Hi
As a way of demonstrating how the ATO appears to think about the HDT and the issue of income/capital, here is a copy of a Private Binding Ruling that makes very interesting reading.....
66298
Edited version of private ruling
Authorisation Number 66298
This ruling is a private ruling for the purposes of Division 359 of Schedule 1 of the
Taxation Administration Act 1953.
What this ruling is about:
1. Can you claim a full deduction for interest payable on your bank loan under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the acquisition of income units in a hybrid trust?
2. Can you claim a full deduction for annual interest payable on your bank loan under section 8-1 of the ITAA 1997 in relation to the acquisition of income units in a hybrid trust in the event of an estimated negative annual return?
Ruling:
1. Can you claim a full deduction for interest payable on your bank loan under section 8-1 of the ITAA 1997 for the acquisition of income units in a hybrid trust?
No.
2. Can you claim a full deduction for annual interest payable on your bank loan under section 8-1 of the ITAA 1997 in relation to the acquisition of income units in a hybrid trust in the event of an estimated negative annual return?
No. You can only claim a deduction equivalent to the amount of assessable income distributions received.
The scheme that is the subject of the ruling:
The settlor has established a hybrid trust.
The corporate trustee has the power at any time to create capital or income units in the trust.
If units have not been issued, the trustee has the discretion to distribute income and capital to discretionary beneficiaries of the trust.
The trustee has created income units in the trust.
You will borrow funds from a bank and use those borrowings to subscribe to units in the trust.
The trust will use the subscribed capital to purchase a rental property.
Under the terms of subscription for the Income Units to you:
the trust will provide the rental property as security for your borrowings;
you as the only unit holder are entitled to all of the income of the trust; and
the trustee of the trust cannot issue further units of any kind without the express written permission of the unit holders.
The rental property will be a residential property.
An arms length rental agreement will be entered into between the trust and the tenant via a letting agent.
There will be no relationship between the trustee and the tenant or yourself and the tenant.
It is expected that the property will rent for $1,200 per week.
Once the Units are issued, the trustee, in accordance with the terms of the trust, will distribute all the income of the trust to the unit holders each income year.
The property will not be your main residence.
There will be no brokerage or stamp duty costs associated with the buying and selling of the Income Units of the trust.
The estimated interest expense on the borrowings is to be about $180,000 per annum and the estimated income payable to the unit holder is to be about $60,000 per annum.
It is expected that the income paid to the unit holder will increase each financial year relative to the increase in value of the property.
Relevant provisions:
Income Tax Assessment Act 1997 Section 8-1.
Explanation: (This does not form part of the notice of private ruling)
Taxation Ruling No. IT 2385 is about expenses incurred by beneficiaries of discretionary trusts. IT 2385 states the Commissioner does not allow deductions to beneficiaries of trusts in relation to trust income unless it is established the beneficiaries were presently entitled to the trust income when the expenditure was incurred. This view is consistent with the decision handed down by the Administrative Appeals Tribunal (AAT reference QT 85/1311; 87 ATC 318) where it was stated:
For the expenditure to be deemed to be an allowable deduction, it must be demonstrated that a claimant is presently entitled to a share of the trust income of the trust estate.
The trust deed provides that a unit holder in the trust has a present or fixed entitlement to the trust income. Clauses 5 and 9 of the trust deed state:
Subject to clause 9, the Trustee may at any time before the end of each financial year and from time to time up to and including the vesting day: (a) pay, transfer or set aside all or part of the income to or for any or all of the beneficiaries;
…the Trustee cannot vary or alter the rights and restrictions attaching to an Income Unit after it has been issued.
If there are Income Units existing, the Trustee must pay all of the Income to Income Unitholders divided equally between each Income Unit and in accordance with their respective unitholding.
If there are Income Units existing, the Trustee cannot exercise the discretion in clause 6 of this Deed with respect to the Income.
If there are Income Units existing, the Trustee cannot issue any Units which purport to deal with the Income other than further Income Units.
If there are Income Units existing, the Trustee cannot issue further Income Units without the written consent of all Income Unitholders.
Therefore the Commissioner is satisfied your trust has the characteristics of a hybrid trust, in that income distributions are fixed whereas capital distributions are discretionary. Therefore the interest payable on your bank loan for the acquisition of income units in the trust may be allowable as a deduction under section 8-1 of the ITAA 1997, subject to Taxation Ruling IT 2684.
Taxation Ruling IT 2684 is about the deductibility of interest on money borrowed to acquire units in a property unit trust. IT 2684 discusses the deductibility of interest on money borrowed to acquire units in a property unit in respect to four situations:
split property unit trusts.
growth units with negligible income.
where apportionment of interest expenses is necessary.
other property unit trusts.
Your circumstances require consideration of whether ‘apportionment of interest expenses is necessary’. This is because the units you intend to purchase in the trust do not have a fixed entitlement to capital and therefore do not have the features of ‘split property units’, ‘growth units’ or ‘other property units’ as described in IT 2684.
In respect to the situation of ‘where apportionment of interest expenses is necessary’ paragraphs 9, 10 and 11 of IT 2684 provide the following guidance:
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.
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.
In determining whether an interest expense has the character of an outgoing incurred in gaining or producing assessable income, the motive of the taxpayer (or the end which the taxpayer subjectively had in view) in incurring it may be a relevant factor ( Fletcher & Ors v. FC of T 91 ATC 4538 at 4957; (1991) 22 ATR 613 at 622). In a case where the taxpayer's motive or purpose is relevant, it will be necessary to look at the motive or purpose at the time the interest outgoing was incurred ( FC of T v. Total Holdings (Australia) Pty. Ltd. 79 ATC 4279 per Lockhart J. at 4283; (1979) 9 ATR 885 at 891).
In applying paragraphs 9, 10 and 11 of IT 2684 to your circumstances, it is necessary to apportion the interest expense for the following reasons:
as the capital return under the trust remains discretionary, the expected capital return from the units cannot be quantified. Therefore the anticipated income return in itself does not provide an obvious commercial explanation for incurring the interest. Your private ruling applications states the estimated income return to you as a unit holder will be around 2% per annum.
as you have advised, there is a private purpose or motive for establishing a hybrid trust and purchasing units in this trust, where the capital return is discretionary. Your purpose is to obtain the private advantage of asset protection given because due to your occupation you have a high exposure to legal action against you. Therefore, the nature of your interest outgoing will not have the character of an outgoing fully incurred for the purpose of gaining or producing assessable income.
We note section 8-1 of the ITAA 1997 states you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income however you cannot deduct a loss or outgoing to the extent that it is a loss or outgoing of a capital nature or it is a loss or outgoing of a private or domestic nature.
In conclusion, apportionment of the interest expenses is necessary in respect to your purchase of units in the trust because the nature of your interest payments do not have the character of an outgoing fully incurred in producing assessable income or of an outgoing fully incurred in a transaction with an obvious commercial explanation. This is because your motives for purchasing units in a trust where the capital return is discretionary include the private purpose of asset protection. Being so, your interest expense is only deductible up to the extent of the assessable income actually received. This is consistent with the decision in Ure v. Federal Commissioner of Taxation (1981) 81 ATC 4100; 11 ATR 484.
DISCLAIMER
The Register of private binding rulings is a historical public record of written binding advice the Tax Office has issued to specific entities.
Each record is based on the facts of a specific situation as advised to the Tax Office and reflects our view of the law in force at the time the advice was issued.
Before we place a record on the Register, we edit it to protect the applicant’s privacy, so this record may not disclose all the relevant facts or circumstances on which our advice was based.
The Register is not updated to reflect changes in the law or the Tax Office’s views, withdrawal of the advice, or any other change in circumstances.
Given the above, this record is not a publication approved in writing by the Commissioner. It is not intended to provide advice, nor does it set out the Tax Office’s general administrative practice. Therefore this record is non-binding and provides no protection (including from any penalty or interest).
The Commissioner is required to apply the law in the way set out in the ruling only in respect of the entity/ies on whose behalf the ruling was sought.
Edited versions of written binding advice as published on the Register of private binding rulings cannot be relied upon as precedent by any other entity.
--------------------------------------------------------------------------------
Copyright
© Commonwealth of Australia 2004
This work is copyright. You may download, display, print and reproduce this material in unaltered form only (retaining this notice) for your personal, non-commercial use or use within your organisation. Apart from any use as permitted under the Copyright Act 1968, all other rights are reserved.
Requests for further authorisation should be directed to the Commonwealth Copyright Administration, Intellectual Property Branch, Department of Communications, Information Technology and the Arts, GPO Box 2154, Canberra ACT 2601 or posted at
http://www.dcita.gov.au/cca.
. While it might provide opportunities, it also makes effective planning difficult.
