trust qu

Hi everyone,

Last weekend I was discussing hybrid trusts with a friend of mine who is studying accounting and works F/T for an accountant (doing tax returns & the like). He said that they had clients who instead used a unit trust, the profits of which they flowed into a discretionary trust, and from the discretionary trust they distributed profits around the family. He reckons this is a much better stucture than the hybrid trust, which still allows you to access negative gearing benefits.

By the end of the night he, and another friend, had themselves convinced this structure was much better than simply using a hybrid trust.

Can anyone out there comment?

Cheers

John
 
Re: trust qu WARNING LONG ANSWER

Originally posted by john doe
Hi everyone,

Last weekend I was discussing hybrid trusts with a friend of mine who is studying accounting and works F/T for an accountant (doing tax returns & the like). He said that they had clients who instead used a unit trust, the profits of which they flowed into a discretionary trust, and from the discretionary trust they distributed profits around the family. He reckons this is a much better stucture than the hybrid trust, which still allows you to access negative gearing benefits.

By the end of the night he, and another friend, had themselves convinced this structure was much better than simply using a hybrid trust.

Can anyone out there comment?

Cheers

John

Interesting question JD. Obviously you (and your trustbuddies) should seek legal and accounting advice. But here are a few idle thoughts and first principles.

The reason YOU get asset protection when assets are held in a discretionary trust is that YOU (even if you personally are the trustee - which isn't recommended) don't BENEFICIALLY own the assets.

The assets are LEGALLY held by the Trustee (ie the name of the land title register is the trustee's) but they are held for the BENEFIT of the beneficiaries of the trust.

Ie it's like saying "well I'm holding this asset but I'm just minding it for someone, so you can't take it off me for things I've done wrong because it ain't really mine."

But here's the twist - the beneficiaries of the discretionary trust can also say "Nope I don't own that asset either. So you can't take it off me if I'VE done something wrong."

That's because none of the beneficiaries of the discretionary trust have a right to any of the assets which are being held for their benefit (other than on a winding up of the trust but let's not worry about that now) rather the ONLY right which the beneficiary of a discretionary trust has is to say "Trustee do your job according to the trust deed".

That's it.

The trustee in its discretion may choose to favour YOU as a beneficiary with a distribution of income or capital or it may not. But you can't complain if you get nothing!

The KEY of course is to make sure you control the trustee and can hire and fire the trustee (ie you are a director of the trustee company and are the Appointer under the trust deed).

*huge breath*

Okay now that we've established that, let's look at how this differs from a unit trust. With a unit trust it is a little bit like owning a share conceptually.

Let me digress a moment and compare share ownership with unit trust ownership, because it will help us all understand the question at hand.

When you own a share, say a CBA share, you own a part of the BUSINESS which is the Commonwealth Bank. But that doesn't give you a right to walk into a bank and make off with the office chairs or ask for your 31 millionth of the business back. (you'll get arrested if you do :D ) Rather, what you own is a right to share in the profits of the business (if any are distributed as dividends at the director's discretion out of the profits) and (heaven forbid) if the CBA was wound up you'd get your 31 millionth of the PROCEEDS of sale of all the CBA's assets.

*another huge breath*

So then let's compare that with a unit trust. Let's say a unit trust has 100 units issued. The trustee of the trust owns a house. If you own 1 unit then you also, like with a shareholder, have a right to receive 1/100th of the PROCEEDS of the sale of the property on a winding up of the unit trust. BUT - and here's the key distinction - you also do own 1/100th of the house BENEFICIALLY (the certificate of title will show the trustee as the registered owner). If it were a company instead, you've got no PROPRIETARY interest in the house - where it's a unit trust - you DO.

Compare this also with what the discretionary trustee beneficiary has - NO ownership of that house and not even the certainty that they will get cut in on any rent earned by it.

* this is getting realllly long apologies I'm not more succinct*

Let's also remind ourselves what negative gearing means in this context. If you borrow money to buy something that will earn you income, then you can count as an allowable deduction against your assessable income any interest which you have had to pay on that loan. The great thing is that you can set that deduction off against not only the income which the asset earns, but, if there's any deduction left over, that can be applied against your other income to reduce the amount of tax you pay.

*i'm getting around to addressing the question - really!*

So in the structure your mates like, as I understand it, the
trustee of the unit trust buys the property. That purchase is (presumably) funded by the money subscribed for the units. The units are bought by the trustee of a separate discretionary trust.

My question is this, how do YOU then access -ve gearing if you haven't borrowed to acquire an asset which earns income?

From an asset protection perspective you can't just lend money to the discretionary trust because the interest and repayments due to you could go to your creditors instead. :(

If the trustee of the discretionary trust borrowed to buy the units then the trustee could -ve gear. Perhaps where you are coming from is that YOU and not your Company is the trustee? While that may be a good thought, the trouble is that you'd be intermingling YOUR assets with the TRUST assets and that's a No No as a trustee!

If you borrow to buy the units in the unit trust then, sure you can -ve gear, but the units you own are an asset which your creditors could snaffle.

SO, all in all I don't think this is any better than a hybrid trust, in fact I think it's worse.

On hybrid trusts though, I'm still of the view that they don't provide sufficient asset protection. The units you own are still open to be snaffled by your creditors. I suppose that if the trustee keeps the trust geared or decides in its discretion that the income falls into a different category than that which the units have a right to then maybe that's okay. BUT I have concerns that the trustee would be acting to the detriment of the unitholders possibly in breach of trust. ALSO I think that the ability to negative gear may be tenuous if the trustee can play too many games with the right to income of the unitholder...

BUT it's certainly far from clear and will depend to a degree on what the actual hybrid trust deed says...


I hope that's given you some insights JD. Of course you should get your own legal and accounting advice.

Cheers
N.
 
Nigel, you took the words right out of my mouth!

Mind you, I don't think i could have possibly out it all like that,

JD, I think your friends have somewhat missed the point of the hybrid trust and may I respectfully suggest that they learn a little more about them properly before commenting . . .

Dale
 
Hi Guys,

Thanks for your replies. Nigel, thanks for the essay:) I think I need to re-read it a couple of times. Sounds like my friends was leading me astray.

Thanks again

John
 
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