Rules within Unit Trusts

Whether a HDT or a UT can allow the unit holder to claim interest or not will depend on the wording of the deed. it has to be worded in such a way that any income or capital gain must go to the unit holder. Who would borrow to buy units if there was no surety of getting an income someday. Not sure of the commercial benefit for someone to buy units that would only produce income in 12+ years if they had not hope of getting any capital gains.

The recent Tax Alert 2008/3 refers to the Uncommercial Use of Trusts. Many Accountants are not using their Trusts in a Commercial way. So whether the Deed is a Unit Trust Deed or a Hybrid Trust Deed the same rules apply to commerciality. Commerciality means that whether one invests in property or shares they must invest with the intention of making money over time. The reason why the ATO allows a tax deduction for negative gearing is because they expect that the property will one day become positively geared and the property goes up in value and at some time in the future they will get their income tax and capital gains tax when the property is sold. 

 The use of Income Units and Capital Units is still valid as long as you have built an intention to make money down the track either out of the income units or from the capital units.  

Many Accountants had designed their Trust Deeds so that the Income Units could be redeemed at cost. This is uncommercial as there was no intention to make a profit. No one in their right mind has the intention to invest into something that loses them money forever.

In PR 66298 the Taxpayer was denied the interest deduction to the level of the rental received because the Trust Deed stated that the Income Units would get a 2% return for the life of the investment and hence could never become positively geared. This is uncommercial. In this case the Private Ruling was denied not because there were Income Units or Capital Units but because there was no commerciality in the arrangement.

Hence back to the book. As long as the Income Units can be redeemed at market value than there is commerciality. This is confirmed in IT2684. 

In IT2684 it explains how Income and Capital Units should be used and as long as its used in this way than there is commerciality and the ATO is happy. 

Also to avoid Part4A (where your primary purpose is to avoid tax as opposed to a commercial intent) there are many reasons why Income Units could be redeemed at market value and reissued to another person other than to avoid tax. You may want to direct some income to the wife so she could qualify for a loan to buy another property. 

The ATO in the recent tax alert 2008/03 and media release indicate that they were only interested in the Uncommercial Use of Trust.  Some commentators were suggesting that the ATO did not like Trusts. This is not the case. They simply did not like the wrongful use of the Trust.  

Quoting from ATO Media release 2008/13

“The Tax Office is not concerned about all 'discretionary', or 'hybrid’ trust arrangements.

“Rather, we are concerned about negatively-geared trust arrangements which involve the taxpayer incurring interest expenses or borrowing costs where all or a proportion of the borrowed funds could be used for the benefit of the beneficiaries, or where the taxpayer’s interest in the trust could be brought to an end before their costs of investment have been recouped.”

We wrote an Article in the Australian Property Investor magazine a few months ago explaining this in great depth. Or go to http://www.chan-naylor.com.au for another piece we wrote on the Tax Alert.  
We have also confirmed this with both out Tax Lawyers and Queens Councils.

Hi Terry
Just as its wrong to say that everyone should have a Trust, its also wrong to say that no one should have a Trust, which is what some commentators are saying. For every 10 clients that see us, around 6 to 7 out of the 10 would need some form of a Trust and the other 3 or 4 would need some other solution, other than a Trust.

However in the event that a client does need a Trust (but the correct Trust as all Trusts are different in their application) than there are many more reasons to have the property in a Trust than in ones own name.

For example the flexibility of directing income to the lower tax payer without the transfer of the property which attracts capital gains tax and Stamp Duty costs.

Although in a Trust the Income Units needs to be redeemed at market value the definition of what market value is quite different to what market value is when the property is held in ones own name. Hence there could be substantial differences in the redemption value of Income units when compared to the market value of transferring a property.

If you bought Income Units in GPT Property Trust or Westfield Property Trust the Income Units, although gave a 8-9% income return also had a 2%-3% Capital Gain component to them. Hence as long as your own Trust Deed reflected the same commercial terms than you have complied with commerciality.

Commerciality could also be valued by taking the aggregate years that the property were negative plus the aggregate years that the property were positive and as long as the total years were positive than that constituted commerciality.

As you can see there are many ways to value “market value” and in most instances they would be less than what the market value of a property was. It was clear after discussions with the ATO that they wanted some connection with the “market”.

They mostly objected to the Trust Deed that required a redemption of Income Units “at cost”  but they acknowledged that sometimes the capital component could be in negative territory and that investments do not always go up in value.

There is also no stamp duty in most States when units are redeemed and reissued. There are substantial stamp duty costs when transferring properties held in ones own name.

Some argued that there was a lost of Asset Protection because the Units themselves were an asset. However the way we have structured our Property Investors Trust Deed ™ requires that both the Directors of the Trustee Company is required to agree to the forced sale or redemption of the Units before a Creditor is able to force the Unit Holder into redeeming their units.

A creditor could force a sale if the property was held in your own name.

This means the asset protection feature is retained in our PIT’s. This is confirmed by our Tax Lawyers who have assisted us in putting our Trust Deeds to reflect what we believe was required in a Trust that held property which as you know is quite unique to other asset classes such as Shares. We believe the standard Hybrid Trust is more appropriate to Shares but totally inappropriate to properties. Again that is only our opinion. We respect others may not share our opinion.

Also we have included a feature that allows the properties held in our PITS to clone into several Trusts without CGT and Stamp Duty such that should mum and dad want to pass 3 properties to their 3 children’s own Trusts this can be done without CGT and stamp duty.

Also we have found a way around the 80 year Vesting Date so that our PIT’s do not disappear after 80 years triggering a CGT and Stamp Duty event. When we first discovered this we were criticized by our competitors because they claimed that this was impossible and somehow we were doing something illegal. However as I understand it there has since been other Legal Firms who have also found a way around the 80 year Vesting date.

The only difference was we saw the 80 year Vesting date as a huge problem and we threw time and resources in finding a solution where as at the time other Lawyers did not see it as being such a problem and did not allocate time and resources towards finding a solution. Everything has a solution, it simply depends on how important and urgent it is perceived to be before one would throw money and resources towards it. It was very important for us because we ran a property strategy called our Wealth 4 Life which required the properties to be passed from generation to generation and the 80 year Vesting date was totally inappropriate and needed to be corrected.

No doubt before someone claims we are advertising our products here, let me just say that to answer Terry’s question as to why a Trust is still a valuable tool to use in light of the need to redeem units at market value,  there was no other way to answer it without highlighting the advantages of our PIT’s versus the other Trusts that are out there.

If we did not differentiate the 2 than it simply creates more confusion especially when someone gives what appears to be contradictory advice but in fact they are referring to 2 different products.

Naturally you are free to continue to use the other Trusts as long as you are fully informed to make an accurate assessment because there is so much misinformation out there.

There is an old saying that “a little information is dangerous” and it could not be more true in people’s understanding or misunderstanding about Trusts and their appropriate use.

Again this is meant to inform and educate and you are free to buy whatever Trust Deeds you and your Advisor believe are appropriate for your needs.

Thanks for the detailed answer Bianca.