Trusts are a valuable tool that can protect assets and make things more tax efficient. This is especially so of unit trusts here in Australia; however, they can be complex to set up correctly. In this article we take a look at what is a unit trust, as well as explore their structure, tax benefits and more. Let’s go.
What are Trusts?
Trusts in their most basic form are a structure which allows a person or company to hold an asset for the benefit of others. The person who controls the asset is the trustee and those who benefit are the beneficiaries. The assets held in a trust can vary but typically include property, shares, businesses, and business premises.
The creator of the trust, known as the settler, sets out the specific rules as to how these assets should be managed in a document called the trust deed.
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What is a unit trust?
A unit trust is a trust in which one or more beneficiaries hold ‘defined entitlements’ to the capital and any income of the trust. These fixed defined entitlements are referred to as ‘units‘, and the beneficiaries holding the units are referred to as ‘Unit Holders‘.
Unit trusts are commonly used for people to ‘pool’ their money together and make investments.
Smaller investors also use unit trusts for property investments and developments. For example, two business partners may set up a unit trust through which to hold their business premises.
Other types of trusts
In addition to unit trusts, there are also a number of other trusts used in Australia:
Discretionary Trusts
A discretionary trust (also known as a family trust), is a trust established to hold a family’s assets or operate a business. Generally, they are established for asset protection and/or tax purposes. Discretionary trusts are the most common type of trust used by business owners in Australia.
Hybrid Trusts
A hybrid trust bears characteristics of both discretionary and unit trusts. The trustee is empowered to distribute trust income and capital among nominated beneficiaries – as with discretionary trusts.
However, the income and capital are proportionally distributed – as with unit trusts – based on the number of units each beneficiary holds. Hybrid trusts are often the favoured structures when there are significant investment assets involved, due to their income tax and capital gains tax benefits.
Special Disability Trusts
The special disability trust allows immediate family members and carers to set up a trust to benefit another family member. Before the trust can be set up, the prospective beneficiary must be assessed as severely disabled per the requirements of the trust’s legislation.
Family members are then allowed to make private financial contributions for the future and current care of the beneficiary.
Unit trusts vs discretionary trusts
A unit trust differs from a discretionary (or family) trust in that the trustee generally does not hold discretion over the distribution of assets to beneficiaries.
Unit trusts divide assets into units, similar to shares. Each beneficiary (known as a “unit holder”) owns a given number of those units, and at the end of each year, each unitholder receives a distribution from the trust.
Are there different types of unit trusts?
Yes. For tax purposes, there are two categories of unit trusts – fixed and non-fixed. In a fixed trust 100% of 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 then a ‘non-fixed’ trust, (which are sometimes referred to as a ‘hybrid trust’ because they have a hybrid of fixed and non-fixed interests).
How do people hold units in a unit trust?
The most common way to hold units in a unit trust is either through a super fund or through a discretionary trust.
Unit trusts and tax
A unit trust is not generally taxed at all and is classed as a ‘flow-through’ entity for tax purposes. Instead, the unitholders are taxed on their share of the trust’s income.
However, sometimes there is trust income that no unitholder is entitled to. In this circumstance, the trustee is taxed at the highest marginal tax rate (45%). For this reason, trustees typically distribute all income to the unitholders every financial year.
If the trust disposes of all assets, it is generally subject to capital gains tax (CGT). Broadly, you calculate CGT on the difference between the asset sale price and the price paid for its acquisition.
The trust may be eligible for the 50% CGT discount if you hold the asset in the trust for 12 months or more. This means that 50% of the sale price is tax-free and only the remaining 50% is subject to tax.
How to set up a unit trust
The below are key steps that need to be taken in setting up a unit trust and trust deed – the legal document that sets out the conditions, terms, and rules for creating and managing your trust
Step 1: Decide who owns the trust
You will need to decide who the unit holders are.
Also known as the beneficiaries, these are the individuals or corporations that have contributed capital to the trust, and therefore hold an interest in it. You’ll need to provide their full name, address, company name (and ACN) and whether the person or company is acting as a trustee.
Step 2: Decide how the equity or ownership of the trust is defined (by units in the unit trust).
For each unitholder, you will need to decide on both the number of units held and the dollar value per unit. Ordinary units generally give the holder a right to vote, a right to income and capital of the trust and a right to a distribution of assets on the winding-up of the trust.
Step 3: Decide who will be the Trustee
The Trustee is the person who legally owns the trust’s assets (property for example). The Trustee can be a company or a person. You will need to provide their full name and address.
Step 4: Decide on the name of the trust.
If the name is to be used to operate a business, it is advisable to register that name with ASIC and obtain a registered trademark if necessary.
Step 5: Prepare a unit holders agreement (if necessary).
This legally binding document is in addition to the trust deed and is executed by the unitholders. It addresses the additional and complementary legal, financial and management aspects of operating your unit trust. This is an important document if the units are held by unrelated parties.
Unit trusts - Pros and Cons
In addition to the tax advantages mentioned above, other unit trust advantages include:
Asset Protection
Unit trust holders also enjoy asset protection from internal, as well as external parties.
As none of the beneficiaries hold legal rights in the trust property, they cannot claim the trust’s assets. Consequently, if any of the beneficiaries cannot pay off their debts, the creditors cannot seize the trust property as compensation.
Similarly, if one of the beneficiaries’ is involved in court proceedings such as divorce, the court cannot direct the trust’s assets towards satisfying the spouse’s claims.
Deregulation
A trust, unlike a company, isn’t as heavily regulated. While a Company needs to comply with regulations monitored by legislation, ASX and ASIC, trusts do not have such limitations. They are also easier to wind up than companies.
However, there are disadvantages to unit trusts and these include:
Potential loss of control
As none of the trust holders have legal rights over the trust, they are at the mercy of the trustee. A trustee being the only decision-maker and legal rights holder, might make decisions that the beneficiaries don’t always agree with.
Fixed trust status
For certain tax attributes to flow-through a unit trust, e.g. franking credits, and for losses to be carried forward, the trust will need to qualify as a ‘fixed trust’ for tax purposes. This is very difficult to achieve, and many ‘off-the-shelf’ Unit Trust Deeds are unlikely to qualify as compliant fixed trusts.
Costs
Unit trusts are traditionally more expensive to set up than a sole trader, or even a company. Additionally, the beneficiaries might be subject to PAYG calculations. If their income is higher than a certain amount, they would end up paying a higher tax amount than required by company tax.
Getting good advice is key
While off the shelf unit trust deeds are commonplace today, seeking professional advice is highly recommended in order to fully appreciate the complexities involved in successfully using a unit trust within your business and investment structures.
