Hybrid Discretionary Trusts - The final word.

JIT and bene313
It is in fact a combination of a CGT issue, stamp duty (NSW, VIC & WA), land tax and SMSF. The most important is the CGT issue...

Thanks, very interesting stuff, I wasn't fully aware of these details and the logic behind them.

The CGT Issue

I subscribe for 2,000 $1.00 each units in a newly created unit trust. The trust acquires 2 properties for $1,000 each being property A and property B. Property A does not increase in value over the next 5 years while property B doubles in value. I decide to sell property A for $1,000 due to its poor performance. I wish to get my hands on the $1,000 cash. Each unit in the unit trust is worth $1.50. I would need to redeem 666 units to get the $1,000 out of the unit trust. I make a capital gain of $333.

Chris, I'm a bit slow on the uptake here, just to be sure regarding the $333 capital gain...

This is 666 units at $1.00 each ($666) that are now worth 666 x $1.50 ($1000), so the capital gain is $1000 - $666 ~ $333... ?
 
Maybe it is the trustee declaration form?

Well done Terry. For someone who doesn't know much about SMSFs you nailed it first go. Chan & Naylor have a new SMSF, trademarked of course, which provides the vote allocation at trustee meetings to be determined by reference to members balances. So if you have 2 members and one has $10,000 and the other $90,000 then the one with the smaller balance is always outvoted. They loose all their powers as a trustee.

See the Enduring Family Super Fund FAQ. Question number 2.

The problem is with the Trustee Declaration and what you have to sign. I have highlighted the section in the attached.

If Mum has the lower balance she is signing a false declaration.

Regarding the perpetuity period in South Australia I have had it on very good advice that if the Trustee resides in South Australia and the assets of the trust are in South Australia then the fund has no perpetuity period. Otherwise it's just more marketing. Why doesn't Phillip Fox, Mallesons and other major law firms subscribe to the arguement?

Chris
 

Attachments

  • Trustee Declaration SPR86106n71089.pdf
    120.3 KB · Views: 128
I find it rather amusing that the only state in Australia has been chosen that expressly removes the power of the court to vary a deed for the purpose of a tax advantage.

s.59C(3)(a) Trustee Act 1936

Cheers,

Rob
 
This is 666 units at $1.00 each ($666) that are now worth 666 x $1.50 ($1000), so the capital gain is $1000 - $666 ~ $333... ?

JIT. That's correct. The problem is mixing appreciating assets in a fixed trust. What if you want $2,000 from the trust. Do you sell Property B and make $1,000 capital gain? Do you borrow in the trust and redeem 1,332 units and make a $668 capital gain or do you do a combination of both and make a $1,333 capital gain? It all should sort itself out in the long run but the difference in tax payable depending upon the timing of redemption and disposal of trust assets can be significant.

Chris
 
JIT. That's correct. The problem is mixing appreciating assets in a fixed trust. What if you want $2,000 from the trust. Do you sell Property B and make $1,000 capital gain? Do you borrow in the trust and redeem 1,332 units and make a $668 capital gain or do you do a combination of both and make a $1,333 capital gain? It all should sort itself out in the long run but the difference in tax payable depending upon the timing of redemption and disposal of trust assets can be significant.

Chris

Great, thanks Chris.

It's been good to have a frank and open discussion about the HDT.

Much appreciated.

I'm out of questions, anyone else... ?
 
Great, thanks Chris.

It's been good to have a frank and open discussion about the HDT.

Much appreciated.

I'm out of questions, anyone else... ?

I was hoping that James GG or Coasty Mike would get engaged in the discussions also
 
I am running out of questions, but we need to keep this discussion going.

Chris, what about the land tax issues, with a fixed unit trust that qualifies for a land tax threshold in NSW. If units are held by a discretionary trust or a hybrid trust, will the trust get the tax free threshold?
 
Regarding the perpetuity period in South Australia I have had it on very good advice that if the Trustee resides in South Australia and the assets of the trust are in South Australia then the fund has no perpetuity period. Otherwise it's just more marketing. Why doesn't Phillip Fox, Mallesons and other major law firms subscribe to the arguement?

Chris

Thanks Chris. There are many unknown issues here I think, such as:
- What about the Common Laws rules against perpetuities,
- Must appointor reside in SA?,
- must settlor reside in SA?
- must settlement occur in SA?
- place of administration of the trust,
- domiciling the trust in SA (is just just having a SA registered office for the trustee?),

Taking all precautions and doing every thing in SA would be prudent. But really we may have to wait another 35 years or so and see if any of the trusts established in 1966 when the law changed have any problems.

It is no secret that SA is the only state with no perpetuity laws. Every lawyer knows about it, so it is good marketing.
 
Trustee paying commercial rent in HT property

Hi Chris

Really appreciate your contribution and updates on the hybrid trust (HT). Is the ATO still looking askance if trustee has moved away from PPOR (for reasons such as children schooling) into a HT investment property and pay commercial rent? If the HT is profitable with the trustee rent arrangement does the existing MacQuarie trust deed meet with the expectation of the ATO? This is a flexibility aspect, to be able to maintain interest deductibility of loan for the investment units that the trustee holds in the HT while renting from the trust on occasion.
 
I was reading the below on the net by Stewart Wemyss, other Brokers have mentioned similair which would seem to be an additional hurdle for HDT's, especially now with tighter lending criteria

Hybrid & Unit Trust

Not all lenders will lend to a hybrid or unit trust – in fact, only a handful will. The reason for this is that unit holders could on-sell their units in the trust to a third party and this might affect the lenders capacity to act upon any guarantees. There are rumours that one bank actually suffered loss because of this very fact.

Hybrid trusts are even more unpopular with lenders than unit trusts. Very few lenders in Australia accept hybrid trusts as borrowers and for this and many other reasons, I would caution anyone against using these entities.

PS: great to read these updates Chris and am finding posts by others very interesting
 
Hi Red

In my experience I wouldnt go as far as Stuart as to recommend against the structure per se due to lending issues, since I believe u set the structures that work for you, then look to make finance work.

Obviously that has to work in parallel with your Finance Broker, since a structure thats not "lendable" is useless............I know Stuart has a few more deals under his belt than me and that has to count for something, so maybe his approach does have good value.


ta
rolf
 
Chris, what about the land tax issues, with a fixed unit trust that qualifies for a land tax threshold in NSW. If units are held by a discretionary trust or a hybrid trust, will the trust get the tax free threshold?

Terry

Good question. I would get asked this at least 3 or 4 times a week. Land Tax is important and has to be a major consideration when investing in residential or commercial real estate. A land tax unit trust (i.e. a trust that satisfies the requirements of 3A and 3B of the Land Tax Management Act 1956) receives the threshold. The NSW Act then looks at the unitholders as 'secondary landowners'. If the unitholders are individuals or a self managed superfund then the threshold would be available, depending on other property holdings, excluding the family home.

The most common questions I get are:

1. I am buying a residential property and using a unit trust in which the units are going to be held by a discretionary trust. As I won't get the threshold I don't need to use a land tax unit trust? Most of the people establishing this structure do so to have the flexibility of transferring the units in the unit trust to a self managed superfund. As I point out that if the units are transferred to an SMSF then the threshold would apply as long as the unit trust is a land tax unit trust. So even if the threshold won't be available at first consider who may hold the units in the future.

2. Can I convert a standard unit trust into a land tax unit trust? Yes it is possible. It is a very painful amendment. I only do them on the basis that the client agrees to apply for a Private Binding Ruling prior to execution of the amendment. The OSR can be a bit unpredictable.

Chris
 
Really appreciate your contribution and updates on the hybrid trust (HT). Is the ATO still looking askance if trustee has moved away from PPOR (for reasons such as children schooling) into a HT investment property and pay commercial rent? If the HT is profitable with the trustee rent arrangement does the existing MacQuarie trust deed meet with the expectation of the ATO? This is a flexibility aspect, to be able to maintain interest deductibility of loan for the investment units that the trustee holds in the HT while renting from the trust on occasion.

Francesco

The ATO and I had a big battle over related parties renting the property. They are still paranoid from the Home Loan Unit Trust fiasco. I specifically asked that they remove from the facts of the ruling that a related party cannot rent the property. The issued the ruling with that in the facts of the ruling despite my request. I could object and spend another 10 months arguing the toss. The ATO and Treasury get very nervious at the thought of people claiming their mortgage.

With the Home Loan Unit Trust you acquired your home in a unit trust and the breadwinner holds the units (ordinary) and borrows to acquire the units. Market rent is paid to the trustee. I never understood the benefits. Land tax is payable, the capital gains exemption is lost and you can't stop paying rent if the property is positive. You end up taking after tax income (to pay the rent) and paying it to the trust in the form of rent and paying tax a second time on that money. ATO was still very paranoid.

The Macquarie Group Services Hybrid Discretionary Trust complied with the ATO view from July 2010. Although there has been a few changes since then as my negotiations with the ATO continued I would not amend a HDT established with MGS after July 2010.

Chris
 
Other Trust Aspects

In relation to keeping the thread going I think it would be useful if we discussed some other aspects of property and trusts especially current ones. I still feel that hybrids have their place, however, you need to consider other aspects and variables when selecting a structure.

For example the 'Landholder Duty' provisions are being introduced into the South Australian and Queensland State revenue legislation commencing on 1 July 2011. It already exists in NSW, WA and VIC.

Question: What did Queensland leave out of their 'Landholder Duty' provisions that is really bad for residential property investors.

Chris
 
Francesco

The ATO and I had a big battle over related parties renting the property. They are still paranoid from the Home Loan Unit Trust fiasco. I specifically asked that they remove from the facts of the ruling that a related party cannot rent the property. The issued the ruling with that in the facts of the ruling despite my request. I could object and spend another 10 months arguing the toss. The ATO and Treasury get very nervious at the thought of people claiming their mortgage.

With the Home Loan Unit Trust you acquired your home in a unit trust and the breadwinner holds the units (ordinary) and borrows to acquire the units. Market rent is paid to the trustee. I never understood the benefits. Land tax is payable, the capital gains exemption is lost and you can't stop paying rent if the property is positive. You end up taking after tax income (to pay the rent) and paying it to the trust in the form of rent and paying tax a second time on that money. ATO was still very paranoid.

The Macquarie Group Services Hybrid Discretionary Trust complied with the ATO view from July 2010. Although there has been a few changes since then as my negotiations with the ATO continued I would not amend a HDT established with MGS after July 2010.

Chris

Hi Chris

I can understand ATO being paranoid about claiming tax deductible interest on units, but ATO really should see beyond it that they collect potentially double tax as you have pointed out. As I mentioned previously, normally trustees have a PPOR but after a number of years, circumstances and family needs require relocation and if HT owns a suitable property that meets the need, why not rent to the trustee. There are advantages: assured tenant care, trustee renovation to enhance CG, assured rent collection and assured stability of tenancy period.

This is flexibility for a number of years. When trustees move on, property is rented to others. For investors interested in buy and hold strategy, this flexibility in HT is a natural adjunct.
 
I can understand ATO being paranoid about claiming tax deductible interest on units, but ATO really should see beyond it that they collect potentially double tax as you have pointed out. As I mentioned previously, normally trustees have a PPOR but after a number of years, circumstances and family needs require relocation and if HT owns a suitable property that meets the need, why not rent to the trustee. There are advantages: assured tenant care, trustee renovation to enhance CG, assured rent collection and assured stability of tenancy period.

This is flexibility for a number of years. When trustees move on, property is rented to others. For investors interested in buy and hold strategy, this flexibility in HT is a natural adjunct.

Francesco

You are putting a lot of faith in the ATO. The ATO is a machine made up of practices and proceedures. The ATO has a lot of people in it. I work with some of those people both senior and junior and they are good people. However, they are still to a very large degree the pocket of the Government. And when the economy takes a turn for the worse the Government still needs its money. "I told you we would be back into surplus by XXXX". Your views are more in line with a Liberal Government that is more sympathetic to the person who has got ahead or trying to get ahead and pay the minimal legal amount of tax. As the big fella said "You guys aren't doing so well with my money that I should start donating it to you." Paying more tax than you legally have to is effectively donating your money to the Government.

I prefer the Salvation Army.

I see your point but if you go against it you will drown as you will swimming against a rip.

Chris
 
Back to issue, streaming & redemption.

If a unit only carried rights to taxable income, I guess that the market value is lower due to the diminished rights.

Therefore, redemption at market value does not mean an effective double taxation given that the proceeds are not the classical 'net asset value' of the assets acquired with the settled sum.

The beneficiary does not have rights to the underlying capital in the full sense, only rights relating to fair dealing by the trustees in the funding of the income stream.

I see no reason why the Commissioner should deny deductions for borrowings to acquire income units just based on the above facts where everything is at arm's length on valuation and rights.

The classical view that the settled sum (cash subscribed) is converted to other (unit) trust property for which the beneficiary has an interest in the entire income AND capital does not apply in the above case.

Therefore, if tax sheltered amounts are not part of the unit trust corpus etc. then they could be streamed to other discretionary beneficiaries.

Provided this is factored into the valuations, it should not restrict the beneficiary claiming interest deductions on borrowings to subscribe for shares.

Is this the line of reasoning finding favour (or toleration) ?

Cheers,

Rob
 
Deductibility of past interest

Chris,

I have an MGS HDT established in 2005 with no amendments to date. I am back in Oz since Jan this year but prior to that I have been overseas. We accumulated alot of tax losses over the period we were overseas in relation to two properties we held (and still hold) in that HDT.

From your earlier post in this thread i got the impression that if i update the HDT then all of those losses will remain available to me. If I don't, then I could lose them, is that right?

Thanks.
 
Just read this on the NTAA website recently

News
Hybrid Discretionary Trusts

Author: Brent Jones

NTAA concerns about confusing emails

We at the NTAA have always had concerns about hybrid trusts (at least in relation to the supposed benefits of borrowing to buy units in those trusts and claiming the interest deductions, though there are also other concerns such as with the small business concessions) and have not been able to find a suitable deed that we could stand behind and provide to members.

Recently MGS mentioned NTAA Corporate in relation to amending hybrid trust deeds. We have a copy of the email and are frankly confused by it as we do not have a hybrid trust deed for them to amend. We understand that they may be marketing but they should get their facts straight.

Further to their email, a search of the ATO's PBR register for "hybrid trust" since 1 July 2008 only provided 5 PBRs, with 4 of them relating to interest deductions (all were denied in part or full), and the fifth relating to CGT on the distribution of assets from the hybrid trust to a unitholder (CGT was applicable). Thus we are also interested and look forward to receiving any information about this PBR.
 
Back to issue, streaming & redemption.

If a unit only carried rights to taxable income, I guess that the market value is lower due to the diminished rights.

Therefore, redemption at market value does not mean an effective double taxation given that the proceeds are not the classical 'net asset value' of the assets acquired with the settled sum.

The beneficiary does not have rights to the underlying capital in the full sense, only rights relating to fair dealing by the trustees in the funding of the income stream.

I see no reason why the Commissioner should deny deductions for borrowings to acquire income units just based on the above facts where everything is at arm's length on valuation and rights.

The classical view that the settled sum (cash subscribed) is converted to other (unit) trust property for which the beneficiary has an interest in the entire income AND capital does not apply in the above case.

Therefore, if tax sheltered amounts are not part of the unit trust corpus etc. then they could be streamed to other discretionary beneficiaries.

Provided this is factored into the valuations, it should not restrict the beneficiary claiming interest deductions on borrowings to subscribe for shares.

Is this the line of reasoning finding favour (or toleration) ?

Cheers,

Rob

RobG

What do you mean by taxable income? Is that revenue income and stautory income? If so I agree with you.

I can't control the ATO view and should I add don't agree with the ATO view.

I accept your position, however is it academic? If the ATO don't agree we have the right to spend $200,000 and test the law. I assume you know a lot of times the ATO has lost in court. But yuo and I pay through our taxes for them to fight you to prove your right.

Chris
 
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