Trusts and Net Financial Investment Losses

[Ebbie]

I noticed in this years tax return there is a section IT5 - Net Financial Investment Loss.

http://www.ato.gov.au/individuals/content.asp?doc=/content/00223018.htm&page=2

Complete this item if you received income from or claimed deductions in relation to any of the following types of investments:

- shares
- an interest in a managed investment scheme
- rights or options in respect of any of your shares or interests in a managed investment scheme
- distributions from a partnership that included income or losses from an investment listed above
- interests in trusts that you provided consideration to acquire
- any investment that is of a similar nature to those listed above.

If you are not sure whether an investment you hold is a financial investment, go to www.ato.gov.au/incometests. If you are still not sure, phone the Individual infoline on 13 28 61.


I assume the purchase of Income Units in a Hybrid Trust would be classed as a 'financial investment', and there would be a reportable Net Financial Investment Loss if the interest on the loan was higher than the income distribution received.

However, in the case where a Discretionary Trust is used instead and the individual borrows x dollars at y% interest and on-loans the funds to the trust at the same commercial interest rates, there would be no Net Financial Investment Loss. Even if the ATO classed the transaction as a 'financial investment' the individuals interest deduction would always be equal to the amount of interest received from the trust.

Does this sound right?

 

[Ebbie]

So using some figures as an example:

Individual A borrows $100K at 10% p.a and buys 100K Income Units in a Hybrid Trust. The Trust buys a property and distributes $7K net rental income to the individual (unit holder). The individual must report a Net Financial Investment Loss of $3K.

Individual B borrows $100K at 10% p.a and lends the $100K to a Discretionary Trust. The Trust buys a property and pays 10% p.a interest to the individual (with a formal loan agreement). The individual breaks even and doesn't make a Net Financial Investment Loss.

 

[alexlee]

If you were borrowing to buy units in a trust that's unrelated to you, say in a listed property trust, then your first scenario is fine.

There are further issues in relation to hybrid trusts.

 

[Ebbie]

There are further issues in relation to hybrid trusts.

Such as? The ATO's definition of 'financial investments' isn't very clear.

Would Individual A have a Net Financial Investment Loss or not? If not, I suspect it would be beneficial in that it wouldn't affect government payments such as Family Tax Benefit (which now adds back any investment losses in addition to rental property losses, as part of the Income Test).

 

[alexlee]

Such as? The ATO's definition of 'financial investments' isn't very clear.

Would Individual A have a Net Financial Investment Loss or not? If not, I suspect it would be beneficial in that it wouldn't affect government payments such as Family Tax Benefit (which now adds back any investment losses in addition to rental property losses, as part of the Income Test).

Do a search on hybrid trusts. There are plenty of opinions. It's not as simple as you think, and certainly not as simple as just 'you make a loss therefore you can claim it'. It's not always a matter of just applying the rule, but history and precedent. Hybrid trusts are a fairly new structure. You could argue, for example, that you can borrow 100% to buy shares that pay very little dividends and therefore there is no reasonable expectation that it will ever be positive tax income, but a lot of these things are grandfathered in by historical practice.

 

[Ebbie]

Anyone?

Where did all the Hybrid Trust users go who have negatively geared properties?

 

[Ebbie]

Do a search on hybrid trusts. There are plenty of opinions. It's not as simple as you think, and certainly not as simple as just 'you make a loss therefore you can claim it'. It's not always a matter of just applying the rule, but history and precedent. Hybrid trusts are a fairly new structure. You could argue, for example, that you can borrow 100% to buy shares that pay very little dividends and therefore there is no reasonable expectation that it will ever be positive tax income, but a lot of these things are grandfathered in by historical practice.

Hi alexlee, ok I understand what you are saying now. I'm not questioning the hybrid trust itself or whether or not I can claim the full deduction as I understand what I can and can't claim with my specific trust deeds.

I'm talking about the Net Financial Investment Loss in general (assuming you have a legitimate interest deduction that is higher than the income distribution) so I guess you could ignore the fact I said Hybrid Trust, and all the controversy surrounding that, and probably use a normal unit trust in my example instead.

 

[alexlee]

If you're just borrowing to buy units in a trust you have no control over (say a listed property trust), then the interest is certainly deductible.

I don't understand what you're asking if you don't distinguish between unit and hybrid trusts. Are you purely looking for a way to negatively gear? Putting it in a unit trust doesn't give you asset protection or allow income streaming. Reading your post, the question is not 'can you deduct interest if you borrow to buy units in a unit trust', but 'why are you doing it in the first place'? Borrowing to buy units in a unit trust really isn't that much different from buying it in your own name.

 

[Ebbie]

I think we might be getting off the topic now so I mustn't have made my question very clear. The ATO has put a new question in the tax return this year at item IT5 under the heading of Income Tests which asks for your "Net Financial Investment Loss".

Assuming the individual does have a Hybrid Trust where the interest on the loan (for the purchase of Income Units) is higher than the income distribution received from the trust AND is fully deductible - would the difference (loss) between the income received and the interest paid be the figure you put at item IT5.

Is this an example of the type of "Financial Investment" the ATO is looking for with this question (I assume it would be)? I don't think their definition of interests in trusts that you provided consideration to acquire really differentiates between trusts that are related to you and commercial trusts you have no control over.

I could probably rephrase my initial question to "if you are already negatively gearing an investment property in a Hybrid Trust, with no other investment losses to report, do you show the loss at question IT5 of your tax return?" or "is a Hybrid Trust included in the ATO's definition of a Financial Investment at question IT5 of the Individual's tax return?".

Am I making sense now?

 

[Rob G.]

A unit is an interest in a trust.

Cheers,

Rob

 

[Ebbie]

A unit is an interest in a trust.

Cheers,

Rob

Thanks Rob, it sounds too obvious when you put it like that.

 

[dan c]

I could probably rephrase my initial question to "if you are already negatively gearing an investment property in a Hybrid Trust, with no other investment losses to report, do you show the loss at question IT5 of your tax return?" or "is a Hybrid Trust included in the ATO's definition of a Financial Investment at question IT5 of the Individual's tax return?".

Yes, you show the loss.