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.
How does a Unit Trust work?
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.
Advantages of a Unit Trust
There are several benefits to using a unit trust.
A unit trust may offer asset protection through a properly drafted trust deed.
Easy to add new equity partners
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.
Fewer regulations than companies & less onerous substantiation rules
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.
Interests are fixed
When non-related parties are in the same unit trust, their interests are fixed.
capital gains tax discount
The unit trust may also be eligible for the 50% capital gains tax discount and the small business concessions.
Disadvantages of a Unit Trust
There are some drawbacks to using a unit trust.
Capital gains liabilities
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.
Losses may be trapped in the trust
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.
Reduction of small business concessions
The flow-through of small business concessions may be reduced by cost base adjustments.
Unit Trusts are complex and can be difficult to understand
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.
How do you set up a Unit Trust?
There are two methods for establishing a unit trust:
The Settlor contributes an initial sum, known as the Settled Sum, to the Trustee, who holds it according to the terms of the unit trust deed. After the trust is established, other individuals can subscribe for units in the trust.
One or more initial unit holders subscribe for initial units in the trust by paying the subscribed amount to the Trustee.
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.
Who should be a trustee?
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.
Who should be a unit holder?
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.
‘Fixed’ and ‘non-fixed’ Unit Trusts
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.
Fixed Unit Trusts
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:
Persons (such as individuals, companies, trusts) have fixed entitlements to all of the income of the trust and it's capital, and
The trust deed includes a clause stating that units can only be redeemed or issued at a price based on the net asset value of the unit trust according to Australian accounting principles at the time of redemption or issuance.
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.
Advantages of a fixed Unit Trust
Income tax advantages
In a unit trust, only net income earned in a financial year has to be distributed among the unit holders. This distribution must be included in the unit holders' income in the same financial year in which the trust earned the income, rather than the year in which the income is distributed.
The classification of trust income, such as dividend income or income resulting from capital gains, is recognised in the individual unit holders' income tax returns and any imputation credits or foreign tax credits are passed on to the unit holders based on the trustee's distribution.
If the unit holders are over 18 years of age, they can benefit from the tax-free threshold when the trustee distributes income to them.
The trustee of a fixed unit trust must distribute all of the trust's income and cannot accumulate income within the trust.
The trust can make contributions to the unit holders' superannuation accounts in proportion to their unit holdings, which means the tax on the trust's income may be limited to the 15% tax rate on superannuation contributions.
If the fixed unit trust has a loss and has received imputation credits in the same financial year, the trustee can lodge its own income tax return and carry the loss forward to the next financial year and claim a refund of the imputation credits.
If units are held through a family trust, unit holders may also have access to various income tax, asset protection, and estate planning advantages connected to family trusts.
Capital gains tax advantages
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.
Asset protection advantages
Unit holders can opt to have distributions made to them in the form of a bare trust rather than receiving physical payment. In this case, the trustee will establish a bare trust for the unit holder within the fixed unit trust and retain the funds that were intended for distribution.
If a unit holder is a minor or otherwise legally incapacitated, the trustee can hold the funds intended for distribution from the fixed unit trust in a bare trust until the unit holder reaches the age of 18.
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.
Disadvantages of a fixed Unit Trust
A fixed Unit Trust cannot distribute losses to unit holders
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.
Trustee does not have discretion over the distribution of income
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.
How long does a Unit Trust last?
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.
How is a Unit Trust wound up?
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.