Why don't big firms sell HDTs?

Discussion in 'Accounting and Tax' started by alexlee, 6th Dec, 2006.

  1. alexlee

    alexlee Member

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    I'm reading the HDT thread, and just wanted to make a general comment on why big firms may not recommend that their clients use a certain type of structure such as HDTs. Reason: they are not experts at it. Now, obviously a big 4 firm has the resouces to find out everything about HDTs if they want to, so why wouldn't they? Profitability. Most big firm tax departments deal with large corporations. They're experts in transfer pricing, etc. This is profitable because that sort of work allows firms to charge out their juniors' hours at high rates. THAT's where a big firm's profits come from.

    Many big firms do tax planning for individuals only as a result of doing work for their businesses. I don't think any of the big 4 have tax planning groups for middle class individuals. Their overheads are too high.

    Most of the income from a HDT comes from selling the product itself, and at relatively low prices. Perhaps even more importantly, an accountant doing that doesn't NEED the resources of a big firm. You don't need an army of juniors to sell or administer HDTs.

    So for a big 4 firm, selling HDTs just isn't profitable enough for them to bother.

    In the same way, most financial planners do not recommend IPs.
    Alex
     
  2. DavidMc

    DavidMc Member

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    Ernst and Young quoted $5,000 to do my trusts return...
     
  3. alexlee

    alexlee Member

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    Whereas a smaller firm might have charged less. The Big 4 might be better for certain things that require a worldwide firm (transfer pricing, audits in multiple locations around the world, etc) but big companies don't always offer the best service or product.
     
  4. Twitch

    Twitch Member

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    I go to a medium sized accounting firm which specialises in structures and returns for doctors, hence their bread and butter is asset protection structures and tax minimisation for high income earners. They strongly recommend against HDTs, and this is not through ignorance, lack of margins or laziness. In their opinion; HDTs are inhererntly flawed through the income units not being at market value, they are untested in the courts and unlikely to withstand such a test, and as such not suitable for people in professions with high risk of litigation.

    This is not a popular opinion in this forum I know, but there you have it.
     
  5. alexlee

    alexlee Member

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    Twitch, if the units only entitle the unitholder to the INCOME of the trust, how does one calculate the market value? I would have thought the only way is some sort of discounted cashflow method?
     
  6. Twitch

    Twitch Member

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    It's not a matter of calculation method, the question is how the ATO/ courts would see the purchase of income only units that produce only say 3% yield where money is being borrowed @ 7%. Does that look at arms length? Or is something else up???
     
  7. JIT

    JIT Member

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    Really? That's interesting. What's Dales' take on this?

    The yield increases over time doesn't it, and the interest is on a principal that is unpaid (if interest only) and the principal amount does not rise with inflation...?

    GSJ
     
  8. alexlee

    alexlee Member

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    There are two elements to this, though. One is deductibility of interest payments. If the ATO says it's just a scheme predominantly for tax benefits then it can disallow interest payments. Notwithstanding that, though, the property is still owned by the trust. If the ATO disallows the interest deductions, will it invalidate the legal ownership as well?
    Alex
     
  9. Twitch

    Twitch Member

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    I doubt it, ATO doesn't have any say on that.
     
  10. alexlee

    alexlee Member

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    In which case, even if a doctor is sued and the ATO invalidates the interest deductions, if anything the doctor will have fewer personal assets because the ATO would go after him/her for back taxes. However, the trust assets will still be protected. I don't see why a HDT is not a good choice if the person is at risk of being sued. If anything a trust would be more beneficial to such a person (whether the ATO allows the tax deduction or not: that is a matter of tax, not of asset protection).
    Alex
     
  11. DaleGG

    DaleGG Member

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    Hi

    Naturally, I am biased. I use a HDT for my own investing and recommend them in my practice and so therefore please take my comments with a grain of salt.

    The basic reason why I think the HDT is OK at law is:

    • the structure is a common enough structure used for owning assets
    • the borrowing to acquire income producing assets is common enough and at commercially normal rates
    • the rental income in the trust will increase and accordingly the profit distribution will also increase; again quite normal and common
    • if the trust sells the property and makes a CG then that CG should be distributed to the unit holder if any units are on issue.
    • I am also aware that the tax office have looked closely at the structure and how it works on a couple of occassions over the years and taken no action whatsoever
    • they have issued a private binding ruling confirming their comfort with the structure and the claim for interest deductions.

    I think there are many people who do not understand the structure properly, nor how the investment works properly, and accordingly take a conservative approach and recommend against them. I used to do this myself until I had sufficient information and knowledge to make my own mind up.

    Again, I am biased so please consider further research and due diligence
    Have fun

    Dale

     
  12. JIT

    JIT Member

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    Thanks for the reply Dale, sounds OK to me.

    GSJ
     
  13. alexlee

    alexlee Member

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    Hi, Dale,
    My understanding of the reading of the docs is that the income units entitles the unit holder to income proportional to value of units / market value of assets? Is this correct? i.e. as trust assets grow the portion of income the unitholder is entitled to decreases, though the income of the trust increases?
    Alex
     
  14. Rolf Latham

    Rolf Latham Member

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    Hi Dale

    there is so much truth in what you say...........lack of specific knowledge causes people to retreat to what they know..........I too, when I was a green broker would baulk at various structures

    Experience is a wonderful teacher !

    ta
    rolf
     
  15. JIT

    JIT Member

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    That's what I thought too, and, doesn't the proportion of capital gains distributable to the income unit holder get affected by this % too???

    GSJ
     
  16. alexlee

    alexlee Member

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    Dale's view seems to be (correct me if I'm wrong) that the INCOME units entitles the unitholder to BOTH normal income (rent, etc) AND CG. When you look at your tax return, CG is taxed as part of your normal income (in that it doesn't have a special rate - the discount is something that's applied BEFORE you put it into your tax return). CAPITAL units refers to distribution of the capital of the the trust (i.e. not tax income, but the assets themselves). Given you have depreciation, the cash generated by the trust is likely to be higher than the taxable (distributable) income, so the capital of the trust increases over time.

    If this is the case, then say you buy units for $200k. In 10 years the property goes to $400k. Trust sells, taxable CG $200k. The income units represent 50% of the trust assets, so the unitholder gets 100k in CG (puts $50k on his tax return). The other $100k can be distributed to other beneficiaries.

    Or to put it another way, even if you don't redeem any of the units, given enough time you get income streaming anyway. Since redemption of the units seems to be a sticking point, would one conservative method be to not redeem at all, but over time the proportion of income and CG the unitholder is entitled to decreases anyway so more is discretionary?
    Alex
     
  17. JIT

    JIT Member

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    Yes that was my undertanding too. But, when I read this below...

    Is Dale referring here to the whole 200k capital gain (ie. 100K on your tax return after the 50% CG discount)???

    GSJ
     
  18. DaleGG

    DaleGG Member

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    Hi Alex

    Yes, that makes good sense and is our basic understanding, too.

    However, we are also aware that differing trust deeds will have differing rules for profit distribution.

    Dale

     
  19. DaleGG

    DaleGG Member

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    Hi Alex

    Yes, that is my understanding and belief.

    Dale

     
  20. GreatPig

    GreatPig Member

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    It would be really good if this issue of capital gains could be positively cleared up.

    While Dale believes CG should be distributed to the unitholder, that's not what Greg Vale from Kevin Monro solicitors noted in his document Trusts in Structuring a few years ago. In that he said:

    And as I commented elsewhere recently, it seems to me that if CG was considered income that the unitholder has a right to, then assets that only produce CG (eg. vacant land) should be allowed deductions for expenses and loan interest, which they currently aren't, as holding them should be considered an income-producing activity.

    While I realise the ATO loves to have two bites of the cherry if it can, I think saying CG is income for distribution purposes but not for deductibility purposes is a bit rough.

    It looks like it's going to take someone doing this (ie. distributing CG discretionally with units on issue) to be audited before we'll have an answer that we can be confident in.

    GP