Why don't big firms sell HDTs?

Accountants Clarification...

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.
Very sorry, but I'm not really getting my head around this one.

Using this example quoted above from Alex, as it is easier for me to understand this way - do Dale or any other accountants or lawyers or anyone else on this forum believe that:

(1)
The unitholder gets distributed 100K CG (so 50k in his tax return, after the 50% CG discount), and the other 100k CG gets distributed amongst other beneficiaries.

OR

(2)
The unitholder gets distributed the whole 200k CG (so 100k in his tax return, after the 50% CG discount).

OR


(3)
The whole 200k CG can be distributed amongst beneficiaries (does not have to be distributed to the unitholder, and each beneficiary gets a 50% CG discount on the CG distributed to them).

Thanks for the clarification.


My understanding has been that option number (1) is how it works??? - and am not sure what issue 'Ronin' from the other HDT thread had here, if there are at least some CG that are distributed to the unitholder, even though it may proportionately decrease over time...???

GSJ
 
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(1)[/B] The unitholder gets distributed 100K CG (so 50k in his tax return, after the 50% CG discount), and the other 100k CG gets distributed amongst other beneficiaries.

My understanding has been that option number (1) is how it works??? - and am not sure what issue 'Ronin' from the other HDT thread had here, if there are at least some CG that are distributed to the unitholder, even though it may proportionately decrease over time...???

GSJ
My understanding of the documents is that (1) applies. The calculation being, unit cost / market value of trust assets = 50% (200 / 400) so the unitholder gets 50% of ALL taxable income from the trust (including CG).

Ronin's main concern seems to be how the trust could theoretically redeem the income units at cost, and then just happily distribute ALL CG at the trustee's discretion, to the seeming detriment of the unit-holder.
Alex
 
It will probably depend on how your trust deed is written, but by mine I would say the answer would have to be one of either 2 or 3.

By my trust deed, the unitholder is entitled to the Special Attributable Income of the trust, which means that proportion of total income that can be attributed to the funds received from those units.

So if you believe CG is considered trust income, then the unitholder should be entitled to all of the CG, as it would all be attributable to the original unit funds (since it would be the asset purchased with those funds that generated the CG).

However, if you believe CG is not considered trust income, then the unitholder would not be entitled to any of the CG.

IMO, normal income (rent, dividends, etc) would only be apportioned if CG was not considered income. In that case, once the asset had doubled in value, only half of the rent or whatever would then be attributable to the original funds. But if CG was considered as income, then all revenue generated by the purchased asset, no matter how much it increased in value, would be attributable to the original funds, since the gain would be just another form of income, and therefore need to be distributed to the unitholder.

IMHO of course.

GP
 
I suppose it really depends on the trust deed. If you specify in relation to the income units that it is entitled to a share of the revenue income = funds subscribed to hybrid trust / MV of investment in relevant income year (I'm quoting from documents sent to me by Dale but not prepared by his office).

However, the docs I have specifically excludes CG from the income the units have rights to. Dale, in your opinion (not legally binding or anything, of course) would striking this clause, and therefore making CG specifically part of the income to which the units are entitled to decrease the issue posed by Ronin?
Alex
 
I've just been doing a bit more research, this time through some documents from Chris Batten's website (I subscribed for a few months when I originally started doing this).

While various documents often just mention "capital", rather than specifically "capital gains", I believe the former is intended to include the latter. I think this can be inferred from the few times "capital gains" is specifically mentioned.

For example, in one of Chris's documents when talking about units issued by unit trusts, he says: "The unitholders are entitled to the income and/or capital of the trust. In a unit trust the unitholders are normally issued with ordinary units that give an entitlement to both income and capital gains". The fact that he distinguishes income and capital gains in that statement implies they are not the same.

And on his website under Property Investment, freely available to read, it talks about the problems of acquiring a property in your own name. He then has two sections, one titled "No flexibility in relation to the distribution of income" and another titled "No flexibility in relation to the distribution of capital". Under the latter heading he says: "Once again a discretionary trust will allow for the distribution of the capital including any capital gain amongst a wide range of beneficiaries."

From reading that I would conclude that he considers capital to include capital gains.

GP
 
Very interesting discussion.

I'd love to hear which of the 3 options presented above....Dale, Coasty Mike, Mry, NickM, Chris Batten, or Julia...would pick (if it can be simplified in this manner for illustration)....? - based on the trust deeds they commonly use...

Thanks,

GSJ
 
Hi

I suppose the thing to remember here is that the trust deeds used by Vale are different to the Batten deeds used byNickM, Coasty Mike and myself. This will mean that the inocme could be properly treated differently in each.

After dealing with the tax office earlier this year with regard to HDT's and their enquiries, I have no doubt at all that the definition of income includes CG and accordingly, all of my clients will be treated this way until Batten proves to me otherwise.

If a HDT has SIU issued then all income, inclding CG, will be distributed to the unit holder in the same proportions as required by the trust deed.

What Nick and Mike do will be entirely up to them and their own individual understanding.

have fun

Dale

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
 
Hi Alex

Absolutely yes.
The tax office main concern is that the individual borrows money and receives a very poor ROI with no right to the CG made if and when the trust sells its assets.

Mind you, I think their view is a little short sighted, too.

So, ensuring that the trust does distribute CG to its SIU holders should reduce their concerns dramatically.

Dale

I suppose it really depends on the trust deed. If you specify in relation to the income units that it is entitled to a share of the revenue income = funds subscribed to hybrid trust / MV of investment in relevant income year (I'm quoting from documents sent to me by Dale but not prepared by his office).

However, the docs I have specifically excludes CG from the income the units have rights to. Dale, in your opinion (not legally binding or anything, of course) would striking this clause, and therefore making CG specifically part of the income to which the units are entitled to decrease the issue posed by Ronin?
Alex
 
Just an aside...

The special income unit holder uses 200k to buy special income units in a trust, which are then used to buy an IP by the trust.

Regarding the investment itself:

- the 200k is effectively invested in residential property, which has a comparatively lower risk/volatility profile than other investments, with good prospects for capital growth, well above inflation.
- it gives a right to a relatively secure/reliable income stream, that is expected to rise with inflation.
- negative gearing makes this a 'tax-advantaged' investment, and more so if the loan is kept interest only and the principal is left unpaid - and this will also increase net income returns.
- the unitholder will get his full 200k back on sale of the IP, effectively making it 'capital-protected'.
- on sale of the IP, the unitholder will get distributed a proportion of the capital gains.
- there is some degree of 'asset protection' for the unitholder in using this trust structure to invest in.

Sounds OK to me, apart from that the income/capital gains distributed to the unitholder may decrease proportionately over time (depending on your trust deed of course).

But, if tax advantage, capital protection and asset protection are also reasons for making this investment in SIU's, then this seems to be an OK, 'commercially viable' investment for the unitholder?

GSJ
 
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Hi Dale,

Thanks for your response.

DaleGG said:
The tax office main concern is that the individual borrows money and receives a very poor ROI with no right to the CG made if and when the trust sells its assets.
Does that also mean they would be concerned about the trust redeeming the units immediately prior to selling the assets? Seems to me that would be the logical thing to do to distribute the CG to someone else.

Cheers,
GP
 
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GSJ said:
the unitholder will get his full 200k back on sale of the IP, effectively making it 'capital-protected'.
Not entirely capital protected. If the IP got sold for a significant loss, the trust may not be able to buy back the units.

apart from that the income/capital gains distributed to the unitholder may decrease proportionately over time
The absolute amount shouldn't decrease on average, only the percentage of the total amount.

So if the property doubled in value, only half the rent would then be distributed to the unitholder (assuming the trust deed allowed that), but one might expect in that situation that the rent would also have doubled so that the unitholder's income would be the same. Of course this would rarely be exactly the case, but if the average yield over longer periods of time stayed about the same, then in that longer term it would average out to be so.

What this does mean though is that the unitholder's ROI is effectively pegged to the percentage yield. If that stays about the same on average over the longer term, then so will the unitholder's ROI, no matter how much the IP increases in value and rents go up.

Cheers,
GP
 
All of which is fair enough, surely. The point of using the trust is to achieve asset protection (which is does, since before the asset is sold, if the unit holder is sued creditors will only get the historical cost of the units and all gains are protected) and income splitting (which it also does as the % of income generated by the trust that must be distributed to the unit holder also decreases). My main objective in using a HDT would be to achieve -ve gearing while still managing to protect my assets and income split, the main benefits of which I might not see for years.

It's a matter of how far you want to push it. If you structure it so that you avoid ALL income to yourself, then it looks more dodgy and the ATO is more likely to forbid it. However, if you structure it such that you only divert a significant portion of the income to other beneficiaries, it makes it less dodgy-looking.
Alex
 
While various documents often just mention "capital", rather than specifically "capital gains", I believe the former is intended to include the latter.
I totally disagree. Capital and capital gains are two different things.

From reading that I would conclude that he considers capital to include capital gains.
I completely disagree with your conclusion too. Basic statements here or there on a subject completely different from HDTs, which you then draw out to create posits, do not create definitive statements.

I have said that I am a conservative accountant and I take a safe conservative view with HDTs. With regards to the issuance of capital gains when special income units, you must be careful to ensure that the ATO does not apply IT 2684 or Fletcher vs Ors conclusions to eliminate your ability to claim interest against the income. While what the deed allows you to do at law, such as distributing capital gains on a discretionary basis while SIUs are issued, the tax man may take a different approach.

At the risk of boring you, note the following from IT 2684
4. Interest expenses incurred wholly to produce assessable income
are generally deductible in full under subsection 51(1) by a unitholder
in a split property unit trust even if the amount of interest incurred is
greater than the amount of assessable income derived from holding
the units for the particular income year (but see the situations where
apportionment is necessary; paragraphs 7 - 14).
So we can claim interest against the units...with some exceptions. What are they?
8. In those cases where apportionment is required, interest is
deductible in the same ratio as the assessable income component of
any distributions for the particular income year bears to the total
distributions.
So in other words, if a trust has units issued and the assessable income of the trust is directed somewhere else (and assessable income here includes capital gains) while units are issued...the interest would be apportioned. There may even be amendments involved going back as well.
9. An interest expense is not fully deductible in those cases where
the expected return from the units, both income and capital growth,
does not provide an obvious commercial explanation for incurring the
interest. This may arise in situations where the total amount of
income and capital growth which can reasonably be expected from the
units is less than the total interest expense, especially if the amount of
assessable income expected is disproportionately less than the amount
of the interest expense.
10. In the type of situation referred to in paragraph 9, it is necessary
to carefully examine all of the circumstances of the case, including the
direct and indirect objects and advantages sought by the unitholder in acquiring the units and in making the interest outgoing. The indirect
objects may include private or domestic purposes (e.g. Ure v. FC of T
81 ATC 4100; (1981) 11 ATR 484), or the manufacturing of a
taxation deduction (e.g. FC of T v. Ilbery 81 ATC 4661; (1981) 11
ATR 827 ). If it can be concluded that the interest expense is incurred
for dual or multiple purposes, including private or domestic purposes,
it is necessary to apportion the expense.
So if distributions seem to lack a commercial explanation and/or is much less than expected (because it went somewhere else other than the unit holder), the ATO will investigate further and thanks to Part IVA, they have even more teeth. It appears that the extent of their powers will only be that they can reduce the interest deduction in your own name.

This leads me to ensure that if capital gains are going to be issued on a discretionary basis, I would redeem the SIUs first to stay safe.

I would want to see more from the ATO with regards to their view of trusts that issue CGs in ignorance of the SIU holder, or if the person receiving the CG did so because of the CG units held in their own name while someone else held special non-cg income units, and their view of valuing the same units from each other for CG purposes etc.... but the thing that worries me is that the more people start abusing trusts, the more likely the ATO will be more conservative in their approach.
 
Mry, in that case, what is your view on how the trust deed Dale uses states that the amount of income the unitholder is entitled to (assuming it includes both ordinary income and capital gains - I agree that capital and capital gains are different) is calculated by unit value / market value x income? i.e. not all the asset / trust's income is attributable to the unitholder as that's what the trust deed allows them to to.
Alex
 
Mry, in that case, what is your view on how the trust deed Dale uses states that the amount of income the unitholder is entitled to (assuming it includes both ordinary income and capital gains - I agree that capital and capital gains are different) is calculated by unit value / market value x income? i.e. not all the asset / trust's income is attributable to the unitholder as that's what the trust deed allows them to to.
Alex
It is amazing how often I go back to refer to this thread, but examine this quote of Chris Batten's.
I have seen the PIT Deed and can confirm that it is a hybrid discretionary trust that has the ability to direct income to discretionary beneficiaries that would otherwise go to Income Unitholders under the deeds you currently source. The problem is that the ATO MAY apportion the interest in line with IT2684 and Fletcher & Ors v. FC of T 91 ATC 4538 at 4957. The hybrid discretionary trust has many benefits for property investors and to push the limits whereby the arrangement becomes artificial and contrived is asking for trouble from the ATO.
Emphasis added by me.

Just because a trust deed says something doesn't mean the tax commissioner will be forced to agree.

I have no doubt that the tax commissioner will agree with the claiming of interest against the issued units from a trust on an operational basis. We've got it in writing. But if you start apportioning the distributions of income from the HDT on the basis of equity growth, or distributing CGs while the SIUs are issued, the tax commissioner will likely take a close look at the SIUs and what they actually represent.

The main stumbling block is that SIUs are not purchased on a market basis of the value of the income stream, they are purchased for the cost of the property plus stamp duty. On that basis the commissioner could argue that the units are essentially both rental income and capital income based, equivalent to an IP purchase in that person's name, and that distributions to anyone other than the unit holder constitutes a Part IVA breach due to income splitting. Would it work in court? No idea, but I don't want to have the client that finds that out the hard way.
 
Mry,

Thanks for mentioning that IT 2684. It made for interesting reading (under the circumstances - generally it would be quite boring :D).

Mry said:
if a trust has units issued and the assessable income of the trust is directed somewhere else (and assessable income here includes capital gains) while units are issued...
I don't know how you concluded that (the bold part) from what's written in IT 2684. Here are a couple of other extracts from that document:

If growth units in a split property unit trust are expected to produce only negligible income, the essential character of the interest expenses is for the gaining or producing of a capital gain rather than assessable income
an outgoing incurred to gain both assessable income and either non-assessable distributions or capital gains
Both of those indicate to me that assessible income does not include capital gains.

From the way I read it, that document essentially states that interest deductibility is tied to the intention to produce assessible income, which does not include capital gains. Indeed, it explicitly states that where the intention is primarily or solely capital gains, then the interest deduction would be apportioned or disallowed completely.

However, with your later point:

Mry said:
The main stumbling block is that SIUs are not purchased on a market basis of the value of the income stream, they are purchased for the cost of the property plus stamp duty.
I agree that that could be an issue. In IT 2684 it talks about the unitholder benefitting from capital growth by an increase in the value of the units, but then it's not talking about an HDT with discretionary distribution ability, so the whole document may not be that applicable.

Is anyone aware of any private rulings obtained on this particular aspect of HDTs?

Cheers,
GP
 
From the way I read it, that document essentially states that interest deductibility is tied to the intention to produce assessible income, which does not include capital gains. Indeed, it explicitly states that where the intention is primarily or solely capital gains, then the interest deduction would be apportioned or disallowed completely.
Negatively geared property investment is about negative assessible income while holding the property with the intention of capital gain in the future, no?
Alex
 
Both of those indicate to me that assessable income does not include capital gains.
Its just at accounting school, they teach that assessable income includes capital gains, eg

s105 ITAA
Your assessable income includes your net capital gain (if any) for the income year.

For some reason in this IT has decided to split it up. Actually, I have never seen that elsewhere, this is quite odd. I suppose for the purpose of this IT, assessable income means regular income earned from using the asset as an income producing asset, and capital gains as the taxable capital gains from the sale of the asset. I can see your point though from your excerpts.
 
Hi GP

The interesting thing about all this is that we (Batten, Vale, NickM, Coasty Mike, Mry and myself) are all working from our own interpretations of the HDT and how it works. None of us have the ability to say with absolute certainthat this is how the ATO thinks and more importantly, this is how the courts would think.

Hence the confusion for people like yourself who genuinely want to do the right thing and have a very good understanding of it all.

Yes, it does make sense for the HDT to redeem the units before the property is sold and then act like a discretionary trust and distribute the CG to any beneficiary it sees fit to do so.

However, one of the ATO arguments is that the redemption of the units causes a CGT event because the units are deemed to be disposed of by the individual at their market value.

This then brings another area of interpretation into play.....

What is the market value of the units?

Is it the $1 per unit initially paid?
Is it the value of the assets in the trust divided byt he number of units already issued?
Is the market value a different figure based on any one of a variety of different methods for valuing businesses and shares?

Unfortunately, on this matter, the law is silent.

All we know is that the units must be valued at their market value to keep the ATO happy.

Therefore, the consenus amopngts the accountants that I ahve spoken to is that we have some discretion to apply the market value that best suits our needs providing that we can substantiate that market value.

GP, I know that the answers here are not as clear as you would like. Believe me, I would love more finite answers myself, but, the uncertainty is part of the beauty of tax law and creates the opportunities that we all seek to reduce our tax.

Have fun

Dale



Hi Dale,

Thanks for your response.


Does that also mean they would be concerned about the trust redeeming the units immediately prior to selling the assets? Seems to me that would be the logical thing to do to distribute the CG to someone else.

Cheers,
GP
 
Hi Dale,

Thanks for that.

DaleGG said:
All we know is that the units must be valued at their market value to keep the ATO happy.
I don't know how the proper market value would be calculated either, but in the case of where the income units are used to purchase a single IP, I would assume that they would at least have to be worth the current market value of the IP.

In which case redeeming them before selling would give no benefit at all in relation to the CG issue.

but, the uncertainty is part of the beauty of tax law and creates the opportunities that we all seek to reduce our tax.
Well... beauty is in the eye of the beholder as they say :D. While it might provide opportunities, it also makes effective planning difficult.

Cheers,
GP
 
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