HDT explanation for Dummies???

[austini]

... All Dale is saying is that some HDT deeds will pass (because they are really glorified unit trusts). I questioned what are the advantages of a HDT now?

Hi Julia,

As mentioned I'm only a layperson but I suppose one advantage may be that a single trust can operate as a DT & UT allowiing more flexibility overall for a mix of investments / tax planning. Hence less cost to setup and maintain. Although from what I vaguely remember asset protection is supposedly better when the DT owns the Unit in a UT.

Cheers - Gordon

 

[alexlee]

Hi Julia,

As mentioned I'm only a layperson but I suppose one advantage may be that a single trust can operate as a DT & UT allowiing more flexibility overall for a mix of investments. Hence less cost to setup and maintain. Although from what I vaguely remember asset protection is supposedly better when the DT owns the Unit in a UT.

Having the DT own units in a UT is a totally different issue, and pretty irrelevant when you want the individual to get the interest deductions. If the DT had enough income to take the interest deductions from buying units, why bother with the UT at all? I would straight have the DT own the IPs.

HDTs give interest deductibility at the inidivual level, unlike using a simple DT. However, if there is a CGT event on the redemption of the units at market, then that's a potentially big cost you won't have with DTs.

Of course it depends on what other income you have.
Alex

 

[austini]

Hi Gang,

Here is something I stumbled upon awhile back in relatiion to determining MARKET VALUE. I don't know if this has been superseded by more recent case law but if it hasn't would this be relevant if the underlying asset linked to the HDT units was property:

"Market value
The Income Tax Assessment Act contains no definition of market value. The most widely accepted definition of market value can be found in the High Court decision of Spencer v The Commonwealth (1987) 5 CLR 418. The High Court held that in assessing the value of land, the basis of valuation should be the price that a willing purchaser would pay to a vendor not unwilling, but not anxious to sell. Isaacs J said (at 441):

"To arrive at the value of the land at that date, we have, as I conceive, to suppose it sold then, not be means of a forced sale, but by voluntary bargaining between the plaintiff and a purchaser, willing to trade, but neither of them so anxious to do so that he would overlook any ordinary business considerations."

A similar test was also adopted by the High Court in Abrahams v Federal Commissioner of Taxation (1945) 70 CLR 23, 29-30 where Williams J. said the market value of shares was:

"the price which a willing but not anxious vendor could reasonably expect to obtain and a hypothetical willing but not anxious purchaser could reasonably expect to have to pay for the shares if the vendor and purchaser had got together and agreed on a price in friendly negotiation, the basis of the bargaining being that the purchaser would be entitled to be registered as the owner of the shares but when registered would hold them subject to the provisions of the memorandum and articles of association of the company, including any restrictions on transfer which they might contain."

The extent to which the potential uses of an asset may influence the proper determination of the market value of that asset were canvassed in Collis' case. It would seem that particularly in the case of land "the special adaptability of land for a specific purpose is an element in value", although "it is essential to the existence of a market value that there be some continuing demand for land for that purpose" (see Hustler's Pty Ltd v The Valuer-General (1967) 14 L.G.R.A. 269, referred to in Collis at 4841).

In Taxation Determination TD 10, the Commissioner stated that where the "market value" of an asset needs to be determined for CGT purposes, taxpayers can choose to:

Obtain a detailed valuation from a qualified valuer; or
Compute their own valuation based on reasonably objective and supportable data."

If nothing else it makes for some good bedtime reading (not) Gee I'm glad I'm not an accountant as too much of this stuff would give me a headache.

Cheers - Gordon

 

[MattR]

Gee I'm glad I'm not an accountant as too much of this stuff would give me a headache.

Cheers - Gordon

Not a problem since I started snorting Panadol


Market Value = Pay the valuer for the value you want! That would never happen...would it.

 

[JamesGG]

James

What about a few other quotes in Dale’s article ie
“ Tax benefits are nice to have, but the stress of failing a tax review along with the pain of repaying tax benefits and fines aren’t worth the hassle, in my opinion”

And

“As a special income unit holder, you must be entitled to the income of the trust derived from the assets acquired from your subscription to the units of the trust. Without this entitlement, the nexus between the costs incurred by you in interest paid on your loan won’t be tax deductible. And the problem is that for a long time now, “income” for tax purposes includes capital gains.”

And

“…. the units are bought back at their market value for tax purposes, regardless of the price paid for those units initially. This redemption will trigger a CGT event for the individual who subscribed to those special income units.”

Hiya,

None of this is new. Julia, I must admit that I do like, however, the way that you chose not to quote the part about the trust having complete discretion over all distributions (including capital gains income) if units have been redeemed before the profit distribution occurs.

Furthermore, none of Dale's comments about hybrids potentially failing the ATO's scrutiny referred to the MGS deeds, which have been analysed several times by the ATO without any negative feedback. See this post, again, if you will.

What Dale was saying, as pointed out in my last post, is that investors need to ensure that their deed is not promising things that the tax office have already disagreed with; he provides examples of such promises in the article, as you have seen. It is these type of deeds that have had negative PBR's issued against them in recent times. With a correctly written deed, investors should not have any problems. Again:

Hybrid trusts aren't dead, as some misinformed people have claimed...

And having said all that;

...they are really glorified unit trusts.

...I find it hard to believe that you actually read the same sentences that I did, with a conclusion like that.

As we all know, a hybrid is a long-term planning tool. Focussing too much on the short-term is not likely to yield the best results, in any circumstances. The hybrid simply allows for that added flexibility of acting as either a discretionary trust, or, a unit trust, as the situation sees fit.

Naturally, the structure is not for everyone and should not be marketed as a 'one-size-fits-all' product. Nor should it be marketed as a way of avoiding tax in a manner that the tax office have already objected to, as I know some firms have chosen to do.

However, when used correctly, it can be a powerful long-term planning tool that may be well worth including as part of one's investment strategy.

I am aware, Julia, that you do not like hybrids for a number of reasons and that they do not fit your business model. However, that does not mean that they are worthless and I am sure that I am not the only person on this forum who thinks so. Please, keep an open mind and play nice

Cheers

James.

 

[JIT]

Furthermore, none of Dale's comments about hybrids potentially failing the ATO's scrutiny referred to the MGS deeds, which have been analysed several times by the ATO without any negative feedback. See this post, again, if you will.

Mry,

Given what James says above, there doesn't seem much point in getting a PBR.

Also, have you or Julia not seen the MGS trust deed yet?

GSJ

 

[julia]

So James I conclude from the information you provide that the only advantage of a HDT is being able to change from a unit trust to a discretionary trust but to do this the units must be redeemed at market value which effectively means CGT must be paid on all the assets in the trust. Is this correct?

 

[sue78]

I still don't understand what it is...I must be so dumb!

 

[julia]

Maybe there is smoke in your eyes.

 

[JamesGG]

So James I conclude from the information you provide that the only advantage of a HDT is being able to change from a unit trust to a discretionary trust but to do this the units must be redeemed at market value which effectively means CGT must be paid on all the assets in the trust. Is this correct?

Hiya,

No, not correct, I'm afraid. The value of the units is not linked directly to the value of the assets.

So while there is some CGT to be paid on the redemption of units, this should be outweighed by the tax savings of being able to distribute that income in a discretionary manner. Naturally, if one does not intend to sell their properties...

Of course, there are other advantages to running a property business through a hybrid. Travel allowances, gifts and other creative deductions being one. Estate planning being another. The key, of course, is future planning and long-term flexibility. But, I am sure you do not need me to espouse the benefits of using an appropriate structure, Julia.

Cheers

James.

 

[julia]

James,

1) Why do you need a Hybrid trust to gain all the tax deductions you list?

2) What is the redemption price of the units linked to?

 

[JamesGG]

Hiya,

Naturally, creative deductions are not restricted purely to hybrids; I apologise if I gave that impression. However, an individual cannot claim a gift to themself, or a travel allowance for investigating more property. A company or trust, though, can pay for such expenses, as you know. I am not sure why you felt the need to ask this question, as I am sure you must have known the answer.

I have been advised that the redemption of units is typically linked to CPI. For the ultra-conservative amongst us, some have preferred to see their units grow at the same velocity as the RBA interest rate. Another option is to use a net present value formula. The important thing, is to be able to demonstrate that we have provided a reasonable method of calculating fair market value for those units.

Cheers

James.

 

[Mry]

Given what James says above, there doesn't seem much point in getting a PBR.

There are only three things that will satisfy me enough to use a hybrid, and I talked about them in my article.

What would prove once and for all that you can negative gear with a hybrid?
1. A Tax ruling (most likely).
2. A court ruling (most authoritative).
3. Announcement from the Treasurer to amend the law (snowball in hell likely).

A private binding ruling from the ATO only helps the person applying for it. It is only useful in determining how the commissioner thinks.

A few times early in my profession I have accepted the verbal advice of other accountants without checking their underlying support for such claims. When they were wrong, I paid the price. Never again. If I am going to discuss or make claims, I back them up with cases, legislation and rulings, and I check anything that I am only 99% sure of. I will not accept any claims unless they come through the proper channels.

Also, have you or Julia not seen the MGS trust deed yet?

I bought one for myself. And I will offer no comments on trust deeds offered by firms in public. I don't want to get sued.

 

[Shuttergirl]

Well people, now I am well and truly lost LOL.............

I'm sure it is an interesting discussion and I hope to revisit this thread after alot more reading

 

[Mry]

I probably should have warned you about that.

 

[JamesGG]

Well people, now I am well and truly lost LOL.............

I'm sure it is an interesting discussion and I hope to revisit this thread after alot more reading

Hiya,

I do apologise for that... again, I am at least partially responsible for this thread going off course.

If I may, I would again suggest that you read Dale's first two articles, available online at his website. This should give you a good start as to how it all works. As you can see though, professional opinion is divided and so this is something that you should be absolutely certain of before getting involved.

Cheers

James.

 

[bene313]

I have been advised that the redemption of units is typically linked to CPI. For the ultra-conservative amongst us, some have preferred to see their units grow at the same velocity as the RBA interest rate. Another option is to use a net present value formula. The important thing, is to be able to demonstrate that we have provided a reasonable method of calculating fair market value for those units.

Hi James and all

Perhaps you or someone else could verify the following for me.

1) If the units are valued at cost times CPI, what is stopping the ATO from ruling the arrangement as one of private nature in order to receive asset protection? Or ruling that the arrangement is between related parties, and that the purchase of units was never intended to turn a profit. In both situations, interest apportioned over the last five years.

2) How would the growth in value of the units be at all linked the cash rate set by the RBA? Again, the ATO could rule as a private arrangement.

3) Net Present Value would mean the units are valued at the discounted value of all expected future cashflows. If the unit holder is absolutely entitled to income from the trust while the units are on issue, then capital gains would be included in this income. In that case, the expectation of future capital gains (as represented by the equity in the assets of the trust) should be included as part of this valuation. Therefore, on redemption of the units, the unit holder would be receiving a capital gain similar to if they had sold the property themselves. No arguments from the ATO there.

Thanks

Ben

 

[bene313]

1) If the units are valued at cost times CPI, what is stopping the ATO from ruling the arrangement as one of private nature in order to receive asset protection? Or ruling that the arrangement is between related parties, and that the purchase of units was never intended to turn a profit. In both situations, interest apportioned over the last five years.

James and all

Perhaps the units could be valued at cost times CPI because that's all someone would be willing to pay for them. ie. The Trustee can redeem the units at no lesser value than the consideration paid for them, so why would anyone else pay more than that?

On the other hand, the ATO could probably apply the market substitution rule here. ie. Why would I buy units for $100,000 which only entitle me to income, when I can buy a property for $100,000 which entitles me to income and ownership (and hence capital growth). Of course the argument to this is that the units are entirely separate from the property held in the trust and the trust can do whatever it wants with the money it received for the units. Well in that case how did the individual get the loan for the units? All the ATO needs to do is go to the bank which made the loan, and discover that the loan is actually for the property (just indirectly through a related party transaction). Hence, the market substitution applies.

Any ideas from the accountants here?

Cheers

Ben

 

[secret squirrel]

accountant funny here sometimes. hybrid trust good or bad. ed chan multi millionaire driving nice mercedes maybe wrong but he wealthy from them. smart. he not posting on forums debating. out making money. like me. but not from hybrids. mine from property. i read julia website and why not out making millions like ed instead of worrying about fruit picking. maybe he wrong. but who cares. people sign off on own return. u take risks. like everything in life. i dont know if hybrid right or wrong but at least some people making lots of money. like property. sometimes old people sell land for less than market value. who cares. they happy and we make profit. they should due diligence if they feel ripped off. some people need to learn about capitalism. to me hybrid is good marketing tool for some accountants and lawyers. good on them.

 

[alexlee]

It's not a simple structure and there are very few precedents, Shuttergirl. As you can see even professionals and experts don't agree on it.

James, my understanding is that redemption at cost would not be allowed by the ATO because transfer of assets has to be for market value. That is, that rule of an arms length seller and buyer without coercion.

For a listed company, this is whatever is quoted in the price. It may be that a share, for example, is 'undervalued', but since it's freely traded the ATO generally doesn't intervene on publicly traded securities.

However, this is a private, unlisted trust. Except in unusual circumstances (due to something wrong with the properties held by the trust, say), how can you justify saying the units would only appreciate by CPI? If I was buying a property unit trust, surely I would expect more than CPI?

As you said, any company / trust (including normal discretionary trusts) would have the ability to deduct gifts, etc that are not available to individuals. This in itself is not an incentive to use a HDT over a DT.

My question is what makes the HDT better than, say, a normal DT. While the numbers vary, my own view is that if you have to pay CGT when you transfer the shares, that means when you want to turn the HDT back into an ordinary DT, you may have significant costs. The advantage of a HDT initially is that you get all the tax deductions.

However, it may take 5 years or more for even a normal property to be TAX positive (note depreciation is part of tax so the thing isn't making a TAXABLE income until rent less expenses less depreciation is positive). At that time, even though taxable income is low, you would have to pay a chunk to the ATO for CGT. While that may still be preferrable to some people, it's certainly not appropriate in all circumstances. In my personal case, I can just put IPs into a family trust and transfer dividend income to offset it.

At this point, do we have tax rulings confirming that the CPI appreciation method is allowed? For example, are there similar rules for, say, valuing preference shares with limited voting powers (which would make it similar to a special income unit with no voting powers)?
Alex