Discussion in 'Accounting and Tax' started by alexlee, 6th Dec, 2006.
Yes, I do think that is reasonable.
umm hopefully a quick somewhat related question ... how does the HDT treat the purchase of the units back from the unit holder?
assuming that your HDT has experienced capital growth (unrealised), and say your units which you purchased for $100,000 now have a market value of $150,000.
Now in order to redeem the units the HDT pays out 150,000 but in its books has units with a historic cost of $100,000
Is the HDT therefore making a $50,000 loss? or how is this $50,000 treated?
Particularly given for the individual unit holder, they will need to declare a 50k capital gain from the redemption of the units.
umm still curious as to the answer to this question?
accounting for the hdt would be DR units 100,000 CR bank 150,000 ... DR somethin?? 50,000 .. what is the something?
I'm certainly no expert on trusts, though I do have one, but this is the way I thought things worked with respect to the SIU's.
I take out a loan to buy SIU's in a trust, that I'm also a beneficiary of. The SIU's give me a right to the distributions of the trust in a pro-rata manner (ie if the SIU's I own make up half of the capital of the trust, then I'm entitled to half the Distributions). AFAIK this is required by the banks to enable me to finance the loan for the SIU's. It's like a guarantee of income that I put on the banks forms. As a beneficiary, the trust can (at it's discretion) distribute to me, though I don't have a right to this income (only to the SIU income if they are issued)
While the SIU's are issued, I retain this right to income, though it may be diluted by further SIU being issued.
The trust owns the property, so until the trust sells the property there is no CGT event with respect to the property. When the property is sold the trust must pay CGT out of the funds received, and in my mind, this happens prior to the distribution (though I'm sure that there are others mechanisms).
Anyway, getting back to the SIU's, if the trust takes out a loan in it's name (assuming it is now CF+) and buys back the SIU's at the issue price, then what we are left with is essentially a hybrid trust that owns a property that generates money. That money can be distributed to tax payers, which must pay tax on that income.
By way of example
Let's say I buy a house for $200K through a trust. I take out a loan for $200K to buy SIU's and the trust buys the house. Let's say it initially rents for $150 per week, so it is CF- (ignoring depreciation etc). It's negatively geared, so I claim the loss on my tax.
Let's say 5 years down the track, the rent has risen to $300 per week, so it is now CF+ so I decide that the trust should take out a loan and repay me my original $200K as redemption for the SIU's.
As a very rough approximation (for concept only), let's say that the trust now makes $100 per week after interest repayments. That $100 per week has to be distributed to the beneficiary's, all of which need to pay tax on the income (though admittedly these may be at different rates)
To me this seems like a pretty good investment for the long term (and is generally how I understand HDT's to work at a simplistic level).
Sure we've claimed against interest for 5 years, but I now have a trust distributing me income and it costs me nothing. The government is happy because I pay tax on that, and if/when the property is sold, the government gets the Capital Gains tax.
I fail to see how redeeming the SIU's at the cost price is avoiding tax.
If you paid Capital Gains on the SIU redemption, then surely that would need to reduce the Capital Gains paid on the sale of the propery from within the trust, otherwise you are paying capital gains tax twice on the same Capital Gain. Maybe it's possible to pay part of your capital gain on the SIU redemption, but why you'd want to, I don't know (maybe to offset a capital loss or something?)
The way I see it, the purpose of the SIU's is two-fold. Firstly for the benefit of the bank so that they know that the funds are due to you when they are assessing your for credit, as they would be if you owned the property in your own name, and secondly the guaranteed distributions ensure that tax deduction from the borrowed funds is associated with an income, so that it is legally claimable. Without the SIU's it would be possible to borrow money and distribute income to someone else which would make the interest on the borrowed funds non-deductible, as you are not expecting a return from the investment.
Does this make sense, or have I missed something?
this is basically the question i am asking .. as i obviously dont want to pay CG twice! and to be conservative i will most likely value units at market value rather than cost.
I think that would happen simply because of the amount paid to buy back the units.
For example, if you paid $100K for the units and later the trust paid $200K to buy them back, then the trust would effectively have a $100K capital loss. This would presumably be offset against capital gains when the property was sold, reducing the distributable capital gain.
Not saying it is, but the key point is that if SIUs can be redeemed for cost, then the person claiming the deductions can be different to the person paying the CGT. Typically the former would be a high income earner while the latter would be a low income earner, thus providing a benefit due to their different tax rates.
As an extreme example, consider this situation (relatively uncommon, but it could apply to me): the property is in NZ and you have family there to distribute to. You as a high income earner get the loan and buy units, claiming interest deductions for some years (interest is deductible now for foreign property), and then after redeeming the units at cost you sell the property and distribute the capital gain to your NZ relatives. Since it's foreign-sourced profit going to a non-resident, I don't believe there would be any tax payable here (maybe some withholding tax, but I don't think so) and there's no capital gains tax in NZ. So you get all the deductions here in Australia and nobody pays CGT!
Or imagine if say a private company was buying the units because the shareholder was on a high income, so would have to pay more tax to take the money out of the company first. By being able to redeem the units for cost and then distribute the CG to a low income earner, there is an effective transfer of company funds to the low income earner, bypassing the high income earning shareholder (ie. the company makes a loss and the low income earner makes a profit, effectively transferring the amount of the loss from the company to the low income earner - assuming the CG was more than the loss).
All just my understanding of course and not intended as any sort of advice.
If as you say (and I agree with you) the unit holder must receive the capital gain when the units are redeemed, what is the benefit of having a HDT?
The redemption of units does not create a capital gains event for the trust, at all. It does, however, seem to create a capital gains event for the individual just as when an individual invests in units in a managed fund.
so if the redemption is valued at greater than cost, you will pay capital gains tax individually, and then when the asset is later sold by the trust, capital gains tax will be paid again on the distribution of the gain?
argh .. i might have to look at gettin all my assets out of the HDT before they grow!
Please do not do anything rash or hasty.
There are way too many issues involved to make this as simple as some things.....
The redemption of units in a HDT is not all that common. Yes, it does happen, but, not very often.
The sale of any IP will always trigger a CGT event anyway.
If the trust has made a CGT event and it has previously redeemed all its units then the trust may be able to distribute the CG to any beneficiary and thus the family unit could pay a lower rate of tax than you would if the property was in your own name.
I hope that this helps. Please speak to your own accountant to consider the facts; how your accountant deals with these issues; and to consider your options carefully before making any decisions.
actually i think i may be suffering from a bit of brain fade ... and havent put quite enough thought into it .. although i was hoping a text book or newsletter or article would give me the journal entries in practice ...
on thinking about it a bit more, the market value of the units for the unit holders should be net of unrealised capital gains (tax) on the (future) sale of the underlying property... although the question might then become, at what rate should you calculate it? .. anyone know how unit trusts / managed funds do it? and you would still potentially double tax yourself, but to a lesser extent ...
there doesnt happen to be an accounting std on trusts by any chance? or a recommended text?
Actually I don't believe I did say that. I was just pointing out some reasons as to why that might be seen as a valid argument.
Compared to an ordinary DT you mean?
Well at least you can negatively gear with an HDT, and the unitholder's circumstances might have changed by the time the capital gains come through (ie. they may no longer be on a high income). Even if they haven't, surely negative gearing against someone's other income must be better than letting the trust accumulate an income loss that may never be offset?
Also, you have the flexibility to combine funds from issued units with other funds, either gifted or on personal loan accounts, whereby only a percentage of the total income would then need to go to the unitholder (this is not really a tax benefit, except where it might avoid trust losses, but still a benefit of an HDT over a DT).
And then there's the JV scenario, where the different investors would want a right to their percentage of the income (although that could also be done with an ordinary unit trust).
I agree though that outside of the changed-circumstances and trust loss scenario above, the tax benefits of an HDT would seem to be limited if the unitholder had to receive the CG.
If it redeems for higher than the issue price though, would that be considered a capital loss to the trust that could be offset by other capital gains on the sale of assets?
In some ways it would be similar to the trust short-selling units and covering at a loss.
I would think it's more like a company buying back its own shares. There's no tax implication to the company: the shares just get 'cancelled' against shareholders equity, right?
No, the redemption does not create any taxable CG or Capital Loss, at all for the trust.
Then it seems that Bort would be correct if units are redeemed at the market value of the assets they are attributed to. The unitholder would effectively pay CGT on the unrealised capital gain of the asset, by virtue of it being reflected in the value of the units, and the same gain would later be taxed again when it's distributed.
Sounds like a good argument for redeeming at cost to me.
Just getting back to income distributions for a moment, and apportioning the distribution based on the purchase price to SIU's issued, say the trust invested $200K into a managed fund (with $100K raised from the SIU's and $100K being funds already in the trust).
Initially 50% of the distribution would be distributed to the SIU holder and the other half to discretionary beneficiaries.
But what if the distributions from the managed fund (say $10K for the first year) were automatically reinvested? The trust would now have assets of $210K with the same $100K SIU's on issue. Since the assets were purchased for $210K would the following years trust distribution be as follows:
Special Income Unit Holder: 47.62%
Discretionary Beneficiaries: 52.38%
It's been stated elsewhere on the forum that it's not a good idea to apportion trust distribution on the basis of equity growth but is it still reasonable to apportion the income on the purchase price as above, where funds are automatically reinvested each year? This means the percentage of income distributed to the SIU would decrease annually.
i would guess it would depend how you treated the unit holder portion of that reinvestment - ie $5k ... did the unit holder use the 5K to either a) buy more units, b) loan the $5k to the trust or c) gift 5k to the trust
so that if you used a gift, then yes that would increase the proportion available to discretionary beneficiaries ..... buying more units would result in no change, and a loan would mean that the trust would have to pay out the loan interest first before apportioning the remainder, however, there would still be a higher split towards beneficiaries ...
well thats my guess anyways ..without putting numbers to it ....
As Bort suggests, even if the funds are reinvested, they still have to be distributed to someone first, on paper at least.
This means that the unitholder would have received a $5K distribution, which they'd have to add to their taxable income. And as Bort states, what they did after that to get $5K back into the trust would determine how it would be treated.
That's my understanding anyway.
Hi GP and Bort, I didn't make it very clear but I meant to say the income in my example was distributed to the unit holder, added to their taxable income, and then loaned back to the trust with a non-interest bearing loan.
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