Hybrid trusts: combining discretionary and unit trust features
A hybrid trust is a trust that combines features of both discretionary and unit trusts. Typically, a hybrid trust issues units to its members (like a unit trust), but the trustee also has discretion to distribute income to a broader class of beneficiaries (like a discretionary trust). This structure attempts to combine the flexibility of a discretionary trust with the fixed entitlement features of a unit trust.
Hybrid trusts were historically popular for property development and investment structures because they allowed income to be directed to unit holders (who had invested capital) while also giving the trustee discretion to distribute additional income to other beneficiaries for tax planning purposes.
However, hybrid trusts have become more complex from a tax perspective in recent years. The Tax Commissioner has taken a close interest in whether the unit holders in a hybrid trust have ‘fixed entitlements’ for the purposes of various tax provisions. If the unit holders do not have fixed entitlements (because the trustee’s discretion dilutes their interests), the trust may lose access to concessions that depend on fixed entitlements, including use of trust losses under Schedule 2F, franking credits for unit holders (without a family trust election), and the CGT small business concessions.
The trust deed for a hybrid trust must be carefully drafted to balance the interests of unit holders against the trustee’s discretionary powers. The deed should clearly define the rights attaching to each class of interest, the circumstances in which the trustee can exercise discretion, and the relationship between fixed and discretionary entitlements.
At CoSec Partners, hybrid trust deeds cost $429 including GST, drafted and signed off by Key Legal, an independent external law firm. Given the complexity of hybrid structures, we recommend that clients obtain independent tax advice on whether a hybrid trust is the appropriate structure for their specific circumstances before establishment.
Frequently asked questions
Are hybrid trusts still used in Australia?
They are, but far less than before the ATO’s scrutiny of fixed entitlements tightened. Where the structure is being considered, independent tax advice on whether a hybrid is appropriate for the specific circumstances should come before the deed is prepared, not after.
What is the main tax risk with a hybrid trust?
That unit holders are found not to hold fixed entitlements, because the trustee’s discretion can dilute their interests. If fixed status fails, the trust may lose access to concessions the structure was set up to obtain, including use of trust losses under Schedule 2F, franking credits for unit holders without a family trust election, and the CGT small business concessions.
Can a hybrid trust be converted to a plain unit trust?
Sometimes, where the deed has a sufficient variation power. The obstacles are the same as for any substantial variation: acting within the deed’s power, and the resettlement, CGT, and duty consequences of changing the interests the deed creates. Both should be confirmed before any amendment is executed.
This article is general information only and does not constitute legal, financial, or tax advice. While we endeavour to keep content accurate and current, laws and regulations change frequently. For advice specific to your circumstances, please consult a qualified professional adviser. CoSec Partners Pty Ltd accepts no liability for actions taken based on this content.