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Tax Determination

Continuing on from our tax article in the January edition of API, Julia Hartman offers this summary of the Australian Taxation Office’s draft Taxation Determination 2008/D16 which deals with hybrid trusts:

Example 1: Paul borrows $1 million and settles it on the trust. The trust issues half the units to him and half to his wife. In this case only half the interest on the $1 million would be deductible to Paul. 

Example 2: Paul is issued with all the units but there is some discretion in the deed that profits can be distributed to his family or the trustee can redeem the units for the price paid by Paul rather than the market value of the underlying asset. In this case very little of the interest will be deductible and at a maximum only enough to offset the income. So Paul receives no negative gearing benefit.  

Example 3: The units are redeemable at only the price Paul paid and his family is entitled to the capital gain generated by the investment. Again, only a portion of the interest will be deductible but a greater percentage than in Example 2 because in this example, while the units are on issue, Paul will be entitled to all the income of the trust.  

Example 4: The trustee has discretion as to how the income is distributed but all the capital gain must go to Paul as the only unit holder (if the units still exist). Again, the units can be redeemed at the price paid for them. In this case the interest on Paul’s loan is not deductible at all.

The ruling goes on to describe in detail the type of trusts that it applies to. (f) and (g) are the most significant points:

(f) The taxpayer’s units do not give the taxpayer an entitlement to all of the benefits which may reasonably be expected to be produced by the asset(s)... Alternatively, an objective implication to be drawn from the trust deed is that the taxpayer cannot reasonably expect to receive all such benefits.”

(g) For example, the taxpayer’s units:

(i) may carry no entitlement to share in realised capital gains of the trust,

(ii) may carry no entitlement to share in anything other than realised capital gains of the trust,

(iii) may carry an entitlement to share only in part of the income of the trust, or

(iv) may be redeemable, at the trustee’s discretion, for an amount which fails to reflect the taxpayer’s contribution to the trust (for example the cost of the units or their market value where such value reflects the limited nature of the rights which the units carry).

If the complexities of the issues covered in the draft confuse you, consider the following quotes:

“The terms of trust indicate that the taxpayer will not enjoy, or cannot reasonably expect to enjoy, all of the benefits flowing from the trust capital which he or she has funded with the borrowed money.

“If the provision of benefits to the other beneficiaries was considered insignificant, or merely incidental to the assessable income to be provided to the taxpayer, this complex structure would not be necessary.”

Julia Hartman is a CPA, registered tax agent and founder of BAN TACS Accountants Pty Ltd.

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