In recent years much has been said of the use of a hybrid trust. The term is not specific and includes many different types of trusts, where there may be different entitlements to revenueand capital.
It is argued by some that this type of trust provides for all the benefits flowing from a discretionary trust (the flexibility to deal with income) with the advantages of being able to use negative gearing in respect of fixed entitlements to income, usually through units issued with such rights.
At one level the 'flow through' characteristics of a trust and the ability to stream trust income Tax Ruling (TR 92/13 Income Tax: Distribution by trustees of dividend income under the imputation system) provides substantial flexibility and the potential to reduce overall income tax liabilities. On the other the dichotomy between tax law (s95) income and trust law income provide many complexities that are as yet unresolved. Combined with the specific application of CGT Event E4 to fixed trust entitlements, a trust provides a complex vehicle that warrants careful consideration.
The use of negative gearing in the context of property transactions is well known. The potential deductibility of the excess of allowable interest deductions over property income can provide a number of advantages. Some entities allow gearing at either or both entity level and the shareholder or beneficiary level. Others present specific issues, for example the lack of an interest in a discretionary trust. The Commissioner's view in the context of borrowing to acquire shares in a company is outlined inIncome Tax Ruling 2606 Income Tax:
Deduction for Interest on Borrowingsto Fund Share Acquisitions.
While Income Tax 2606 refers to the treatment of borrowings in relation to shares in a company and the consequences of the decision by the Federal Commisioner of Taxation v. Total Holdings (Aust) Pty Ltd (1979)79 ATC 4279 9 ATR 885 it provides some guidance in relation to borrowing to acquire interests in trusts.
In the Commissioner's view, so longas a beneficiary in a hybrid trust structure continues to be entitled to all of the income derived by thetrust, a deduction would be allowedfor 100 per cent of the interest incurred on borrowings utilized to acquire the units in the trust.Where other beneficiaries becomeentitled to income through theexercise of the trustee's discretionary powers, the Commissioner will argue that interest incurred by the unit holders must be apportioned. The basis for such apportionment is unclear. Whether previous income entitlements are relevant has not been stated and the matter isunfortunately unresolved. These matters have recently come under consideration in Tax Alert TA 2008/3.
The Tax Office considers that the arrangement outlined above may give rise to taxation issues that include:
- whether, and the extent to which, the taxpayer's borrowing costs are deductible under section 8-1 or section 25-25 of the Income Tax Assessment Act 1997 (ITAA 1997);
- whether a capital gain could arise under the capital gains tax provisions in Part 3-1 of the ITAA 1997 when trust interests are redeemed or new interests are issued;
- whether the taxpayer has 'created' a trust in which the taxpayer or their children have an interest, such that the trust may be subject to section 102 of the Income Tax Assessment Act 1936 (ITAA 1936); and
- whether the general anti-avoidance provisions in Part IVA of the ITAA 1936 may apply to the arrangement, on the basis that its dominant purpose is to enable the taxpayer to obtain a tax benefit.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
