beneficiaries, that you can still achieve negative gearing within a Trust? If so, that's still pretty cool.
 
It is not a question of what you actually do it is a question of what the deed could allow you to do
Yes, I understand that. So if the deed has Paul as the only beneficiary, but an independent appointor (eg accountant, lawyer), and a corporate trustee with multiple directors and shareholders, is it possible to achieve both negative gearing and asset protection with such a Trust?

I'm genuinely curious, not trying to score any points. I don't have a dog in this fight. :)
 
Yes, I understand that. So if the deed has Paul as the only beneficiary, but an independent appointor (eg accountant, lawyer), and a corporate trustee with multiple directors and shareholders, is it possible to achieve both negative gearing and asset protection with such a Trust?

I'm genuinely curious, not trying to score any points. I don't have a dog in this fight. :)

There is no asset protection for unit holders.

There is no interest deduction for unit holders where the deed allows ANY discretion on streaming benefits flowing from assets secured by the units.

Unit trust deeds go to extreme lengths to even deny any power of amending the deed in this respect.

Merely electing to not exercise any discretion is not good enough.

Having a Corporate Trustee with directors being associates who provide a service for fees could be deemed streaming of benefits in certain cases, especially if payments are non-commercial.

I am confused why the ATO dragged their feet for so long on an issue that appears well settled in Law.

It has just allowed promoters to profit further at investors' expense.

Cheers,

Rob
 
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ANy comments from Chan & Naylor or other Accountants who were previoulsy selling these Trusts.

Would be interested to hear thoughts on this ruling.
 
There is no asset protection for unit holders.
Thanks, Rob, that sounds pretty clear then - you get to choose negative gearing or "asset protection and discretion in distribution", but can't have both, which seems entirely reasonable.

Am I right in saying that the ATO are planning to claw back any previously claimed negative gearing benefits? Ouch! I'd be annoyed if I'd trusted those encouraging the use of a hybrid for property investing. (I understand that some professional services businesses are a different matter.)
 
From the look of it nothing in this ruling really affects the MGS hybrid trust because none of the examples given by the ATO are applicable to the MGS trust deed. :)

My understanding is the MGS hybrid trust deed classes capital gain as income to be distributed to the SIU holder. The special income units are also redeemed at market value (based on the underlying asset).

The two downsides (which I wasn't aware of 5 years ago when I first set up a hybrid trust) is the double taxation on the capital gain if you redeem the special income units before the trust sells the underlying asset/s. You could probably get around this by selling the property in the trust first, distributing the capital gain and then safely redeeming the units at cost, but my original intention was to redeem the units once the trust's cashflow turned positive and keep the property long-term. I was led to believe I could do this. :(

Also, as pointed out by previous posters there is no asset protection because the income units are redeemed at market value so any capital gain is at risk.
 
Ebbie,

I would be concerned about claiming a deduction for interest incurred in the earning of income where that income was actually capital gains re-classified to be income by virtue of the wording of a trust deed. Would want to consider the mechanism by which capital gains are classified as income very carefully.

The various indicia (in tax case law) of what is income and what is a capital gain would probably be applied, and not the wording of a trust deed.

Possibly no requisite nexus between interest expense and production of assessable income (other than capital gains).

Case 4 is the example:-

Example 4

27. Paul arranges for his accountant to set up a trust for himself and his family. Paul and his wife control the corporate trustee.

28. Paul borrows $1 million from a bank, in his own name, and settles it on the trust. The trustee issues 1 million units to Paul. Paul's wife and children are also beneficiaries of the trust. The trustee uses the $1 million to purchase a rental property.

29. The trust deed provides the trustee with a discretion to appoint the income of the trust to Paul, his wife, or his children. Absent such an appointment, no beneficiary is presently entitled to income. Unit holders are, however, entitled to share in amounts which are attributable to realised capital gains of the trust, in proportion to their unit holdings.

30. The units Paul acquires are redeemable at the trustee's discretion. The units are redeemable for an amount equal to the sum Paul settled on the trust. Any remaining trust capital is held for the benefit of the other beneficiaries.

31. Paul's interest expense is not deductible at all... Nor can a connection be perceived between the incurring of the interest and the production of Paul's assessable income (other than net capital gains : see section 51AAA of the ITAA 1936).
 
Ebbie,

I would be concerned about claiming a deduction for interest incurred in the earning of income where that income was actually capital gains re-classified to be income by virtue of the wording of a trust deed. Would want to consider the mechanism by which capital gains are classified as income very carefully.

And what about streaming or capitalising non-assessable amounts.

Also collateral benefits - e.g. associates enjoying the use of the assets.

The list goes on ...

Cheers,

Rob
 
Ebbie,
If you think your hybrid is not caught by the ATO's ruling then you need to ask yourself why did you choose to use a hybrid.

I don't feel the ATO have been dragging their feet. They issued TR 95/33 14 years ago.
 
So does this mean I should not consider using a hybrid trust at all? or only use a hybrid trust that has been worded accurately?
 
Ebbie,
If you think your hybrid is not caught by the ATO's ruling then you need to ask yourself why did you choose to use a hybrid.

So does this mean I should not consider using a hybrid trust at all? or only use a hybrid trust that has been worded accurately?

Hi Julia,

When I first set up my Hybrid Trust 7 years ago the information being provided seemed to paint a very different picture of how hybird trusts actually work, and I’m sure I’m not the only one who was caught out by this.

The main reasons for setting up a Hybrid Trust for me were asset protection and the ability to negative gear, as well as the flexibility and other benefits associated with using trusts. The end goal was always to redeem the income units as soon as possible and operate the trust as a normal discretionary trust once the property became cashflow positive (and I no longer needed the negative gearing).

As the trust gurus seemed to be suggesting at the time, my plan was to purchase income units for $1, negative gear the property for a few years, redeem the income units for $1, and then begin distributing the trust income between the discretionary beneficiaries.

The first I became aware of having to value the units on redemption was around the same time people began discussing the ATO taxpayer alert last year (in March 08). I have since discovered there is really no asset protection with Hybrid Trusts due to the capital growth on the income units, and that any benefit gained from negative gearing will most likely be offset by capital gains tax on redemption of the units. This makes my plan of redeeming the units and holding the property long-term very inefficient (not to mention the extra land tax I've paid along the way!).

So my answer to fuister’s question is personally I would still choose a trust over holding property in my own name but I definitely wouldn’t use a Hybrid Trust again. I was all set to redeem my income units last year so I could operate the trust as a Discretionary Trust instead but then the sharemarket crashed and I had to sell a big chunk of shares & managed funds to avoid a margin call. :eek: I was relying on this share income to divert it to the trust and offset my deductions against it in place of the negative gearing.

Unfortunately I'm still stuck with my income units for now until I can generate another source of income. :(
 
... The main reasons for setting up a Hybrid Trust for me were asset protection and the ability to negative gear, as well as the flexibility and other benefits associated with using trusts. The end goal was always to redeem the income units as soon as possible and operate the trust as a normal discretionary trust once the property became cashflow positive (and I no longer needed the negative gearing). ... :(

Yep, probably the same scenario for quite a few of us back then unfortunately. This is what can happen when one deviates from the "keep it simple" time tested structure approach

Various accountants continue to suggest that HDTs are great for the right circumstances. However I see the "right circumstances" as being applicable to a very small minority if any. Given the absence of asset protection when units are on issue and double CGT if the unit holder redeems and continues to hold the IP it seems far more sensible just to purchase in ones own name and keep gearing to a maximum for asset protection. Amusingly an advantage I see put forward is that a HDT is great if your property's value is in a loss situation you can then redeem the units and revert to a discretionary situation. This is a goal that most investors set out to achieve I think NOT! And on top of this is future legislative risk and still many untested areas of law to boot.

Maybe I have had too many whiskeys tonight but I would suggest that one keep things simple, save heaps on accounting fees and if you want to negative gear a property then do it in you own name.

Cheers - Gordon
 
Yep, probably the same scenario for quite a few of us back then unfortunately.
Thanks for the reply Gordon, I was starting to feel very alone. :)

Amusingly an advantage I see put forward is that a HDT is great if your property's value is in a loss situation you can then redeem the units and revert to a discretionary situation.
I actually got a very low valuation last year which would have worked in my favour had I been able to go through with the redemption. I could have got out of this mess with very little capital gains tax. Unfortunately the longer I have to wait the worse it's going to be.

I just hope I can legitimately continue claiming the full interest deduction in the meantime. I'd really like to see another update from MGS now the ATO have released their ruling.
 
... I actually got a very low valuation last year which would have worked in my favour had I been able to go through with the redemption. I could have got out of this mess with very little capital gains tax. Unfortunately the longer I have to wait the worse it's going to be. ...

Hi Ebbie,

I do honestly feel for your situation. Yes, the loss scenario can be used to advantage and in our case it helped somewhat in the redemption process although our MGS documentation only allowed units to be redeemed at original issue value or greater:eek:

However, to quote the favourite phrase of advisors "start with the end in mind". Does one really set out to purchase an investment property with the intention of it losing value so one can redeem units:eek::eek: I think NOT. This is merely an unfortunate circumstance that comes about through unexpected events and certainly not something that is planned "with the end in mind".

I sincerely hope that eventuallty you will be able to get out of your HDT situation favourably.

Cheers - Gordon
 
This is what can happen when one deviates from the "keep it simple" time tested structure approach

I am also seeing the light, and I am agreeing with the Keep It Simple Stupid moto now too!

Once apon a time this forum use to have some great comments and answeres on these type of question from the GURU's on Trusts (Dale GG, Chris Batten etc)

They must have made enough money from selling us these products and are now retired?? :cool:

(that's a cry for help and we are begging you to come back :p) ha ha
 
Has it occured to you that they were not gurus, but were just pushing their products?
All the comments and answers lead to the same conclusion: buy the product.
You know, the aussie slang for it is "weeing on your back and telling you it's raining, and btw they got these nice umbrellas for sale real cheap" :rolleyes:

these old threads come to mind also
http://www.somersoft.com/forums/showthread.php?t=15223
http://www.somersoft.com/forums/showthread.php?t=18860
http://www.somersoft.com/forums/showthread.php?t=30831

I previously posted Julia's the best thing that happened to API, and unfortunately stopped posting here. Visit her site for much good info.
 
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