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hybrid trust monstrosities 

Introduction to Hybrid Trusts 




Hybrid trusts are among a small group of not-so well-known tax structures out there. Some people don’t know about them. Others don’t like them. For whatever the reason may be, these structures don’t come up a lot.


As such, hybrid trusts can quickly become a taxation and compliance nightmare. Many are not overly fond of them. Having said, sometimes you have to do what you have to do.


As you may already know, a hybrid trust typically combines features of both a discretionary trust and a unit trust. The term “hybrid trust” serves as a broad categorization for trusts that incorporate elements from both discretionary and unit trusts. As expected, a multitude of hybrid trust variations exist. Consequently, when a tax practitioner discusses a hybrid trust, they may be referring to one of several distinct ones within this category.


Hybrid trusts are a combo actually


A prevalent variation of the hybrid trust seeks to amalgamate the most advantageous aspects of both a unit trust and a discretionary trust within a single entity. Why wouldn’t you? This hybrid trust structure typically includes both unit holders and discretionary beneficiaries. The trustee holds the authority to allocate income to the discretionary beneficiaries, while the unit holders possess the entitlement to receive income and capital not distributed to discretionary beneficiaries. Alternatively, the unit holders may be entitled to the entire trust income. They can choose to retain the option to redeem their units at face value. At that juncture the trustee gains complete discretion in distributing income and capital.


While there may be legitimate non-tax motivations for setting up such a structure, one needs to be extra careful here. For instance, it’s crucial to note that the Australian Taxation Office (ATO) has clarified that certain tax advantages often promoted in connection with these trusts, like unit holders claiming deductions for interest payments and other borrowing expenses incurred to acquire units, will not be accessible. A bit of a long sentence – but well worth the read. For more detailed information and guidance on this matter, please refer to ATO documents TD 2008/D16 and TA 2008/3.



Many ways to skin a cat


It’s important to recognize that there exist numerous iterations of hybrid trusts, and not all of them have been under the scrutiny of the ATO. Furthermore, valid non-tax-related rationales may exist for employing a hybrid trust structure, as elucidated in the case of a Class Trust. If there is a legitimate reason, one could potentially assume that said structure would be defensible. Still, tread carefully.



Like I said, a hybrid trust structure therefore blends the characteristics of both a unit trust and a discretionary trust. But as the foundational trust is structured as a unit trust, distributions are made in alignment with the predetermined unit holdings of its members. Discretionary payments, on the other hand, are reserved for exceptional situations. In essence, a hybrid trust brings together the strengths of both trust types. When applied within a business context that involves unrelated members, a hybrid trust configuration effectively resolves the challenge of disbursing non-fixed entitlements.


A few examples:


Consider this scenario: Within a hybrid trust, one of the unitholders requires a lump sum payment of $1,000 resulting from the sale of a business interest. If this trust were structured as a fixed unit trust with units equally distributed among four unit holders, each unit holder would have a 25% entitlement to the $1,000.

Consequently, instead of a single $1,000 payment to the designated beneficiary, the amount would be distributed as $250 to each of the four unit holders. This approach ensures that the payment is subject to taxation individually for each of the four unit holders, rather than consolidating the tax liability into the hands of a single beneficiary who was initially entitled to the full $1,000 payment.


In the scenario described, the remaining three unitholders from the above example would need to arrange a separate arrangement to transfer the $750 owed to the individual originally entitled to receive $1000.

A very rough example, for sure. As with everything else you read on our site, this is all written for very generic educational value. None of what you find on our site actually constitutes advice of any sort. In fact, it is highly unlikely that something you read on our site will apply to your unique situation. Try to think of these casually written blog posts as aiming to create very high levels of awareness of certain issues. So that you can then actually talk to an actual accountant and get proper advice, yes? All good? Excellent. Disclaimer out of the way. Keep reading!



Another way to do it – again.


To address the previously mentioned issue, another approach is to establish the business within a discretionary trust, with one of the primary beneficiaries being the unit trust. However, it’s important to note that if all units are owned by the discretionary trust, the underlying trust controlling the business interest falls under the discretionary trust’s jurisdiction. This might not be advisable, as it centralizes all control in the hands of the discretionary trust’s trustee. Subsequently, all payments become subject to the trustee’s discretion.

You may not want anyone to have that kind of control over everything. In fact, it is recommended that the underlying trust be structured as a unit trust rather than a discretionary trust. This approach ensures a more predictable and transparent distribution process based on unit holdings. That would align with the ownership structure and objectives of the unit holders.


Now, let’s revisit the previous example using a hybrid trust structure.

In a hybrid trust arrangement, the underlying trust is actually structured as a unit trust with the trustee holding limited discretionary powers. In this context, considering the scenario where a $1000 payment needs to be made to a single unit holder, the trustee would exercise their discretion to make a payment to the designated unit holder. This is opposed to dispersing $250 to each of the four unit holders as in the fixed unit trust.

This approach ensures that the specific unit holder entitled to the payment receives it in full. Additionally, the unit holder will be eligible to benefit from any Capital Gains Tax (CGT) advantages resulting from the sale of the business interest and/or will assume responsibility for their appropriate tax obligations. This demonstrates how a hybrid trust structure can provide a flexible and tailored solution to address unique payment and tax-related needs.





Hybrid trusts could even help with taxation – sometimes.


The hybrid trust structure not only resolves the need for establishing two separate trusts. It also streamlines compliance processes by allowing taxation to be applied to the specific unitholder entitled to the lump sum payment.

However, within a hybrid trust setup, potential concerns may arise among unitholders, especially in cases involving multiple unitholders and only one trustee wielding discretionary powers. To address this concern effectively, it is advisable to seek a hybrid trust deed prepared by a lawyer that incorporates a clause limiting discretionary payments unless there is unanimous consent from all unitholders. Such a provision ensures that important decisions regarding discretionary payments are made collectively, with the unanimous agreement of all parties involved, enhancing trust and confidence in the trust’s governance.




In summary..


As a summary, the Hybrid Trust is essentially a blend of two trust types: the Discretionary Trust and the Unit Trust. As shown, this hybrid structure is attractive because it combines the advantages of both trust forms, making it a highly versatile and valuable option. It allows you to divide the trust into units, while still maintaining the flexibility to distribute to beneficiaries at your discretion.


Hybrid trusts leverage the advantageous aspects of both discretionary trusts and unit trusts, combining them within a single entity to form a versatile structure. This approach enables the recognition and preservation of the distinct rights and entitlements of unrelated third parties, while also establishing clear boundaries between these third parties and all associated individuals, including spouses, children, and related family trusts, among others.


Many still love Hybrid trusts though.


Hybrid trusts are often favored for structuring business or investment activities due to their favorable attributes related to income tax, capital gains tax, and asset protection. They become particularly appealing when multiple unrelated parties are involved, such as two distinct family groups jointly purchasing a commercial property. The flexibility and benefits offered by hybrid trusts can make them an advantageous choice in such scenarios, allowing for effective tax planning and asset protection while accommodating the diverse needs and interests of the parties involved.

But, again, don’t rush into anything. Talk to an experienced accountant on this. If you can’t find one, give us a call on 1800 672 670.


If you need tax help, please don’t be in 2 minds.


Contact us on 1800 672 670.