New Website for Batten
- Thread starter coastymike
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That's what I said at the beginning! - but you suggested that in court, a judge would see through all this and use common sense and value units at the property's market value, hence my further questions to you.
And, I believe you're the one that brought up the scenario in the first place?!
Anyway, let's just let this one slip through to the keeper...
This is the reason I am much more conservative with hybrid trusts and do not recommend them much anymore. For those who know me they realise my position has changed. In fact I provide many disclaimers at my meeting with clients who want to go ahead with hybrids. Not because of interest deductibililty. That I am quite confident on. The problem is that the units will be redeemed at market value.
So you have a high income earner holding an asset (units) worth market value. So no asset protection. Then you have the high income earner also being assessed on the capital gain when the property is sold (redemption before is rarely done and usually the two coincide) so little opportunity for streaming.
So I agree that the circumstances in which hybrids are useful do seem limited in my opinion. I have another idea but it is currently waiting on the ok. In the interim strategies such as the salary sacrificing mentioned by Julia are a safer proposition and do have disadvantages but the benefits the hybrids once had have in my view have been diminished to very few people.
The refinancing principle is a huge benefit and the ability to move the property into super but asset protection and income streaming in my view are no longer benefits at all. I believe they are mainly of benefit to high net worth individuals. From a cost perspective it makes no sense for mum and dad purchasing their first investment property to purchase it in a hybrid trust. The accounting and setup fees are high and the ongoing fees also high. Save the money, purchase your next one and then your next one and maybe then it is appropriate.
So you have a high income earner holding an asset (units) worth market value. So no asset protection. Then you have the high income earner also being assessed on the capital gain when the property is sold (redemption before is rarely done and usually the two coincide) so little opportunity for streaming.
So I agree that the circumstances in which hybrids are useful do seem limited in my opinion. I have another idea but it is currently waiting on the ok. In the interim strategies such as the salary sacrificing mentioned by Julia are a safer proposition and do have disadvantages but the benefits the hybrids once had have in my view have been diminished to very few people.
The refinancing principle is a huge benefit and the ability to move the property into super but asset protection and income streaming in my view are no longer benefits at all. I believe they are mainly of benefit to high net worth individuals. From a cost perspective it makes no sense for mum and dad purchasing their first investment property to purchase it in a hybrid trust. The accounting and setup fees are high and the ongoing fees also high. Save the money, purchase your next one and then your next one and maybe then it is appropriate.
GreatPig
I think it's like a lot of things in life. As things change, laws change, cases come along and new interpretations are made then the models also change with them. New things come along and they will also change. Just look at the super landscape. Now we have instalment warrants and the ability to gear using your super fund.
Thank God things do change otherwise we would still swimming around in the swamp.
I think it's like a lot of things in life. As things change, laws change, cases come along and new interpretations are made then the models also change with them. New things come along and they will also change. Just look at the super landscape. Now we have instalment warrants and the ability to gear using your super fund.
Thank God things do change otherwise we would still swimming around in the swamp.
Pat and Coastymike,
In simple terms, could one describe the type of person that would benefit from using a HDT to purchase residential property as someone who:
(1) earns a high income
(2) is purchasing negatively geared, high growth residential property
(3) accumulates and holds these properties over a long time period
(4) does not intend to sell any of these properties
(5) subsequently builds up a large amount of equity or net worth
(6) lives off equity to fund living/lifestyle expenses, hence taking advantage of the re-financing principle
And...anyone else who uses a HDT may be taking a punt on the high court judge of the day if/when a HDT case goes to court? Though, Batten maybe thinks otherwise - perhaps due to his discussions with the ATO?
I would add that if you were older and closer to an age where superannuation may be of benefit to you, and had the foresight to use a unit trust + HDT structure, then this would be more effective and beneficial.
Would this be a good summary?
DaleGG who was advocating HDT's used them himself, and I guess would fit the above criteria, and as I understand it he is using LOE in retirement (from what another poster here said in another thread).
Jit,
I think they are useful for :
1. People where the deductibility of interest on otherwise non deductible debt, available through utilising the refinancing principle, will be greater than the capital gains on redemption of the units. Generally high net worth individuals;
2. People who want to transfer residential property into super.
So I think you have a good summary of who it would be suitable for. Remember that redemption of units will be a CGT event and as MRY has said for a lot of people incurring a capital gain on redemption will mean funds are not available to either pay the capital gain or use strategies to reduce this gain. High Net Worth individuals are not in the same boat.
As an example say you purchase a property for $100K and redeeem the units when the property in the trust is worth $500K. You therefore have a $400K gain.
Using the 50% general CGT discount you are left with a $200K gain in the special income unit holders name.
Now a lot of strategies are available to reduce this gain but for the average bear it will be difficult to reduce this gain significantly. Prepaying $200K worth of interest or purchasing $200K worth of forestry type products is not easy for the average bear. For high net worth individuals this is not an issue at all. Many of my clients purchase $200K worth of biofuel forestry products year on year to offset capital gains on their investments, many prepay huge amounts in interest because they have the funds to do so. The average person cannot.
So yes I believe they are still a very useful tool but not for people on average incomes, with no plans on moving their residential property into super or being able to ever use the refinancing principle. Better off looking at other strategies.
I think they are useful for :
1. People where the deductibility of interest on otherwise non deductible debt, available through utilising the refinancing principle, will be greater than the capital gains on redemption of the units. Generally high net worth individuals;
2. People who want to transfer residential property into super.
So I think you have a good summary of who it would be suitable for. Remember that redemption of units will be a CGT event and as MRY has said for a lot of people incurring a capital gain on redemption will mean funds are not available to either pay the capital gain or use strategies to reduce this gain. High Net Worth individuals are not in the same boat.
As an example say you purchase a property for $100K and redeeem the units when the property in the trust is worth $500K. You therefore have a $400K gain.
Using the 50% general CGT discount you are left with a $200K gain in the special income unit holders name.
Now a lot of strategies are available to reduce this gain but for the average bear it will be difficult to reduce this gain significantly. Prepaying $200K worth of interest or purchasing $200K worth of forestry type products is not easy for the average bear. For high net worth individuals this is not an issue at all. Many of my clients purchase $200K worth of biofuel forestry products year on year to offset capital gains on their investments, many prepay huge amounts in interest because they have the funds to do so. The average person cannot.
So yes I believe they are still a very useful tool but not for people on average incomes, with no plans on moving their residential property into super or being able to ever use the refinancing principle. Better off looking at other strategies.
Thanks for the reply Coastymike.
That makes sense.
I think a lot of people who have used HDT's would probably not meet all of these criteria.
I think it all really boils down to whether you think redeeming units at CPI can be justified.
The way Batten explains it in his video certainly does make sense to me.
By the taxpayer choosing to have unit value linked to CPI, they are guaranteed of capital gains on their units even if the property drops in value, which is certainly possible, and more so over short-medium term time frames and in the context of 'global recessions' and 'house price crashes'.
Personally, I think the Australian residential property markets are going to become more volatile in the years to come than they have been in the past, and show more swings, the likes of which are more apparent in the US markets today.
It's seems like a reasonable commercial decision made by the investor, and a reasonable commercial explanation to me.
Any further thoughts on this point Pat or Coastymike, Mry or Julia, or others? Does it not sound commercial to you at all?
It would appear that Batten is confident that the ATO and Courts would see his logic too.
Still not a clear YES/NO answer to the debate, but will have to do for the time being.
That makes sense.
I think a lot of people who have used HDT's would probably not meet all of these criteria.
I think it all really boils down to whether you think redeeming units at CPI can be justified.
The way Batten explains it in his video certainly does make sense to me.
By the taxpayer choosing to have unit value linked to CPI, they are guaranteed of capital gains on their units even if the property drops in value, which is certainly possible, and more so over short-medium term time frames and in the context of 'global recessions' and 'house price crashes'.
Personally, I think the Australian residential property markets are going to become more volatile in the years to come than they have been in the past, and show more swings, the likes of which are more apparent in the US markets today.
It's seems like a reasonable commercial decision made by the investor, and a reasonable commercial explanation to me.
Any further thoughts on this point Pat or Coastymike, Mry or Julia, or others? Does it not sound commercial to you at all?
It would appear that Batten is confident that the ATO and Courts would see his logic too.
Still not a clear YES/NO answer to the debate, but will have to do for the time being.
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Unfortunately though, the ATO makes it difficult to change with the times without triggering a CGT event.
Cheers,
GP
Jit,
I believe the courts would always value units with regards their relationship to the underlying assets. CPI doesn't hold up from a commercial viewpoint and the fact that the transaction is with a related party gives more emphasis to this argument. As Mike has mentioned, in most cases the redemption of units would roughly coincide with the sale of the property.
The HDT is still very useful for those clients that have say 25% or more of the funds for a property, including stamp duty and legals, in cash and they can then stream this percentage of the yearly profit. This becomes particularly advantageous when their are minors to distribute to each year and the obvious capital gain distribution on sale of the property.
I believe the courts would always value units with regards their relationship to the underlying assets. CPI doesn't hold up from a commercial viewpoint and the fact that the transaction is with a related party gives more emphasis to this argument. As Mike has mentioned, in most cases the redemption of units would roughly coincide with the sale of the property.
The HDT is still very useful for those clients that have say 25% or more of the funds for a property, including stamp duty and legals, in cash and they can then stream this percentage of the yearly profit. This becomes particularly advantageous when their are minors to distribute to each year and the obvious capital gain distribution on sale of the property.
You do realise that most HDTs with the generic unit application form say that the holders of the special income units shall not have an entitlement to any part of the capital of the trust fund.
If market value is the new position then,
1 - Clients with these special income units issued with no rights to capital have not been entitled to negative gear in the past, requiring amendments to deny negative gearing benefits.
2 - The units issued from HDTs are no longer special income units, they are just 'units' like a normal unit trust might issue. The concept of "special income units" is dead in the water for those who want to negative gear.
3 - Clients have to cancel their current units on issue and create new units to ensure the new units have these capital rights. You can't go back and retrospectively cancel and reissue new units.
4 - Clients with the new units have asset protection problems unless they choose to redeem them.
If I was selling these hybrids to clients under the old terms, I'd be checking my PI insurance terms and expecting quite a few calls and emails soon.
This solves all of the issues in the article I wrote about with hybrids, at a cost of making them a very very niche product. I can still see some advantages with this new interpretation (eg a person who wants to buy themselves a 'mega house' as a PPOR in a few years and has 3 IPs under their belt) but you would need to explain the costs of such a strategy (the CGT on redemption) and plan it carefully (combining it with super contributions). Still, the consequences of such a transaction may be no different than if the person bought a property in their own name and transferred it to a spouse or a trust later on. Yes they would incur stamp duty and there may be Part IVA issues, but they may save themselves other costs such as setting up and running a hybrid.
Even so with the refinancing principle, doesn't that trap the deductions in the trust? Unless they can contribute income from another source into that trust, they end up with tax benefits in a trust that don't flow on to their individual positions for quite a few years.
If market value is the new position then,
1 - Clients with these special income units issued with no rights to capital have not been entitled to negative gear in the past, requiring amendments to deny negative gearing benefits.
2 - The units issued from HDTs are no longer special income units, they are just 'units' like a normal unit trust might issue. The concept of "special income units" is dead in the water for those who want to negative gear.
3 - Clients have to cancel their current units on issue and create new units to ensure the new units have these capital rights. You can't go back and retrospectively cancel and reissue new units.
4 - Clients with the new units have asset protection problems unless they choose to redeem them.
If I was selling these hybrids to clients under the old terms, I'd be checking my PI insurance terms and expecting quite a few calls and emails soon.
This solves all of the issues in the article I wrote about with hybrids, at a cost of making them a very very niche product. I can still see some advantages with this new interpretation (eg a person who wants to buy themselves a 'mega house' as a PPOR in a few years and has 3 IPs under their belt) but you would need to explain the costs of such a strategy (the CGT on redemption) and plan it carefully (combining it with super contributions). Still, the consequences of such a transaction may be no different than if the person bought a property in their own name and transferred it to a spouse or a trust later on. Yes they would incur stamp duty and there may be Part IVA issues, but they may save themselves other costs such as setting up and running a hybrid.
Even so with the refinancing principle, doesn't that trap the deductions in the trust? Unless they can contribute income from another source into that trust, they end up with tax benefits in a trust that don't flow on to their individual positions for quite a few years.
I'm still confused here with the difference between "capital" of the trust and "capital gains".
While my trust documentation doesn't define either, it generally talks about "capital" in relation to the assets of the trust, which to me seems to mean the actual tax-paid funds and assets owned by the trust that no one has any immediate entitlement to.
In relation to "capital gains", the explanatory notes that came with the trust state, "the gain will be included in the assessable income of the Trust to be distributed or accumulated in the same way as any other income". This seems to suggest that "capital gains" are trust income rather than trust capital.
However, if that is the case, then it seems to me that trust capital could only have been obtained from gifts, unless not all income has been distributed, and special income unit holders wouldn't have any entitlement to that anyway since it's not attributable to the units.
Which then leads to the question: what are holders of capital units entitled to? If they don't get income, including capital gains, then is the only thing they're entitled to their own money back, or assets obtained through gifting?
Curiouser and curiouser...
GP
While my trust documentation doesn't define either, it generally talks about "capital" in relation to the assets of the trust, which to me seems to mean the actual tax-paid funds and assets owned by the trust that no one has any immediate entitlement to.
In relation to "capital gains", the explanatory notes that came with the trust state, "the gain will be included in the assessable income of the Trust to be distributed or accumulated in the same way as any other income". This seems to suggest that "capital gains" are trust income rather than trust capital.
However, if that is the case, then it seems to me that trust capital could only have been obtained from gifts, unless not all income has been distributed, and special income unit holders wouldn't have any entitlement to that anyway since it's not attributable to the units.
Which then leads to the question: what are holders of capital units entitled to? If they don't get income, including capital gains, then is the only thing they're entitled to their own money back, or assets obtained through gifting?
Curiouser and curiouser...
GP
GreatPig,
Yes a common misconception and MRY I must admit am surprised that this distinction is not clear. Your response does show that maybe this is an area that is a little unclear for you. Don't worry I just finished Taxation of Trusts with the Masters of Tax and even after completing that subject it is still confusing.
The documentation says it is not entitled to the capital of the trust. The special income unit holder is entitled to any "income" of the trust. Now we could go into a lengthy discussion on Section 95, definition of income and share of net income of the trust, the proportionate view (confirmed in Zeta Holdings case) vs the quantum view (confirmed in Richardsons case), the Commissioner's capital beneficiary approach which is totally different to what the High Courts have upheld but alas the view is that the special income unit holder is entitled to income of the trust. The trust deed makes it clear that for Section 95 income purposes it will include capital gains.
Now does that mean someone will also be entitled to the capital (i.e. the underlying property) when the special income unit holder is sued. Well that is for the courts to decide.
I am amazed however the number of people who do not know the difference between trust corpus (capital) and capital gains included in Section 95 net income.
Yes a common misconception and MRY I must admit am surprised that this distinction is not clear. Your response does show that maybe this is an area that is a little unclear for you. Don't worry I just finished Taxation of Trusts with the Masters of Tax and even after completing that subject it is still confusing.
The documentation says it is not entitled to the capital of the trust. The special income unit holder is entitled to any "income" of the trust. Now we could go into a lengthy discussion on Section 95, definition of income and share of net income of the trust, the proportionate view (confirmed in Zeta Holdings case) vs the quantum view (confirmed in Richardsons case), the Commissioner's capital beneficiary approach which is totally different to what the High Courts have upheld but alas the view is that the special income unit holder is entitled to income of the trust. The trust deed makes it clear that for Section 95 income purposes it will include capital gains.
Now does that mean someone will also be entitled to the capital (i.e. the underlying property) when the special income unit holder is sued. Well that is for the courts to decide.
I am amazed however the number of people who do not know the difference between trust corpus (capital) and capital gains included in Section 95 net income.
But what about when the units become positively geared, and you then want to income stream?
Could you reasonably redeem using CPI to value units at this time?
At this time you are not selling the property.
Pat said:
I see what you're saying. So when you buy a property worth say 400k, and issue 300k worth of units, with the remaining 100k + stamp duty/legals in cash, you can stream about 25% of any net profits while units are on issue and about 25% of any capital gains on sale of the property.
Is that correct?
If so, for those purchasing initially at 90% LVR or 97% LVR, this isn't a great benefit at all.
GreatPig,
Exactly. That has been the issue from the other side. A special income unit holder is entitled to their subscription price for the units and any future income streams (both income and capital). However they are not entitled to any underlying property in the trust. It is similar to an annuity. You are purchasing a future income stream. Now that has been the very issue. If capital gains were not included in net income then what sort of stream were you purchasing. A pretty pathetic one. And is this commercial. Probably not. Does this mean the interest would have been apportioned or not deductible. Probably.
I think many people confused capital gains and capital during the whole discussion. They are two very very different things.
There have been and always will be two issues. Tax deductibility on interest used to acquire special income units in the HDT and the "value" of those units for asset protection purposes. Now I hold the view that they have market value. But many people have different views. Whether they have market value or CPI value or a value determined by some court this is different to what income they are entitled to and interest deductibilty for tax purposes.
Exactly. That has been the issue from the other side. A special income unit holder is entitled to their subscription price for the units and any future income streams (both income and capital). However they are not entitled to any underlying property in the trust. It is similar to an annuity. You are purchasing a future income stream. Now that has been the very issue. If capital gains were not included in net income then what sort of stream were you purchasing. A pretty pathetic one. And is this commercial. Probably not. Does this mean the interest would have been apportioned or not deductible. Probably.
I think many people confused capital gains and capital during the whole discussion. They are two very very different things.
There have been and always will be two issues. Tax deductibility on interest used to acquire special income units in the HDT and the "value" of those units for asset protection purposes. Now I hold the view that they have market value. But many people have different views. Whether they have market value or CPI value or a value determined by some court this is different to what income they are entitled to and interest deductibilty for tax purposes.
I'm clinging on to CPI value at the moment, like Batten, a bit 'aggressive' perhaps - otherwise...the HDT goes in the bin for me.
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