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
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
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
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
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.
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Exemptions or concessions on stamp duty could apply when contemplating the purchase or transfer of NSW real estate.
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