The Commissioner in TD 2009/17 placed some doubt on deductibility of interest on loans used to acquire units in a trust where the units:
- may carry no entitlement to share in realised capital gains of the trust
- may carry no entitlement to share in anything other than realised capital gains of the trust
- may carry an entitlement to share in only part of the income of the trust, or
- may be redeemable, at the trustee’s discretion, for an amount which fails to reflect the taxpayer’s contribution to the trust (for example the cost of the units or their market value, where such value reflects the limited nature of the rights which the units carry).
However the Full Court of the Federal Court recently had to consider whether interest on borrowings by the taxpayer to purchase units in a hybrid trust was deductible. The Court held that the answer to this question depended on the terms of the trust deed. In this case the trust deed provided that the unit holders were entitled to the component of the income that was not realised and unrealised capital gains and that amount of the capital which represented the aggregate issue price of all units then on issue. The discretionary beneficiaries were entitled to that part of the trust fund which represented realised and unrealised capital gains derived from the holding or realisation of any investment.
The effect of the trust deed therefore was that a holder of a unit in the trust had an entitlement to all of the income other than capital gains and the capital of the trust to the extent of the issue price.
However as is the case with many trust deeds there was a clause in the trust deed that gave a discretion to the trustee to determine whether any amounts received or disbursed are on capital or income account or partly on capital and partly on income account and in what proportions. The Commissioner argued that this meant the trust was a discretionary trust. However in the Court’s view such a clause did not cause the trust to be a discretionary trust. This Court held that this clause was a power clause and not a trust clause. Therefore as a power clause it could not vary the trust clause which gave an entitlement to the unit holders to income and capital other than that part of the trust fund which represented realised and unrealised capital gains derived from the holding or realisation of any investment.
The Court therefore held that the terms of this particular hybrid trust were such that the trust was a fixed trust of the income other than with respect to capital gains. Therefore, to that extent, the trust was not a discretionary trust. The Court then applied general principles as to deductibility of interest stated in the previous authorities and held that the interest was deductible.
The Commissioner sought to argue an apportionment of the interest. However because the Commissioner had not raised this issue in the tribunal below, the Court said it did not have to consider this question. Therefore the question of apportionment still appears to be open. Nevertheless at least in a case of a hybrid trust in similar terms it would appear, subject to the issue of apportionment, that interest on borrowings to acquire a unit in such a trust is deductible.
It is important to note that the decision is confined to the terms of the trust deed involved and does not necessarily extend to all hybrid trusts.