In many circumstances, an investor's loan borrowing costs can be deducted against the investor's income in a given financial year.
However, a recent case has shown that an investment in a hybrid trust may not allow for the borrowing costs to be wholly deductible.
Cleardocs Hybrid Trust To preserve an investor's tax deductions, the trustee under a Cleardocs Hybrid Trust deed must honestly assess all receipts as on income or capital account.Jeff Holowaychuk
A recent decision of the Federal Court highlights three considerations for investors setting up and investing in hybrid trusts:
The Full Federal Court in Forrest v Commissioner of Taxation considered the income tax implications of a taxpayer's investment in a hybrid trust and whether the borrowing costs associated with that investment were tax deductible.
The taxpayer (and his associates) established a hybrid trust known as the Minderoo Trust (Trust). The taxpayer borrowed $4.5 million to buy units, and therefore became both a unitholder and a discretionary beneficiary of the Trust.
The Trust was established for the primary purpose of purchasing shares in a mining company. The Trust's investment in the mining company dictated the manner in which the income and capital assets were distributed. So:
Further, the Trust deed gave the trustee a discretion to:
The taxpayer claimed income tax deductions for the costs of borrowing to purchase his units.
For the 2000, 2001 and 2002 financial years, the Commissioner denied the deductions on the basis that:
Under the law, for the ATO to accept a claim for a deduction for borrowing costs on an investment in a trust, the taxpayer must be presently entitled to a fixed proportion of any income distributed from the trust.
The taxpayer, argued that:
The Full Federal Court found, in favour of the taxpayer that the interest on the loan was wholly deductible. The Court based its decision on the fact that:
The Commissioner had also argued in Court for the deductions to be apportioned on the basis that the Trust had both fixed and discretionary components. The Court refused the Commissioner's request on the basis that the argument had not been raised when the case was at the Administrative Appeals Tribunal before it was appealed to the Federal Court. The topic of apportionment is discussed separately in a previous ClearLaw article here.
The Cleardocs Hybrid Trust deed contains a similar clause to the one considered by the Federal Court in Forrest v Commissioner of Taxation. As a result, trustees of a Cleardocs Hybrid Trust must take care to ensure that all receipts are correctly classified as on either income or capital account, or make an honest attempt to do so, before distributing to unitholders and beneficiaries.
An incorrect classification may have serious tax implications for the trust's investors.
For more information, contact Maddocks on (03) 9288 0555 and ask for a member of the Maddocks Tax and Revenue Team.
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Geoff Musgrove is a partner in the Maddocks Commercial team.
Geoff's principal areas of practice are:
Geoff acts for a wide range of commercial, government, accounting, manufacturing, professional and rural industry clients.
The legal information and commentary on this site is general only. Documents ordered through Cleardocs affect the user's legal rights and liabilities. To assess their suitability for the user, legal accounting and financial advice must be obtained.
For more information, contact Maddocks on (03) 9258 3555 and ask to speak to a member of their team.