Why don't big firms sell HDTs?

Almost understood...

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

Originally Posted by alexlee
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
Hi,

Just re-read those private rulings a couple of times.

So, referring to Alex's question to Dale above, if you do have a trust deed that allows this - ie, meaning that the unitholder does NOT have a 'present or fixed entitlement to the trust income', then in this instance, where the SIU person is negatively gearing, with no guaranteed entitlement to future income, you need to show the ATO how this is 'commercially viable'. ie, what's the point of the SIU person negatively gearing if they don't have any definite income/capital growth/gains prospects in the future? So, this is something that the ATO would look closely at. If the income is disproportionately low compared to the interest expense, not all of the interest expense may be tax deductible, hence 'apportioning of the interest expense' may be required here. If you then argue, that there are other reasons for this setup, such as 'asset protection', then this may not work, as this may be classed as a 'private use', so the interest expense is NOT fully incurred in earning an income, and so the amount tax deductible may be decreased accordingly. If this is the case, however, I don't see the point of having a trust deed with this wording - ie. you are reducing the income to the SIU person, and in doing so, reduce the tax deductible interest expense - so, net effect = NIL?.

Dale
- so, I think I am getting closer to understanding what you were saying before with this reply to Alex's post quoted above?!

To make things simpler/safer though, as you and others have mentioned, it's probably better to just give ALL income to the unitholder! ie, the 'conservative' interpretation of the use of the HDT.

So this would mean having a trust deed that specifically entitles the unitholder to a 'present or fixed entitlement to the trust income', or, if it doesn't, just give the unitholder ALL the income anyway to be safe.

This is all of course, while SIU's are on issue, once they are redeemed, at a 'market value', then the HDT can regain it's ordinary discretionary powers.

Is this understanding correct???

Thanks for the clarification.

GSJ
 
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Market Value???

In determining 'market value', I understand there are various methods for this.

Can't the ATO just ask the SIU person or the trust to get a property valuer to value the relevant investment property at a 'fair and open market value'???

Isn't this the most accurate way of assessing the true market value of the SIU's???

GSJ
 
I’m not a fan of fixed unit trusts. A facet that I don’t like is the potential problem from the distribution of CG and the flow through of any applicable CGT discounts/concessions. Unit holders might be distributed CG income and not be entitled to the same CGT discounts as the trust.
What CGT discount does the trust get?
 
the private purpose of asset protection
That's something of a worry.

If every use of a trust other than earning income is "private purpose", then the only acceptable intention for setting up the trust and buying income units is earning income if you want 100% interest deductibility.

But one has to wonder what's the commercial benefit of a trust purely in relation to earning income? I can't see any. The only advantage I can see is the ability to later redeem the units and distribute discretionally, which has the dominant purpose of tax minimisation.

So your two choices would seem to be either limiting interest deductibility due to private purpose, or being hit with Part IVa for operating a tax minimisation scheme!

How good can it get... :rolleyes:

Cheers,
GP
 
The Problem of Redemption...

Eventually, to use the discretionary powers of the HDT to your advantage, you need to redeem the SIU's, and also before the actual sale of the relevant investment property.

Redemption at the cost price of the SIU's would seem to be ideal, or maybe a little above the cost price.

But, I just can't see how you can redeem the SIU's for anything less than the value of this investment property? That is what the SIU's are effectively used to buy in the first place??? So if you are not selling the property, the SIU person or the trustee/trust should get an independent property valuation to determine the market value of the units??? How do you justify using other methods of valuation?

Is it because in the trust deeds, you say the SIU person has no rights to the 'capital holdings', but does have rights to income (including capital gains?)???

Regardless of how you word a trust deed, does it make financial sense for the SIU person to value their SIU's in any other way???

If redeeming occurs at a price above the cost of the units, and before a sale of the property, then doesn't the trust/'you' have to increase borrowings for this to occur?

If redemption never occurs or the property is never sold, then it won't be an issue, but what's the point of the HDT then?

Further, the value of the SIU's to begin with was the same price as the investment property, so on sale, shouldn't it be directly related to the potential value of this property at this point in time??? Does it make any sense to value it one way on purchase, and a completely different way on redemption???

My real concern is that if the above points are valid, what are the remaining advantages to using a HDT in this situation...maybe marginally more allowable tax deductions, maybe the 'refinancing principle', and again maybe some degree of 'asset protection'...but these are still debatable...with disadvantages of increased running/compliance costs and a potentially smaller spectrum of lenders who lend for properties bought in a HDT...And 'flexibility', well, I'm really not sure where the flexibility is here...? I guess though, if you are not negative gearing like this, and not issuing SIU's, it can provide the benefits of a normal DT?

Are there other alternatives??? Having a UT on top of the HDT??? - not sure if this is going to make any real difference? A DT - well, not really great if you're negative gearing?

Any thoughts?

Please convince me otherwise!

And, to re-state a previous question, what happens to people who use a tax loophole, after a tax loophole is shut down by the ATO??? For instance, to people who were renting their PPOR from a HDT and claiming wonderful tax deductions, what happens now that we know the ATO views this unfavourably? - do you get penalised, pay back unpaid taxes, or just stop doing what you were doing before?!

GSJ
 
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A Solution to Redemption...

Just a thought, if you do say that the redemption price must be the real market value of the investment property itself (as I had decribed in the previous post) at the redemption time, could you...

Have in the trust deed something saying to the effect that:

'If the unitholder wishes to redeem their units in the trust, prior to the sale of the investment property (the timing of which is at the trustee's discretion), they can make this request to the trustee - who has the power to accept or reject this request. If accepted, the unitholder will only be entitled to an amount equal to the cost of the units initially purchased, and will forfeit potential gains due to the increase in market value of those units.'

So, the trust here is encouraging the unitholder to be a long-term, buy and hold investor, and leave the appropriate timing of the sale of the property (if ever) up to the trustee, and the risk for the unitholder in this case is that if they want their capital back at an earlier time, they will only get that same amount back and no more??? A bit like those 'capital guaranteed' investments on the market at the moment. In doing this, one may potentially eliminate the uncertainty associated with differing interpretations of 'market value' all together???

Does this seem like a reasonable financial risk for this investment in SIU's for the unitholder?

I'm sure there are managed investment products out there which have similar types of associated risks?

If one does this, does it make the whole arrangement more 'commercially viable'?

GSJ
 
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I look forward to reading the replies on this thread today by proponents/supporters/users of the HDT, as at present, having re-read this thread and Ronin's thread, the inherent flaws of the HDT (when SIU's are issued for investment property with negative gearing) are becoming more apparent to me...I just want some direct answers to what I think are reasonable arguments/questions...

Thanks,

GSJ
 
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Hi

Yes, you are doing well.
If the trust deed provides discretion in distributing income that should go to the unit holder then the ATO and the courts will rightly say that no tax deduction is allowed for the interest paid by the unit holder on the loan used to buy the units.

If the deed says that the income (including any CG) goes to the unit holder then there should be no problems at all.

It is the discretion that can cause problems.

Keep it simple and you should not have too many concerns.

Dale


Hi,

Just re-read those private rulings a couple of times.

So, referring to Alex's question to Dale above, if you do have a trust deed that allows this - ie, meaning that the unitholder does NOT have a 'present or fixed entitlement to the trust income', then in this instance, where the SIU person is negatively gearing, with no guaranteed entitlement to future income, you need to show the ATO how this is 'commercially viable'. ie, what's the point of the SIU person negatively gearing if they don't have any definite income/capital growth/gains prospects in the future? So, this is something that the ATO would look closely at. If the income is disproportionately low compared to the interest expense, not all of the interest expense may be tax deductible, hence 'apportioning of the interest expense' may be required here. If you then argue, that there are other reasons for this setup, such as 'asset protection', then this may not work, as this may be classed as a 'private use', so the interest expense is NOT fully incurred in earning an income, and so the amount tax deductible may be decreased accordingly. If this is the case, however, I don't see the point of having a trust deed with this wording - ie. you are reducing the income to the SIU person, and in doing so, reduce the tax deductible interest expense - so, net effect = NIL?.

Dale
- so, I think I am getting closer to understanding what you were saying before with this reply to Alex's post quoted above?!

To make things simpler/safer though, as you and others have mentioned, it's probably better to just give ALL income to the unitholder! ie, the 'conservative' interpretation of the use of the HDT.

So this would mean having a trust deed that specifically entitles the unitholder to a 'present or fixed entitlement to the trust income', or, if it doesn't, just give the unitholder ALL the income anyway to be safe.

This is all of course, while SIU's are on issue, once they are redeemed, at a 'market value', then the HDT can regain it's ordinary discretionary powers.

Is this understanding correct???

Thanks for the clarification.

GSJ
 
Hi

No, not really. A secretary or a factory worker with one IP may not have any real asset protection concerns. An investor with multiple IP's could argue a different line as could a professional whose chances of being sued increase every year.

At the end of the day, the choice of structure i(for whatever purposes including tax minimisation) is still a legal right that cannot be taken away from you and for the ATO to suggest otherwise is misleading and legally incorrect.

Do you remember Kerry Packer's famous comments when questioned?

The PBR that I quoted was to demonstrate how importantt he trust deed was and to show the ATO thoughts on the matter of Capital Gain expectation.

A good trust deed and a good accountant (such as the brilliant one that you have, GP - NickM, I believe) will argue your case according to your facts and circumstances which will be different to those noted in this PBR.

Have fun
Dale

That's something of a worry.

If every use of a trust other than earning income is "private purpose", then the only acceptable intention for setting up the trust and buying income units is earning income if you want 100% interest deductibility.

But one has to wonder what's the commercial benefit of a trust purely in relation to earning income? I can't see any. The only advantage I can see is the ability to later redeem the units and distribute discretionally, which has the dominant purpose of tax minimisation.

So your two choices would seem to be either limiting interest deductibility due to private purpose, or being hit with Part IVa for operating a tax minimisation scheme!

How good can it get... :rolleyes:

Cheers,
GP
 
Hi Dale,

DaleGG said:
A secretary or a factory worker with one IP may not have any real asset protection concerns.
I think the point is though that if their only reason for setting up the trust and buying income units was earning income, why would they do it? Where's the commercial benefit? They could just as easily earn the income in their own names without the overhead of the trust.

And it would seem that if they have any reason other than just earning income, like asset protection, flexibility of distribution, estate planning, etc, it would be considered "private purpose" and could potentially be a problem if negative gearing.

Of course if all revenue is distributed to the unitholder then it's no different to negative gearing in your own name, which is allowed, but in your own name you can't relinquish the right to receiving the capital gains (by redeeming the units with a trust).

Which makes me wonder how redeeming units for less than the market value of the assets attributed to them might be viewed in future.

Cheers,
GP
 
Which makes me wonder how redeeming units for less than the market value of the assets attributed to them might be viewed in future.
If I might throw a spanner in the works to get you thinking, the SIU units are issued for $1. They are redeemed by the trust for $1. If you bought the units on the understanding that they would be redeemed for $1, doesn't that change the way you would treat the capital gains at the end? In that case, isn't it kind of like a bank account, where you put in $100,000, get $5,000 in interest deposited into a different account and then shut the account down by withdrawing the $100,000 (meaning no capital gain or loss)? And with a HDT, the 'interest rate' actually increases each year.

The other issue of course as you have discussed is that the unit holder holds no expectation of receiving a capital gain in their own name (a fact which should be apparent on getting the SIUs), so the ATO is left with the option of reducing the interest claim to the amount of the SIU income, or letting the person claim the interest in full.

This might mean that SIUs are closer in definition to debentures than units.

I am not necessarily espousing this view, just giving you food for thought. There will be problems with most approaches.

I think a valid reason the ATO would accept HDTs is if you argue that it would save on land tax for your investment properties (at least it would here in Queensland). I can't see the ATO using Part IVA to save the state revenue office its tax income, or arguing that saving on land tax, a cost for income producing assets, is a private decision.

I think the ATO's argument is a bit silly too. I work in my business to provide food for my family, thus I should not be able to claim losses because my actions lead to a private purpose. If I setup a trust to create asset protection benefits, that protects my assets so I can continue in business, just like a good insurance policy does. Furthermore, being bankrupt would stop me from being a company director or a tax agent.
 
Hi all,
DaleGG here is a heads up for you :) and for all concerned Dale is my accountant, so I will be doing what ever he says hence the Q's as his words seem to say I should not be doing some of things I am considering.

So here goes.

I am right now in the process of borrowing some money to inject into the HDT so that it may pay out a loan. I am using as security a freehold property that is in the trust.

I was going to purchase Special Units in the trust and we had a meeting last night (directors of the trustee company) and resolved to raise money to pay out the loan.

The trustee resolved to issue 72,000 $1 units, these units would be called "Lurline Special Income Units" they would only be entitled to any income from the property that was used as security, net of any costs associated with maint, management, trustee costs etc. That the units issued would represent 45% of the property( as per valuation for the loan), the HDT is holding the balance of the value, so income is spilt 45/55. If the units are redeemed before the redemption date which will be settlement +30 years then the holder will not be entitled to any capital growth unless the security is sold before that date and before the units are redeemed.

Also the investor has been notified that the units would be subject to a "discount" if redeemed early, ie only worth a percentage on a sliding scale.
year 0 - 1 = .1%
year 1 - 2 = .1% + .3%
and then .3% per year to 30 years.

The plan was that after 30years and the "Lurline Special Income Units" were still issued then they would be redeemed at $1 prior something less. Investor will always be entitled to 45% of the net income (assuming they are holding the units and no others are issued)

My reasoning for this is during the high risk years of the loan, the early years, the trust is limited in its exposure if a creditor gets the units, they are not worth much and the trust would not be forced into costly action. Also the trust is not put into a position if the investor wants their money back early.

However reading what DaleGG has said here I might not be able to do this or if I do then it may impact the "deduction of my loan"

Dale if you are not happy to discuss here that is fine I'll contact your office however I don't mind if you do as we can all learn.

This will be on my 06/07 tax year and yep tell the girls I am still working on getting my financials in order before sending over the 05/06 year. :)
 
Hi Norm

Being a simple person, I ahve to break everything down into bite sized chunks to manage....

So, the trust issuing $72,000 worth of SIU's is common and not an issue.
The trust using the money raised through issuing the SIU's to pay out a trust loan is common and should not be a problem
The trust distributing 45% of the net rental income from this property to the SIU is, in my opinion, OK.

After this, your plans lose some of their normal commercial flavour and accordingly may create problems from a tax perspective. Accordingly, I would not recommend setting any other conditions or rules outside of those noted within the trust deed itself.

I hope that this helps

Dale



Hi all,
DaleGG here is a heads up for you :) and for all concerned Dale is my accountant, so I will be doing what ever he says hence the Q's as his words seem to say I should not be doing some of things I am considering.

So here goes.

I am right now in the process of borrowing some money to inject into the HDT so that it may pay out a loan. I am using as security a freehold property that is in the trust.

I was going to purchase Special Units in the trust and we had a meeting last night (directors of the trustee company) and resolved to raise money to pay out the loan.

The trustee resolved to issue 72,000 $1 units, these units would be called "Lurline Special Income Units" they would only be entitled to any income from the property that was used as security, net of any costs associated with maint, management, trustee costs etc. That the units issued would represent 45% of the property( as per valuation for the loan), the HDT is holding the balance of the value, so income is spilt 45/55. If the units are redeemed before the redemption date which will be settlement +30 years then the holder will not be entitled to any capital growth unless the security is sold before that date and before the units are redeemed.

Also the investor has been notified that the units would be subject to a "discount" if redeemed early, ie only worth a percentage on a sliding scale.
year 0 - 1 = .1%
year 1 - 2 = .1% + .3%
and then .3% per year to 30 years.

The plan was that after 30years and the "Lurline Special Income Units" were still issued then they would be redeemed at $1 prior something less. Investor will always be entitled to 45% of the net income (assuming they are holding the units and no others are issued)

My reasoning for this is during the high risk years of the loan, the early years, the trust is limited in its exposure if a creditor gets the units, they are not worth much and the trust would not be forced into costly action. Also the trust is not put into a position if the investor wants their money back early.

However reading what DaleGG has said here I might not be able to do this or if I do then it may impact the "deduction of my loan"

Dale if you are not happy to discuss here that is fine I'll contact your office however I don't mind if you do as we can all learn.

This will be on my 06/07 tax year and yep tell the girls I am still working on getting my financials in order before sending over the 05/06 year. :)
 
If I might throw a spanner in the works to get you thinking, the SIU units are issued for $1. They are redeemed by the trust for $1. If you bought the units on the understanding that they would be redeemed for $1, doesn't that change the way you would treat the capital gains at the end? In that case, isn't it kind of like a bank account, where you put in $100,000, get $5,000 in interest deposited into a different account and then shut the account down by withdrawing the $100,000 (meaning no capital gain or loss)? And with a HDT, the 'interest rate' actually increases each year...Mry
But we are talking about negative gearing for the unitholder with SIU's in this instance, and what is the point of negative gearing if there is no expectation of capital gain??? Ronin mentioned this at the very start of his thread, why would you do this if you knew at the beginning you were just going to get your money back? I think this is very different to your bank account comparison.

If the units are redeemed before the redemption date which will be settlement +30 years then the holder will not be entitled to any capital growth unless the security is sold before that date and before the units are redeemed.

Also the investor has been notified that the units would be subject to a "discount" if redeemed early, ie only worth a percentage on a sliding scale.
year 0 - 1 = .1%
year 1 - 2 = .1% + .3%
and then .3% per year to 30 years.

The plan was that after 30years and the "Lurline Special Income Units" were still issued then they would be redeemed at $1 prior something less. Investor will always be entitled to 45% of the net income (assuming they are holding the units and no others are issued)

My reasoning for this is during the high risk years of the loan, the early years, the trust is limited in its exposure if a creditor gets the units, they are not worth much and the trust would not be forced into costly action. Also the trust is not put into a position if the investor wants their money back early.
NormH's thoughts above are similar to mine posted earlier (quoted below), but with a specific time frame (30 years) for redemption - which is good as it gives the unitholder a definite exit point from the investment - and the added feature of a discount off the unit price as a penalty for early redemption (could be pushing your luck with this one though):

Have in the trust deed something saying to the effect that:

'If the unitholder wishes to redeem their units in the trust, prior to the sale of the investment property (the timing of which is at the trustee's discretion), they can make this request to the trustee - who has the power to accept or reject this request. If accepted, the unitholder will only be entitled to an amount equal to the cost of the units initially purchased, and will forfeit potential gains due to the increase in market value of those units.'

So, the trust here is encouraging the unitholder to be a long-term, buy and hold investor, and leave the appropriate timing of the sale of the property (if ever) up to the trustee, and the risk for the unitholder in this case is that if they want their capital back at an earlier time, they will only get that same amount back and no more??? A bit like those 'capital guaranteed' investments on the market at the moment. In doing this, one may potentially eliminate the uncertainty associated with differing interpretations of 'market value' all together???...GSJ
I'm just a lay-person in this regards (but have no hesitation in questioning the professionals if things don't make sense to me) - but I really think this sort of thing in a trust deed would make this setup more commercially viable, rather than less so, as Dale has commented?

How you can possibly justify redeeming the units at cost price or some other price based on a valuation method of your convenience, rather than the true market value (ie. the value of the property in question), without something of this nature in the trust deed, is beyond me???

Using various other valuation methods for me is completely illogical and would make this setup, if anything, far less commercially viable???

I really feel the redemption of units at anything other than the true market value is the key point in this discussion and is what could undo the HDT, when used in this way...

I am yet to hear a convincing argument that says otherwise...

Any thoughts? - if you're sitting on the sidelines, please post your 2 cents and join in this interesting discussion...

GSJ
 
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But we are talking about negative gearing for the unitholder with SIU's in this instance, and what is the point of negative gearing if there is no expectation of capital gain??? I think this is very different to your bank account comparison.
Negative gearing is just the result of having more deductions than income. The point to negative gearing I believe is that you are paying off an income producing asset which will increase as time goes by, in addition to the loan being paid off. Many do purchase with the expectation of making a capital gain, but many also purchase to create an income stream (that can also potentially be sold for a capital gain later).
 
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Mry, ok, I agree, IF you pay off the loan principal too - this is the only way to pay off the asset if you are losing money by negative gearing each year - which people do. But the better approach usually I think is to have an IO loan, which has been discussed enough on this forum...
 
Financial Advisor's Opinion

It would be good to see a financial advisor's opinion of the investment in SIU's by the SIU holder.

What would be your assessment of this 'investment product'? Would you advise someone to buy SIU's in this way for an IP that will be negatively geared?

GSJ
 
I just had an interesting thought. The problem with redeeming SIUs at cost seems to be that the unit holder gives up the benefit of CG and only get a low net rent (maybe 3, 4%).

How about attaching some special perks into the unit? Say, in the case of death of the unit holder, the units will be redeemed at double the cost or something (making it similar to a life insurance policy). Or, say, have the units issued for 30 years, and the unitholder has the right to get their money back prior to that but with penalties (redemption only at cost, say) while if the units are redeemed after 30 years they get say 5% return per year. I would think the SIU holder doesn't have to get ALL the IP's returns, just enough to justify the purchase.

Will that change the ATO view?
Alex
 
I just had an interesting thought. The problem with redeeming SIUs at cost seems to be that the unit holder gives up the benefit of CG and only get a low net rent (maybe 3, 4%).

How about attaching some special perks into the unit? Say, in the case of death of the unit holder, the units will be redeemed at double the cost or something (making it similar to a life insurance policy). Or, say, have the units issued for 30 years, and the unitholder has the right to get their money back prior to that but with penalties (redemption only at cost, say) while if the units are redeemed after 30 years they get say 5% return per year. I would think the SIU holder doesn't have to get ALL the IP's returns, just enough to justify the purchase.

Will that change the ATO view?
Alex
Yes, these are similar to the thoughts myself and NormH are having, if you read the previous posts...

Dale has already commented that something along these lines would not be advisable, from his point of view, with respect to NormH's post.

I am interested in others' views on this, as this sort of wording to a trust deed is the only way I think this sort of setup could work with a HDT, and thus make the SIU purchase 'commercially viable' and bypass the contentious issue of defining 'market value' on redemption...

GSJ
 
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Accordingly, I would not recommend setting any other conditions or rules outside of those noted within the trust deed itself.

I hope that this helps

Dale
I too would be reluctant to alter the trust deed, particularly if it has been written by some smart people...but I wonder what these smarties would think of these suggestions?

For those of you in contact with Chris Batten and his team, how does he justify redemption of units at a price other than the value of the property in question at that time, the 'market value'?

GSJ
 
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