Tuesday, September 25, 2018

Identifying trust types

With thanks to the Television Education Network, today’s post considers the above mentioned topic in a ‘vidcast’.

As usual, an edited transcript of the presentation is below:

The first step in the process is to identify what sort of trust we’re dealing with.

Discretionary trusts and unit trusts are usually relatively easy to identify. The discretionary trusts will have a range of beneficiaries, but no single beneficiary will have any fixed entitlement to income or capital from that trust.

Therefore, the rights that a beneficiary has against the trustee are limited to the right to be considered for distributions from time to time and the right to ensure that the trustee fulfills their fiduciary obligations.

If you contrast that with a unit trust, the unit trust will usually have beneficiaries with units or fixed percentages, which entitle them to determinable amounts of the trust income and capital.

Therefore, a unit trust will be treated quite differently from a bankruptcy perspective and a Family Law Act perspective in the event something goes wrong for one of the unit owners.

The hybrid trust is quite different again and there is no single agreed definition.

You could talk to 10 different lawyers and probably get 10 different definitions of what a hybrid trust is.

It is a structure that has been evolving a lot over the last 10 to 15 years and there are a lot of different variations around, which each have slightly different provisions or quirks in the way they operate.

In a general sense, a hybrid trust is a trust which has some discretionary entitlements and some fixed entitlements.

One example of a type of hybrid trust that was particularly common in the lead up to the GFC is a negative gearing hybrid trust, where we have an individual unitholder who goes out and borrows funds to buy units in that trust, and that unit gives the unitholder a fixed entitlement to the income from the trust.

The thinking behind these hybrid trusts is that because the individual had borrowed to acquire an income producing asset, being the units, they could therefore claim a tax deduction for their interest on the borrowings.

However the trust deed would then have a separate provision which said any capital gain that may be realised by the trust could be distributed at the trustee’s discretion to a wide range of beneficiaries.

In other words, we have some discretionary entitlements in relation to capital and some fixed entitlements in relation to income.