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1001 Legal Structure Questions

Discussion in 'Accounting, Tax & Legal' started by -T-, 8th May, 2006.

  1. -T-

    -T- Well-Known Member

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    Hey All

    Ok, maybe not 1001 questions, but it feels like I have 1001 things to learn. I have read Ed's thread (previous) and similarly trawled the SS forums for info. I now know 100 times more thanks to those posts (especially Nigel's; much appreciated!!! Do you get a commission? :)) but I also have 100 more questions.

    I have never seen a complete write-up on how trusts are used with various asset classes and debt vehicles. Hopefully this post will answer questions that others have or even raise more in-depth questions. I most certainly don't expect answers on a platter; I will still keep researching and answer my own questions as discoveries are made. I already think I know the answer to a lot, but am not certain. I'm sure others that have read less are wondering about the simple things too. Anyway, here goes...

    General Structure
    Q. When people talk about a "Hybrid Trust" are they actually talking about the combination of a (hybrid discretionary trust) HDT and (unit trust) UT?

    Q. Are 'discretionary' and 'unit' mutually exclusive in terms of a "Hybrid Trust"? I.e. can a "Hybrid Trust" either be discretionary or unit, but not both at the same time? I'm not sure why you would want it to be both at the same time.

    Q. Is there an issue with having the same trustee in the HDT and the UT? What are the consequences or risks with this?

    Q. What are the real benefits of having a corporate trustee, other than using one as a beneficiary and having access to the corporate tax rate? Is there additional asset protection with a corporate trustee?

    Q. I understand that corporate beneficiaries are used to access the corporate tax rate (30%), but the money still has to come out of the company some how. So what real benefit is this?

    Q. Is it standard practice for the HDT to be a unit holder of the UT? Is this simply how a "Hybrid Trust" works? What are the implications of this?

    Q. When a "Hybrid Trust" needs to go from unit to discretionary due to 'once making a loss but now a profit', what actually happens? Is it a change in the deed or simply a change in the process?

    Special Income Units
    Q. When you buy special income units in a hybrid trust, are you simply buying special income units directly from the UT?

    Q. What are the practical purposes of special income units in a "Hybrid Trust"? This is the area of most confusion for me. :( The way it seems is that units are a way to get a holding in a unit trust and a way to get money into the trust. But...in a "Hybrid Trust" if there are special income units, does that mean that all income MUST be distributed to the unit holders proportionally? If so, does that mean while there are special income units, the trust cannot be discretionary in any form? I think I have this very mixed up. I guess I am interested in how special income units are used and why.

    Q. When are ‘special income units’ generally redeemed? Is it only when the unit holder wants their money back? Does a "Hybrid Trust" have to buy all special income units back before becoming 'discretionary'?

    Q. What happens if you don't know whether you will make a loss or profit in a "Hybrid Trust"? Does this have any impact on buying/owning/redeeming special income units?

    Investment Properties and Mortgages
    Q. Does this sound like the correct process for purchasing an IP using a hybrid trust?
    1. Proposed unit holder obtains mortgage for $x in the name of "'name' as trustee of 'trust'"
    2. Proposed unit holder uses the mortgage funds to purchase x number of $1 units in the UT
    3. UT uses the proceeds of unit sales to purchase IP
    4. Income from the IP is distributed amongst the unit holders as per proportions of holdings in the trust
    5. Unit holders use distributions to pay the interest expense on the mortgage/s

    Q. The only confusion I have with above (IP purchase) is the accounting at the end of the year. If the trust makes a loss, I believe the losses are distributed proportionally amongst unit holders. If it ends up making a profit, what happens? Does the "Hybrid Trust" convert to discretionary? Is it then up to the trustee to distribute at their discretion?


    Equities and Margin Lending
    Q. Is it best for the beneficiary or the trust to have a margin loan? It seems impossible to trade with an account in the trust's name, but the margin loan in the beneficiary's name. This would make me believe that the loan must be in the name of the "Hybrid Trust".

    Q. How is a net loss from trading passed onto a person if the margin loan is in the trust's name? Is there something funky with special income units required (I really have a dislike for them, possibly unjust though)?

    Q. How are franking credits passed on to a person from the trust's trading activities?

    In conclusion...
    Q. Is it ok to use the same "Hybrid Trust" for different asset classes? I have seen that people recommend not combining assets with different levels of risk in the same structure. But is this one of those overkill precautions? I really want to keep things simple.

    Q. Is it going to be much easier once I have a better grasp of the concepts and can I still use my not-so-personal-investment-savvy accountant? They are excellent business accountants and I'd rather keep it everything together.



    -T-
     
  2. Nigel Ward

    Nigel Ward Team InvestEd

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    No commission :( but all donations in unmarked notes in brown paper bag gratefully accepted :D

    I will do my best to answer all these questions...but it may take "a cupla days" or at least several posts.

    Stay tuned.

    N.
     
  3. -T-

    -T- Well-Known Member

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    Just a mental note to add about these trusts purchasing IPs:

    You get the loan, you buy units in the trust, the trust uses the proceeds to purchase the IP, it receives rental income, it pays expenses (insurance, rates, etc), it distributes the remaining profit to the unit holder, the unit holder uses that to pay the interest expense and then they claim the remaining loss.


    The bit this clears up for me is that the trust isn't paying the interest, it distributes the profit and you pay interest but are usually left with a loss to claim.

    :)
     
  4. -T-

    -T- Well-Known Member

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    Another note that covers some of the questions:

    It seems that a "Hybrid Trust" generally refers to a Hybrid Discretionary Trust and the units that you purchase are Special Income Units available due to it being a HDT. The units are not units part of an associated unit trust (UT).

    If this is correct, then what is the purpose of the additional UT. Is it additional asset protection?
     
  5. Nigel Ward

    Nigel Ward Team InvestEd

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    My answers are set out below after "A" in each case.

    More to follow soon.

    Cheers
    N.
     
    Last edited: 10th May, 2006
  6. -T-

    -T- Well-Known Member

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    I'm going to give these a go again... :) If I spell discretionary, beneficiary or distribution incorrectly, it's just because they take so long to type!

    No, generally the hybrid trust discussed is a Hybrid Discretionary Trust (HDT). This is a discretionary trust with a deed that allows the issue of special income units. These units are the basis for being able to personally negative gear an investment that is owned by the hybrid trust. You are claiming a loss against your ownership of the units, not the investment.


    I think that if all of the capital within the trust corresponds to issued units, then it can only act as a unit trust. If the units are less than the capital, then maybe that portion of profit can be discretionally distributed. But I'm still not too sure about this.


    Not sure about this one, but very interested in the answer.


    Not sure about this one, but very interested in the answer.


    Not sure about this one, but very interested in the answer.


    No, the UT is a separate deal. The special income units are actually issued per the trust deed of the HDT. The hybrid trust is hybrid because it can issue its own units.


    It seems that most of the time the Hybrid trust will be making a profit since the interest expense is with the individual. So there really isn't any switching over. Either the distributions cover the entire interest expense and any extra is taxed marginally, or they don't cover the interest expense and you claim a loss.


    No, see above. You are buying special income units in the HDT.


    This question is still of the most interest and I'm still unsure.


    Still of interest and unknown.


    As per above, the hybrid trust will generally be making a profit, you will be making the loss or profit. So it is as easy as working out your individual tax that the end of the year.


    No, the UT has another function. Not sure what yet, but if you replace UT with HDT, it is generally correct.


    As above, the individual with the interest expense makes the loss and beneficiaries make profits. So it's just an individual tax matter.


    More confused on this now. It seems the person needs the margin loan to be able to claim losses. But brokers won't allow a margin loan against an account for a different entity (I think).


    As above, unknown.


    As above, unknown.


    I guess this is about complexity, protection, administration, cost, preference, etc. I'd prefer to keep only one trust because unless I become an accountant or finance person full-time, I'll be swamped. Or maybe I could get a decent accountant. :)


    It's getting easier to comprehend now. But the more I learn, the less confidence I have in my current accountant being able to get it right.

    -T-
     
  7. -T-

    -T- Well-Known Member

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    Many many thanks Nigel

    It looks like you beat me to it. In retrospect, my questions were a little off-track. I get the idea of a hybrid trust much more now.

    I have created the following summary of questions from my latest research. After a little break, I'm going to try to research some more and answer them:

    Q. My trust was setup as a HDT that owns all of the units in a UT which owns the property. I am trying to understand why this was done as opposed to the HDT just owning the IP and there not being any UT. Any ideas anyone?

    Q. The margin loan and trading account thing still has me researching. I'm going to try to find someone who has detailed their experiences with this. I'm not sure how losses would be claimed or how the loan should be structured. Any ideas anyone?

    Q. Is there any possible way of moving IPs in my own name into the trust without a huge SD expense? Can I sell them cheaper to the trust for the sake of gaining asset protection?

    Q. My last confusion is still special income units and redeeming them.
    - Do you only purchase them to move funds into the trust?
    - Do you only redeem them to gain greater discretion for distributions and to get money back to the unit holder?
    - If the total value of units = capital in trust, must all profits be distributed proportionally amongst unit holders?
    - If the capital value in the trust rises, thus leaving amounts to be distributed discretionally, how are the distributions for the unit holders worked out? Is it the percentage of their holding compared to total capital that is applied to the income?

    For example, unit holder owns 100 $1 units. The trust buys an investment for $100 with the proceeds. It makes $10/yr and the unit holder gets all $10. The value rises 100% to $200. The investment still makes an income of $10. How much must go to the unit holder?

    Is it only $5 since he now only has a holding of 50% of the capital? But before he was getting $10. This is the missing link for me :)
     
  8. -T-

    -T- Well-Known Member

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    Ok, afters a lot more reading, I have more answers.

    Apparently this is done for the future benefit of being able to transfer assets to your SMSF without paying stamp duty. It also allows others to purchase units in that trust if need be,


    I found on SS a thread authored by Glebe on exactly this, but it seems there was no solution to using a margin loan with a trust and claiming a loss. I guess that you don't exactly plan to make a loss when gearing into shares, so it's all good. I think I'll get the margin loan in the trust and deal with it.


    I don't think so, SD is the downfall. I'm going to weigh up the pros and cons later.
     
  9. Nigel Ward

    Nigel Ward Team InvestEd

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    Have added additional responses to Mr T's initial post.

    Cheers
    N.