Most people when they think of trusts think about the terms “trust funds” or “family trusts”. In Australia, there are 3 common types of trusts, these are discretionary, unit and hybrid trusts. In this article, we’ll be answering the question – what is a Hybrid Trust?
To start with the basics, trusts in their most basic form are a structure which allows a person or company to hold an asset for the benefit of others. The person who controls the asset is the trustee and those who benefit are the beneficiaries. The assets held in a trust can vary but typically include property, shares, businesses, and business premises.
Trusts are a valuable tool that can protect assets and make things more tax efficient. This is especially so of Hybrid Trusts; although these are often considered one of the more complex trusts to set-up properly to obtain maximum tax benefits.
What is a hybrid trust?
A hybrid trust has characteristics of both discretionary and unit trusts, with the trustee being empowered to distribute trust income and capital among nominated beneficiaries.
Hybrid trusts can take on many forms but the most common is one that combines the best elements of a unit trust with the best elements of a discretionary trust and has both unit holders and discretionary beneficiaries.
With hybrid trusts, income and capital are proportionally distributed – as with unit trusts – based on the number of units each beneficiary holds. Hybrid trusts are often the favoured structure when there are significant investment assets involved, due to their income tax and capital gains tax benefits.
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Other types of trusts
In addition to hybrid trusts, there are also a number of other trusts used in Australia:
Discretionary Trusts
A discretionary trust (also known as a family trust), is a trust established to hold a family’s assets or operate a business. Generally, they are established for asset protection and/or tax purposes. Discretionary trusts are the most common type of trust used by business owners in Australia.
Unit Trusts
A unit trust is a trust in which one or more beneficiaries hold ‘defined entitlements’ to the capital and any income of the trust. These fixed defined entitlements are referred to as ‘units‘, and the beneficiaries holding the units are referred to as ‘Unit Holders‘.
Special Disability Trusts
The special disability trust allows immediate family members and carers to set up a trust to benefit another family member. Before the trust can be set up, the prospective beneficiary must be assessed as severely disabled per the requirements of the trust’s legislation.
Family members are then allowed to make private financial contributions for the future and current care of the beneficiary.
Why have a hybrid trust?
The income tax, capital gains tax and asset protection attached to hybrid trusts means that they are often the preferred method of structuring business or investment activity. This is particularly where more than one un-related party is involved: for example, two separate family groups who are buying a commercial property together.
Hybrid Trust - Advantages & disadvantages
Advantages
- Provides more flexibility with tax planning.
- Ability to issue and redeem units with no stamp duty in some States.
- Income and Capital Gains taxed in the hands of beneficiaries.
- Benefits / income can be passed to beneficiaries without change in ownership of the investments.
- Control of investments can effectively be retained by the appointer of the trustee who normally places the asset in the trust.
- Confidentiality of information as there is no statutory disclosure requirements.
- No audit requirements – Accounts for Income Tax Return preparation is the only requirement.
- If the trust has a corporate trustee, there is limited liability.
- Easy entry and exit of owners.
- Relatively simple to wind-up
Disadvantages
- Cost of creation and administration of the trust is higher than an Individual or Partnership.
- Potential changes to legislation could reduce the effectiveness of a hybrid trust – such as tax laws.
- Careful structuring is required for negatively geared investments as Capital and Revenue losses could get quarantined in the Trust.
- Possible Land Tax treatment as a Special Trust in Victoria and N.S.W.
- When grossed up dividends are less than net losses from other sources, the refundable franking credit is lost, and the carry forward losses are reduced.
Hybrid trusts and tax
Hybrid trusts are efficient tax planning vehicles and usually, hybrid trusts do not pay tax themselves. Instead, the net income flows through them and is attributed to the unit holders. The amount of tax paid by the unit holders depends on their individual tax profiles.
The trust deed is drafted so franking credits, dividend rebates, and different classes of income, capital gains and other tax amounts having tax consequences flow through the trust to the appropriate unit holders.
A hybrid trust may be eligible for the 50% CGT discount if you hold the asset in the trust for 12 months or more. This means that 50% of the sale price is tax-free and only the remaining 50% is subject to tax.
Setting up a hybrid trust
Setting up a hybrid trust involves selecting a trustee, trust assets and beneficiaries, preparation of a trust deed, signing of the trust deed, paying stamp duty (if applicable), and setting up a bank account through which the trust can be administered.
Professional advice is a must
To properly take advantage of a hybrid trust, we recommend getting sound professional advice. The ATO have a particular focus on hybrid trusts and if not set-up correctly you can be faced with increased (not reduced) tax liabilities.
The team at POP Business can provide expert advice on all types of trusts, including hybrid trusts. To find out more, call today – 1300 180 630.
