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A unit trust is a type of trust in which trust assets are divided into units that are owned by the unit holders of the trust. The beneficiaries of a unit trust, also known as unit holders, are entitled to a share of the income and capital of the trust based on the number of units they own.
Unit trusts may have different types of units with different rights attached to them, similar to the way a company may have different types of shares. Unit holders in a unit trust may have a proprietary interest in the assets of the trust, but for tax purposes, it is the units themselves that are considered assets, rather than the underlying interests in the trust assets.
Individuals, companies, superannuation funds, and other trusts can own units in a unit trust. It is common for unit trusts to be held through a superannuation fund or a family discretionary trust.
It is less common for units to be held in an individual's name because the units could be considered assets that are subject to creditors' claims if the individual is sued.
It is also less common for units to be held in a company because companies do not qualify for the 50% capital gains tax discount that may be available to an individual unit holder when they sell their units or when capital gains are distributed by the unit trust.
There are several benefits to using a unit trust.
A unit trust may offer asset protection through a properly drafted trust deed.
It is easy to add new unit holders because there are no value shifting rules.
If units are held through a family trust, unit holders may also have access to various income tax advantages connected to family trusts.
Unit trusts also have fewer regulations than companies. There is no regulator overseeing unit trusts and the substantiation rules are less onerous than those applied to individuals.
When non-related parties are in the same unit trust, their interests are fixed.
The unit trust may also be eligible for the 50% capital gains tax discount and the small business concessions.
There are some drawbacks to using a unit trust.
If the trust is funded by debt rather than equity, the sale of units could result in large capital gains and a change in unit holdings may also result in pre-capital gains tax assets becoming subject to capital gains tax.
Unit holders of a unit trust may also be subject to complex PAYG calculations, and changing the terms or objects of the trust may have capital gains tax and stamp duty consequences.
It may not be possible to elect to have the unit trust treated as a family trust, and losses may be trapped within the structure and the complex trust loss provisions may also apply, which means that it may not be possible to transfer losses to other controlled entities like companies.
The flow-through of small business concessions may be reduced by cost base adjustments.
Clients may find it difficult to understand all of the terms of the trust deed, and unit trusts may be more costly to set up and maintain than sole trader or company structures.
There are two methods for establishing a unit trust:
Using the second method, where one or more initial unit holders subscribe for initial units, it avoids having a Settlor who is not also a unit holder.
The Trustee can be an individual or a company, and we recommend using a company to provide better governance and to avoid the need to keep track of individual Trustees coming and going. The unit trust deed should also entitle the unit holders to hold shares in the trustee company in the same proportion as their units in the trust.
A unit holder could be an individual, a company, a superannuation fund, and other trusts, as all of these entities can all hold units in a unit trust. The most common way to hold units in a unit trust is through a superannuation fund or a family discretionary trust.
It is less common for individuals to hold units in their own name because if the individual is sued, the units are considered an "asset" that can be seized by creditors. It is also less common for units to be held in a company because a company does not qualify for the general 50% capital gains tax discount on any capital gain from selling the units or any capital gain that flows through to the unit holders from the unit trust.
For tax purposes, unit trusts can be classified as either fixed or non-fixed.
A fixed unit trust is one in which the interests in both the income and capital of the trust are held absolutely for the unit holders. Any other type of unit trust is considered a non-fixed trust, also known as a hybrid trust because it has a combination of fixed and non-fixed interests.
A trust may be non-fixed for a number of reasons, such as the Trustee having the discretion to allocate certain income or capital to certain unit holders over others, or having the right to issue or redeem units at a price other than market value, which can shift value from one unit holder to another.
Non-fixed trusts may face difficulties in carrying forward losses, distributing franked dividends from underlying share investments, and qualifying for certain capital gains tax concessions.
While unit holders in a unit trust may believe that they have a fixed interest in the income and capital of the trust, the trust will only be considered a "fixed trust" for the purposes of the trust loss rules in the Income Tax Assessment Act 1936 if it can be demonstrated that:
If the trust deed allows for other methods of valuing new units or the redemption of units, then the trust, even if it is a unit trust with no discretionary elements, will be considered a "non-fixed trust" for the purposes of the trust loss rules. Such trusts must meet additional tests in order to carry forward their losses.
If an asset of the trust is sold, unit holders are entitled to a 50% discount on capital gains. If the asset is held for at least one year before being sold, this discount will be applied when capital income is distributed to unit holders.
The individuals who are the unit holders of the trust under the trust deed are considered to have an ownership interest in the land subject to the trust. This equitable interest is established because the trust deed specifies that the unit holders are currently entitled to the income and capital of the trust and have the right to request that the trustee dissolve the trust and distribute the trust property to the unit holders.
Under the Land Tax legislation in certain states, this unit trust is considered a "fixed unit trust," which means it is eligible for the same threshold as trustees who own land under this trust deed structure.
In New South Wales, the Land Tax Management Act 1956 defines a "fixed trust" as a trust in which the equitable estate in the land subject to the trust is owned by persons who are also considered owners of the land for land tax purposes, and the trustee's equitable interest as trustee of the trust is disregarded.
This means that the unit holders of the trust are considered to own an equitable estate in the land subject to the trust. The trust deed for this fixed unit trust allows the unit holders to be presently entitled to the income and capital of the trust and to request that the trustee wind up the trust and distribute the trust property to them.
A unit trust cannot distribute capital or revenue losses to its unit holders, which means that any losses must be carried forward until a profit is achieved. If a trust incurs a net loss, its unit holders may want to consider holding debt at the unit holder level rather than at the trust level to avoid having negative gearing-type losses locked up in the trust.
In a fixed unit trust, the trustee does not have discretion over the distribution of income, as all income must be distributed to the unit holders.
The duration of a trust can vary depending on the location of the trust and the location of the property held by the trust. For instance, a unit trust established in South Australia has the potential to exist indefinitely, while trusts in other states typically have a maximum lifespan of 80 years.
The unit trust deed, or the legal document that establishes the unit trust, specifies the conditions under which the trust will come to an end. In general, the trust is terminated when the trustee, either on their own or at the direction of the unit holders, declares in writing that the trust will "vest," or be distributed, at a certain time.
The trustee must then collect all of the trust's assets, convert them to cash if necessary, and pay off any debts, including taxes, before distributing the residual assets or cash to the unit holders according to their entitlements.
It is advisable to seek legal and accounting advice before setting up a unit trust in order to fully understand the complexities involved. In addition to a trust deed, it is also recommended to have a "unit holders agreement" in place, as this allows the unit holders to define their relationships with one another and their obligations to each other.
We have much experience setting up unit trusts, and preparing and lodging unit trust income tax returns.
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Any advice contained in this document is general advice only and does not take into consideration the reader’s personal circumstances. Any reference to the reader’s actual circumstances is coincidental. To avoid making a decision not appropriate to you, the content should not be relied upon or act as a substitute for receiving financial advice suitable to your circumstances.
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