Hybrid Discretionary Trusts - The final word.

[Chris Batten]

Hi Chris,

I just read a "newsflash" about HDTs, in it the author mentions about getting a "product ruling" for the use of the HDT... is this something you would consider?

Also, they comment about deed amendments potentially triggering a resettlement of the trust... do you have some certainty from the ATO that if done in a particular way this won't happen and result in a CGT bill for MGS HDT holders?

JIT

As you may be aware I have been attacked by the NTAA over the hybrid issue. I understand that. In 2007 they released the attached Press Release effectively saying they had been bombarded by members who have arranged for clients to enter these arrangements either "wittingly or unwittingly". Some of their members didn't even recommend hybrids and merely picked up clients that already had a hybrid.

For the next 4 years I battled away on behalf of my clients and eventually got a result that some may argue a professional body should have done after being alerted by their members. I understand their embarrasement today. I understand their frustration when a member rings and says "should I amend in the face of TD 2009/17 and if so what will the ATO accept." Does it matter if the professional association sold the product or not? Shouldn't they have sought a result on behalf of their members? Clarity so that their members could advise their clients what to do.

And then along comes Ms Julia Hartman. A crusader against Hybrids. She was very vocal against hybrids and instead promoted an anomaly in the FBT provisions whereby Mum owned the property 99% and Dad 1% and Dad's employer paid the interest and relied on the otherwise-deductible rule. At the time I put up a post, I would appreciate if someone could find it, a little before the budget warning people that the ATO in NTLG meetings had said they would ask Treasury to remove it in the budget. Sure enough it was removed in the budget and some people have a low earning Mum owning 99% of the property and Dad owning 1%.

But more than this. Julia is a big fan of the NTAA. So much so she wrote this in her February 2010 newsletter at page 53 which I have attached:

"Until now BAN TACS has stayed clear of Hybid trusts on the basis that no other purpose could justify their existence other than a tax benefit and so they should be caught by Part IVA. A highly respected tax training and research organisation call the NTAA has openly approved these arrangements and stated that the ATO is not objecting to them. Accordingly, we now withdraw our hesitation and are able to assist our clients should they wish to enter into such arrangements. Though taxpayers should be aware Hybrid trusts have not been tested through the courts so we can not be absolutely certain they will stand up. We would also prefer clients to allow the high income earner to receive the profits in the first year the investment becomes positively geared."

I have attached the newsletter and marked the passage on page 53. This is from the same person who said following the decision in Forrest v FC of T "Stunning point I noticed was a trust can still be a fixed trust even when the trustee has wide discretionary powers." What so stunning? The fact you didn't know this is stunning to me. The trust in Forrest was fixed as to ordinary income entitlements and discretionary as to statutory income entitlements.

Julia states "Anything other than a unit trust and the interest on the money borrowed to buy the units will not be fully deductible.............No longer will it attempt to combine asset protection, income splitting and negative gearing." I can only assume she hasn't read the ruling or she just doesn't know what she is talking about.

Julia has the answer. Consider transferring the property from the hybrid and incurring capital gains tax and stamp duty. Stunning is absolutely on point. Stunningly stupid to advise people when you don't know all the facts and what you are saying is clearly wrong.

Anyway maybe next month the NTAA will say they are again good with Hybrids and Julia will be back to the Feburary 2010 view. As many of you know I have held one view, the same view from the mid 1990's. It's not good to flip flop around and contradict yourself in print as you can end up looking very very stupid and just a parrot of other peoples views.

Sorry JIT. The resettlement answer is in the first few pages. (i.e. no resettlement).

Chris

Link to the recent Bantacs newsletter (This one contradicts the Feburary view but we are certain this might be the final view, however Julia reserves the right to change her view should others change their view or even if others don't change their view and she develops her own view.)

 

[JIT]

Apologies Chris, you did address the resettlement issue earlier on.

Thanks.

 

[coastymike]

Chris maybe you can help me. I am slow and dim witted at times (many times) so maybe missing something here.

Much is made of the fact that units in a unit trust are available to the creditors on bankruptcy. Fair point. I have no issues with that. The same issue is raised with respect to hybrid trusts.

What I don't understand is why strategies for protecting those units (if required or desired) is also not discussed. What about the popular gift and loan-back strategy. This strategy is widely used for protecting the family home so why can't the same strategy be used for protecting equity in any units held by individuals. This strategy is discussed in the 2011 NTAA Tax Structures and Asset Protection paper at page 17. Why isn't this being discussed as a way of mitigating the associated risk ?

And what about the advantages of holding in a unit trust as opposed to the individual names.

1. does holding in individual names allow a transfer to a SMSF at a later stage ?
2. does holding in individual names allow you to consider strategies such as the refinancing principle ?
3. does holding in individual names potentially result in higher stamp duty costs when transferring the property ?

These are but some of the things I ponder. But like I said I am slow and maybe I am missing something. I frequently do.

 

[Terryw]

Chris maybe you can help me. I am slow and dim witted at times (many times) so maybe missing something here.

Much is made of the fact that units in a unit trust are available to the creditors on bankruptcy. Fair point. I have no issues with that. The same issue is raised with respect to hybrid trusts.

What I don't understand is why strategies for protecting those units (if required or desired) is also not discussed. What about the popular gift and loan-back strategy. This strategy is widely used for protecting the family home so why can't the same strategy be used for protecting equity in any units held by individuals. This strategy is discussed in the 2011 NTAA Tax Structures and Asset Protection paper at page 17. Why isn't this being discussed as a way of mitigating the associated risk ?

And what about the advantages of holding in a unit trust as opposed to the individual names.

1. does holding in individual names allow a transfer to a SMSF at a later stage ?
2. does holding in individual names allow you to consider strategies such as the refinancing principle ?
3. does holding in individual names potentially result in higher stamp duty costs when transferring the property ?

These are but some of the things I ponder. But like I said I am slow and maybe I am missing something. I frequently do.

Hi Coasty

The gift would probably be caught by the clawback provisions in the Bankruptcy Act. If done with the intention to avoid creditors the gift could be clawed back indefinitely. If no intention then it could be for up to 10 years (from memory).

There may be ways around this though, however it would still be a real danger.

BTW, some lawyer tried to get a patent on this strategy many years ago (before the Bankruptcy Act was changed). He failed!

 

[coastymike]

Under S121 in order for the transfer to be void the main purpose must be to prevent the transferred property from becoming divisible among the transferor' creditors or to hinder or delay the process of making property available for division among the transferor's creditors.

Now what if the main purpose was to provide a commercial income stream to the gifted trust. The trust has a proper commercial loan agreement in place and receives income on a periodic basis. Was the main purpose to defeat the creditors or receive an income stream ?

Why were the funds gifted to the trust ? For estate planning purposes possibly ? Maybe the trust was established to invest in real estate and due to the economic crisis it chose to retain its cash and lend at a commercial rate rather than take a risk investing in property. Purchasing real estate in the trust would provide good estate planning opportunities. Gifting to the trust to achieve these estate planning objectives would seem reasonable to allow it do so. The trust wants to receive a commercial return on those funds and lends them out at a commercial rate for a period of time. What was the main purpose ?

 

[coastymike]

Other strategies, if you have the relevant funds, might be to establish a Hong Kong based trust. There are the tax issues to deal with but it is a way of staving off the hyneas for a period of time or making the pack go away because things are just too hard.

Hong Kong does not have a foreign judgment reciprocity with Australia. So things becoming interesting and very expensive for the other party. The other party could be in court for years trying to unravel the thing.

There are many ways to protect things. Some things might merely result in a delay to proceedings or might be enough to make the other party go away because it is all too hard. At the end of the day making it difficult for the other party is what it is all about.

What if the same Hong Kong entity not only held a commercial loan to you but there was a commercial loan to a Panamanian Foundation ? The Panama Foundation calls on the loan ? What does the Hong Kong entity do ? Can it sell the units ? It has a registered charge over the unit. What will the bankruptcy trustee do ? Interesting stuff.

 

[Terryw]

Very good Strategies Mike. Has to be carefully planned and implemented.

 

[JIT]

And what about the advantages of holding in a unit trust as opposed to the individual names.

1. does holding in individual names allow a transfer to a SMSF at a later stage ?
2. does holding in individual names allow you to consider strategies such as the refinancing principle ?
3. does holding in individual names potentially result in higher stamp duty costs when transferring the property ?

coastymike, these above issues were brought up earlier in the thread.

Haven't heard of the gift/loan-back strategy so that's interesting, thanks.

 

[Francesco]

....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

Chris

I am learning so much from this thread on your update on HDT. The time you have spent on negotiating with the ATO is clearly paying off.

I am also glad that you and the courts have helped to clarify the legitimate use of the HDT, particularly through the Forrest vs FC of T. As you have mentioned, ATO has made HDT something to be steered clear off on the basis of fear of any disagreement with the ATO can only rely on a costly legal process to resolve. Many tax accountants have practically been complicit with ATO in decrying HDT of having any merits in tax planning.

It is good to have your feedback about the reality of tax culture. Treasury policies sometimes go ahead of themselves and they become de facto vigilanteers for maintaining budgetary surplus without legal underpinnings. It seems that you are describing this situation in your above response, where political persuasions and expediencies rule the day. I accept that the tax framework ATO pursues wrt HDT has grey areas and cannot be established fully through democratic debates and legislation.

However, if any grey area is "significant" it should not be left to political persuasions and budgetary expediencies. It seems investors need the Packers, Rineharts, Forrests and Palmers to help clarify the true legitimate boundaries of HDT for the public good. I hope you will continue to provide your updates. This 'final word' surely will be long!

 

[Chris Batten]

I am also glad that you and the courts have helped to clarify the legitimate use of the HDT, particularly through the Forrest vs FC of T. As you have mentioned, ATO has made HDT something to be steered clear off on the basis of fear of any disagreement with the ATO can only rely on a costly legal process to resolve. Many tax accountants have practically been complicit with ATO in decrying HDT of having any merits in tax planning.

Francesco

Thank you for the post. If I had my way they wouldn't be called hybrid trusts. They would be called Part fixed/Part Variable or Unit and Discretionary Trust. The problem with the word Hybrid is that it encompasses a one size fits all and many people including the ATO focus on this and the potential tax mischief that could be there for one variation and not another.

Not to take away from my marathon negotiations with the ATO but I always thought it would be possible to demonstrate to the ATO the merrits of a part fixed/part variable trust. It is the terms of the trust and the rights and restrictions of beneficiaries (i.e. unitholders) that are at issue. Not a "Hybrid" deed of settlement. Only 4 years and my friends at the ATO realised this was the case. I will admit the ATO gentleman I deal with has a double degree and is a lawyer. I am hoping that it won't take members of the profession 4 years to get it. Unfortunately some have taken an extreme stance that I think they find hard to back away from. I would argue that if we dropped the label tomorrow everyone would get it.

Now on a lighter note. I spoke at length today with the Treasury Official in charge of the Tax Laws Amentment (2011 Measures No.5) Bill 2011 (Streaming of Capital Gains and Franked Dividends) and I might have some news in the next few days. I think those of you with hybrids need to accept the ATO is not going to be happy if the outcome is confirmed at being the one arrived at today. Remember Bamford was good for the ATO concerning Hybrid Trusts. TLAB No.5 is potentially really bad.

When I am settled I will let you know. Most likely Monday but hopefully Friday.

Chris

 

[Piston Broke]

Whilst I appreciate the technical contributions here of some who appear to be "experts"
it's obvious that "the final word" is that there is no "final word" in regards to HDTs and that no "final word" is likely to be arrived at for quite some time if not ever as taxation law is a continuous evolution and there is no "final word".

And maybe, just maybe people selling these HDTs would like to present a more realistic picture, ie not be (once again) so deceptive in their representations.

 

[coastymike]

PistonBroke

Like a lot of things when it comes to tax the rules are always changing. Take Julia's recommendation that husband and wife purchase a property 1/99 and enter into a salary sacrifice arrangement for the interest. Was ok until the government changed the rules.

Then came along Bamford and changes to trust distributions. Having a car in your company now means changes to the statutory method for FBT purposes. Distributing to a minor ? Recent changes now mean the rules have changed.

If you want to ensure tax law never impacts on you ever then even death won't help as this is still a taxing point. The reality is it is a reality of life. Things change including tax law. Deal with it.

 

[Chris Batten]

And maybe, just maybe people selling these HDTs would like to present a more realistic picture, ie not be (once again) so deceptive in their representations.

Mr Piston Broke

When you say there is no final word in relation to Hybrid Discretionary Trusts I don’t understand. In my view it’s all over in terms of the ATO view on hybrids and although Forrest didn’t get the finality it could have I think everyone accepts an entitlement to ordinary income only will result in the deduction being apportioned. The senior counsel I’m talking with including people involved in Commissioner of Taxation v Phillip Bamford & Ors; Phillip Bamford & Anor v Commissioner of Taxation [2010] HCA 10 (‘Bamford”) think that is the correct position.

If your referring to the post yesterday, the end of that post was about the effect of the court’s decision in Bamford and the resultant proposed legislative measures contained in Tax Laws Amendment (2011 Measures No.5) Bill 2011. Bamford and TLAB No.5 didn’t involve hybrids and was meant to address the issue with the failings of Division 6 of the Income Tax Assessment Act 1936. This only affects discretionary trusts and testamentary trusts and as a result of the introduction of TLAB No.5 it has an effect on hybrids. I don’t think Treasury were thinking hybrids when the provisions were drafted.

Bamford decided that income and capital gains were to be distributed on a proportionate basis. I think it is well explained at paragraph 2.9 of the Explanatory Memorandum of TLAB No.5”

“ This is because, under the proportionate approach, the amount included in a beneficiary’s assessable income under Division 6 is the proportion of the income of the trust estate to which a beneficiary is presently entitled applied against ‘the whole of the trust’s taxable income’. On one view, the result of this approach is that a beneficiary includes in their assessable income a “blended” amount of all of the different types of income and capital gains included in the trust’s taxable income.”

This means that if a Special Income Unitholder has units giving an entitlement to 80% of the trusts income then the untiholder would include 80% of the different types of income and capital gains in his or her assessable income. This is why the ATO would like the Bamford decision in relation to hybrid trusts.

The Federal Government brought out TLAB No.5 to break capital gains and franked dividends away from the proportionate approach. This means that a trustee of a hybrid trust could stream the capital gains away from the Special Income Unitholder. Therefore in the absence of amending the hybrid discretionary trust deeds we are possibly back to the Forrest decision in terms of interest deductibility. This is why the ATO wouldn’t like TLAB No.5 in relation to hybrids.

For years the law was uncertain whether the proportionate theory as decided in Zeta Force Pty Limited v Commissioner of Taxation (1998) 84 FCR 70 and released by the ATO in Practice Statement PS LA 2005/1 was the correct interpretation. This was finally put to rest in Bamford. To make distributions more flexible from discretionary trusts and testamentary trusts TLAB No.5 was introduced. It wasn’t introduced for hybrid trusts.

I assume the above may better answer your concerns of deception.

I apologise if you feel deceived. When you say “a more realistic picture” would it make it easier if I reproduced the above as a diagram with stick figures?

If you can better articulate your particular concerns or issues I will be happy to respond.

Chris

 

[Piston Broke]

Thanks for the reply, I do like the info and it is useful and important.
And yes i do use trusts myself, although discretionary.

My comments were to the industry of selling HDTs in general and not specifically yourself, although you certainly play a role in it.
There are few people here that do not believe they were told all the facts and ramifications (legal and financial) of HDTs and would be happy to "undo" their HDTs.
There are many more who will never be heard.
In the many discussions on this forum of such matters, many times the phrase "expert" was used and someone else quoted in terms of HDT benefits.
My specific concern is that those selling a legal document, the MGS HDT should make (and have made) their potential customers a little more aware of the financial consequences instead of just promising negative gearing and asset protection.

Maybe there is a way to dissolve the trust and not incur high costs?

 

[JIT]

btw Great thread, I rated 5 stars.

 

[Francesco]

Yes, kudos to Chris for the forthright contributions.

 

[Ebbie]

Yes, agree with the others - thanks Chris! I've been absent from Somersoft for a while so only found this discussion today. Great thread!

BTW, where's Julia now?

 

[Chris Batten]

When I am settled I will let you know. Most likely Monday but hopefully Friday.

Settled

For all of those that acquired an MGS Discretionary Trust or MGS Hybrid Discretionary Trust you will be pleased with the attached. This applies to deeds established between 2000 and now.

Those that didn't establish an MGS deed check the following:

1. Deed has ability to stream and the trustee has a discretion to determine different amounts on income or capital account.

2. You prepare a compliant resolution prior to 30 June 2011 appointing income and/or capital gains and/or franked dividends.

BTW. Those with MGS deeds you still need to resolve to appoint the income and capital gain prior to 30 June 2011. You need to address present entitlement, capital characterisation and absolute entitlement in the resolution.

Things have changed and those with trusts need to be a bit more diligent regarding the appointment of different receipts of the trustee especially if you want to stream.

To those who established a Deed through MGS in the last 10 years you don't need to upgrade your deed. I am very happy with this result.

Those with hybrid trusts still need to amend the deed to conform with the ATO view and avoid having interest deductions denied. As mentioned previously this is a different point. When there are no units on issue you can stream as if it is a MGS discretionary trust.

Chris

 

[JIT]

To those who established a Deed through MGS in the last 10 years you don't need to upgrade your deed. I am very happy with this result.

Those with hybrid trusts still need to amend the deed to conform with the ATO view and avoid having interest deductions denied. As mentioned previously this is a different point. When there are no units on issue you can stream as if it is a MGS discretionary trust.

Chris

Good to hear Chris, so the MGS HDT has the OK to use for negative gearing, and also as a DT when no units are on issue.

Just in general terms regarding getting an opinion from a "Senior Counsel", I'm not sure what this title means and the significance of an opinion from a SC, but I presume that until an issue goes to Court this opinion is just that, an opinion and not binding on anyone? But perhaps reassuring nonetheless...

 

[Chris Batten]

Just in general terms regarding getting an opinion from a "Senior Counsel", I'm not sure what this title means and the significance of an opinion from a SC, but I presume that until an issue goes to Court this opinion is just that, an opinion and not binding on anyone? But perhaps reassuring nonetheless...

JIT

Previously when a barrister had excelled in their field in front of judges and collegues they could apply and a selection of their piers would nominate a limited number who were the best of the best to the title of Queens Counsel. That expression has been replaced by Senior Counsel in modern times. The process to be selected is the same.

Just to be clear the MGS Deed allows for streaming of capital gains in terms of section 115-228. The ATO don't want people borrowing funds and acquiring units in a trust, hybrid or unit, and only being entitled to revenue income. The irony is that at the moment the only real case on point is Forrest and he only had an entitlement to income and no capital gain.

I think it would be a brave person to run the apportionment argument based on only an entitlement to ordinary income. You have to understand the issue I had been raising with the ATO pre Bamford and how it was even worse post Bamford. I hope you all understand the amendment to the MGS Hybrid Deed wasn't really needed until the legislation that is now TLAB No.5. I hope you all understand I have been running the argument below for years. What happened is almost an absolute joke.

The ATO has always agreed that the proportionate theory applied. They said it publicly in Practice Statement PS LA 2005/1. They argued it and won in Bamford. On their analogy if you had Special Income Units and were entitled to 50% of the ordinary income then the same proportion of the capital gain would follow. To this the ATO agreed. Then if that is the case then why is there a need to amend the MGS Deed? Good Point. That's right Chris, but you can redeem the units at below market value and/or dispose of assets out of the trust at below market value. My response was why do you care if I redeem my units at cost or sell assets for $1. The market vaue substitution rule would apply to both events (i.e. section 116.30 of the ITAA97)

So prior to the release of TLAB No.5 according to the ATO both the proportionate theory applied and the market value substitution rule applied. I am still struggling, as I did for 4 years to work out what the ATO problem was with the MGS HDT. I can understand their problem where the entitlement to income of the unitholder diminishes when the market value of the asset increases (i.e. Property Investor Trust). So I go to Mirvac and they say acquire these units and we are going to use your funds to acquire real estate. If we are successful and the properties double in value your entitlement to income diminishes to 50%. That's at the extreme end of uncommercial.

Now TLAB No.5 takes capital gains outside the proportionate theory I agree that the ATO's argument is somewhat more sensible. I'm not saying it is correct. I am just saying it is more sensible. Imagine going before a judge and the ATO saying the Special Income Unitholder is entitled to 50% of the ordinary income but gets no capital gain and can redeem for $1. The judge would ask the ATO "so you are departing from your public view on the proportionate theory and the market value substitution rule?" We'll in this case your Honour yes but not in Bamford and other cases.

At various stages over the past 4 years I have not believed what I was arguing and who I was arguing with. I actually think the ATO just got so pissed off at people that went too far. They just couldn't accept the diminishing income argument and everyone was lumped into the same basket.

Read the first paragraph of the attached on page 4. I asked the ATO to send me a letter in respect to that paragraph stating that they would not seek to apply the market value substitution rule should that happen. No letter.

Chris