Hybrid Discretionary Trust way to go…….

This is strictly for rocket scientists….

I guess you can make your tax affairs as complex as you like. If you can make it through the following response from our tax advisers you might like to think twice…….

Hello Anthony,

We are pleased to provide an answer to your help desk question.

Question:
IS THIS TOO GOOD TO BE TRUE!! I’ve just read on http://www.chrisbatten.com.au negative geared investments should be held in a hybrid discretionary trust and you get the best of everything, ie asset protection, deduction of the loss at individual income tax return level and you can have your superfund purchase the investment at a later date!

Am I a slow learner up here in the bush??? What do you guys think of this??????

Regards

Tony XXXX

Answer:
Dear Tony XXXX,

Thank you for your network question. IS THIS TOO GOOD TO BE TRUE!!

We confirm:
. your self confidence; and
. that you are not slow learners in the bush.

We generally issue warnings about “hybrid or hybrid unit trusts” because much of the problems are centred on ignorance. The core issues are how do the various Tax Acts operate in relation to:
. trustees; and
. beneficiaries.
We find descriptive terms such as “Hybrid Trusts” all too often clouds the issues.

We do find “hybrid trusts” do suit particular scenarios, but we express caution until the client understands what is achievable.

We would be willing to provide professional advice, if more than $100K of interest deductions were involved.

THE ISSUES WE IDENTIFY

We identify the following issues. We only comment on:
. what is a hybrid trust;
. the deductibility of interest.

The issues we identify from your question are:
. the term “trust” is undefined;
. the terms “trust” and “unit trusts” are undefined;
. the definition of a “discretionary trust” is undefined, and the High Court defining such much more widely than is generally recognised by accountants;
. a trust is not a separate legal personality;
. the ATO and certain legislation are treating certain trusts as entities;
. the full High Court position on derivation of “income” is different from the ATO’s administration of imposing tax on income;
. the full High Court position on derivation of a “capital gain” is different from the ATO’s administration of imposition of tax on a capital gain;
. the operation of the value shifting provisions;
. application of Part IVA.

This list may not be comprehensive.

THE TESTS FOR INTEREST DEDUCTIONS

In extreme brief, interest is deductible as an allowable deduction when:
. it satisfies the preconditions of s 8-1; and
. is not denied elsewhere in the ITAA.

The principal requirements are that there be:
. an outlay (presumably to be satisfied); and
. the outlay be necessarily incurred in producing assessable income. This is also called the “nexus” test. The interest must be incidental and relevant to the derivation of the assessable income.

THE $64m QUESTION

Although it is always “possible” to borrow and pay the interest in the “hybrid beneficiary’s hands”, the mere fact that the borrowing has been made and interest has been paid, will not always mean that a deduction is available.

If the borrower:
. has no interest in trust property; or
. has a disproportional fractional interest in trust property
then the deduction:
. will be denied; or
. may be apportioned: see Munro’s case.

Spassked case is a real reminder with probably $6,500,000 of interest denied.

All too often the interest expense stands out in the individual’s tax return with no income being derived in that year and the ATO’s computer “spits” the deduction out as a query. The client may be entitled to the deduction, but the conflict with the ATO has commenced in relation to:
. the interest; and
. possibly the trust estate.

We recommend caution, until you understand the legal relation ship involved under the trust deed. To establish an entitlement to interest deduction, we would want to read the trust deed before expressing an opinion. All trusts are not the same.

WHAT IS A HYBRID TRUST?

The law of equity does not recognise the term ‘hybrid trusts’. The term “hybrid trust” is used commercially by persons to arrange in some manner:
. the beneficial ownership rights of the beneficiaries;
. the duties and obligations of the trustee; and
. the contractual relationship (if any) between the trustee and the beneficiaries
so that they have been organised in some special way.

The only way one can work out how hybrid trusts work is to:
. read the trust deed; and
. any associated contractual obligations and rights associated with the trust deed.

Search

We have searched the Austlii High Court and Federal Court decisions since 1947 and 1977 respectively to see if the either Court used the terms:
. “hybrid trust”; or
. “hybrid unit trust”.
It appears to be a term not known to the either Court. The implication is that, if the term hybrid trust is not known to the High Court, then it has no place in taxation law in Australia.

GUIDANCE

We have endeavoured to provide some guidance to positively assist you.

What you need to consider include how do the income and CGT provisions apply.

What your client may need is advice as to whether your client is entitled to any tax concessions.

If this is a significant transaction, we recommend that you obtain formal professional advice prior to implementation, as there may be other issues based on a full knowledge of:
· all of the facts of the case;
· all of the relevant legislation; and
· the taxpayer’s situation
that could impact on the tax treatment of the transaction.

This reply should only be treated as a starting point to understand the taxation issues. There are real problems to address with hybrid trusts.

If you would like our assistance with any of the tax planning, please do not hesitate to give me a call.

I trust this addresses your query and we look forward to assisting you again through the Help Desk.

Kind regards,
XX XXXX <i>M.Tax (Hons) ACA</i>

Disclaimer: Answers provided through the XXXXXX Help Desk relate specifically and are limited exclusively to the facts as outlined in the question received from you. Our response is provided for general assistance and guidance only. To the extent that any background facts are incorrect or incomplete then our answer should not be relied upon. It remains the responsibility of XXXXX members and the recipient of this response to apply their professional judgement to the issues involved and the specific circumstances of their clients. Where formal professional advice is required then such advice should be sought.

This response was prepared for the recipient to whom it is addressed and neither XXXXXX Pty Ltd, XXXX, their directors, partners or employees accept any responsibility whatsoever to any other party for the contents of this response.

[xx(]Well, any comments??

cheers

tony