A trust is a legal relationship established through a trust deed, involving two essential parties: a trustee and beneficiaries.
Within this framework, the trustee is entrusted with the responsibility of managing and legally owning the assets placed within the trust. Simultaneously, these assets are held for the benefit of the trust’s beneficiaries.
There are two primary forms of trusts: discretionary trusts and unit trusts.
What is a Unit Trust?
A unit trust is a specific investment structure that allows multiple investors to pool their resources into a single collective fund. Rather than individual investors purchasing assets like real estate or stocks separately, they contribute their funds to the unit trust. This collective approach enables shared ownership and management of assets within the trust.
For instance, consider two medical professionals who decide to establish a unit trust to hold their medical practice. In this scenario, the beneficiaries of the trust, commonly known as unit holders, possess clearly defined entitlements to the trust’s capital and income, typically represented as units.
To illustrate, let’s say Beneficiary A holds 40 units in the unit trust, while Beneficiary B holds 60 units. Consequently, their legal or equitable interest in the trust’s capital and income is 35% and 65%, respectively.
One key feature distinguishing a unit trust from other types of discretionary trusts is that the trustee lacks discretion in deciding how to distribute the trust’s assets or income. Instead, each unit holder has a predetermined and fixed entitlement to a portion of the trust’s capital and/or income, determined by the number of units they hold.
What is the Purpose of a Unit Trust?
The purpose of a unit trust can be categorized into two main objectives:
Unit trusts serve as a mechanism for multiple unrelated individuals or entities to collectively invest in assets like shares or property. This allows them to pool their resources and share in the benefits, risks, and returns associated with these investments.
Business Operation and Capital Raising
Unit trusts are also utilized as a structure for operating a business, particularly when the business aims to raise capital from a group of unrelated owners.
In such cases, the unit trust structure facilitates the acquisition of funds and allows these unrelated business owners to participate in the business’s operations and potential profits.
Eligibility of Unit Holders
Unit holders in a unit trust can comprise a diverse range of individuals and entities, which include:
Individuals: Individuals, as private persons, are eligible to hold units in a unit trust.
Superannuation Funds: Superannuation funds can also be unit holders, but it’s important to note that there may be specific restrictions or regulations governing their participation.
Companies: Companies have the option to hold units in a unit trust. However, it’s worth considering that there are certain limitations associated with this choice. For instance, companies do not qualify for the 50% capital gains tax (CGT) discount, which has implications for their tax treatment.
Other Trusts: Besides individuals and companies, other trusts, such as discretionary trusts, may also participate as unit holders in a unit trust structure.
Factors Influencing Unit Holder Selection
In practice, individuals and companies often do not actively choose to become unit holders in unit trusts. This is due to specific considerations:
50% Capital Gains Tax (CGT) Discount: Companies do not qualify for the 50% CGT discount, which can impact the tax implications of holding units in a unit trust. This discount can substantially reduce the tax payable on capital gains for individuals, but it is not available to companies.
Asset Protection: Individual assets are typically not afforded the same level of protection when held within a unit trust structure compared to other legal entities or structures. As a result, individuals may opt for alternative arrangements to safeguard their assets.
Therefore, while a wide range of entities and individuals can be unit holders in a unit trust, the choice of unit holder often depends on individual circumstances and tax considerations.
Key Components of a Unit Trust
A unit trust comprises several essential elements, including:
The trustee holds the legal ownership of the trust property, even though they may not necessarily be the beneficial owner. Their primary responsibility is to manage the trust fund, and all trust related transactions are conducted in the trustee’s name.
The trustee is personally liable to creditors and accountable to beneficiaries. They are bound by various legal duties, such as carrying out the trust’s terms, acting in good faith, preserving trust assets, exercising reasonable care, avoiding personal gain from their position, refraining from conflicts of interest, and maintaining proper accounts and records.
The Trust Fund
This refers to all the property within the trust, including accumulated income and any other assets held by the trustee as per the trust’s terms.
In a unit trust, the beneficiaries are the unitholders themselves. They hold an underlying interest in the trust property.
Choosing the Trustee
Selecting the trustee is a critical decision. It is generally advisable for a company to serve as the trustee due to several advantages:
- Ease of Control Change: Companies make it easier to effect changes in control.
- Continuity: Companies do not cease to exist, saving the expense of transferring assets to new trustees in case of trustee changes or retirements.
- Limited Liability: Companies offer limited liability protection to trustees, reducing personal liability.
While corporate trustees may have some circumstances where they can be personally liable, they typically provide more protection than individual trustees.
Hence, it is often recommended to appoint a company as the trustee whenever feasible.
Separate Trustees for Different Trusts
Using separate trustees for distinct trusts is generally preferable for two main reasons:
Asset Identification: It avoids the need to determine which assets belong to specific trusts, simplifying asset allocation in case of financial difficulties.
Creditor Protection: Having different trustees reduces the risk that a creditor of one trust can access the assets of other trusts for which the trustee acts.
Trustee's Right of Indemnity
A trustee has the right to be indemnified from trust assets if their liability arises from proper exercise of their duties and powers. This allows trustees to pay expenses from trust funds instead of personal funds.
However, this right can be forfeited if the trustee does not act within their powers, incurs expenses improperly, acts without reasonable diligence, or breaches their duties.
Removal of the Trustee
In most cases, unitholders can remove the trustee through a ‘special resolution,’ requiring approval from at least 75% of the unit holders.
How to Establish a Unit Trust
Setting up a unit trust involves a series of well defined steps and roles, each crucial to the process. Below is a comprehensive guide that explains how to establish a unit trust:
Roles within a Unit Trust
In the framework of a unit trust, two fundamental roles are at play:
Trustee: The trustee assumes the role of the legal owner of the unit trust. This designation carries significant legal responsibilities, primarily in their capacity as a trustee. Their primary duty is to manage the trust’s property for the benefit of the unitholders.
Unitholder: Unitholders are individuals or entities participating in the unit trust. They hold the legal benefits and entitlements within the trust. Unitholders actively contribute to the trust by purchasing units, effectively becoming stakeholders in the trust’s assets and income.
Drafting the Trust Deed
The cornerstone of a unit trust’s establishment is the trust deed. This legal document plays a pivotal role by outlining crucial aspects of the trust, including:
Trustee’s Powers: The trust deed specifies the powers granted to the trustee for managing the trust. It delineates the scope of their authority and responsibilities in managing trust assets and making decisions on behalf of unitholders.
Rights Attached to Units: Within the trust deed, the document defines the rights associated with different units within the trust. These rights may include entitlements to income, voting rights, and other benefits corresponding to unit ownership.
Trust’s Vesting: The trust deed establishes when and how the trust will vest. Vesting represents a critical juncture in the trust’s life cycle, signaling its termination or transition into a new phase.
Preparing Additional Documents
Apart from the trust deed, several essential documents are involved in the setup:
Application Forms for Units: These forms facilitate the process of individuals or entities applying for and purchasing units within the unit trust. They serve as a formal means for prospective unitholders to express their intent to participate.
Certificates for Units Held: Certificates serve as tangible proof of ownership within the unit trust. They are issued to unitholders, providing a documented record of their ownership stake.
Register of Unitholders: The register is a comprehensive record keeping document that tracks all unitholders involved in the unit trust. It ensures transparency and accountability in managing the trust’s ownership structure.
Settling the Trust
Depending on the specific terms and conditions of the trust, the process may require the involvement of a settler.
Settling the trust typically involves the initial contribution of funds or assets, often referred to as the “Settled Sum,” which initiates the trust’s operations.
Shareholders and Unitholders Agreement
An integral part of the unit trust establishment process is the creation of a shareholders and unitholders agreement. This document serves as a governing framework, detailing decision making procedures and control mechanisms within the trust. Some common provisions in these agreements include:
Restrictions on Share and Unit Transfers: It outlines limitations and conditions governing the transfer of shares and units within the trust, safeguarding the trust’s integrity and ownership structure.
Rights to Appoint Directors: The agreement specifies the rights of unitholders regarding the appointment of directors for the corporate trustee. This can significantly impact governance within the trust.
Pre emptive Rights: The agreement delineates pre emptive rights related to the issuance of shares and units within the trust, ensuring existing unitholders have the opportunity to maintain their ownership stake.
Stamp Duty Charges
After successfully establishing the unit trust, it’s important to be aware of stamp duty charges. These charges vary by state in Australia and must be paid within a specific timeframe following the trust’s establishment. Adhering to these legal requirements is essential to remain compliant.
To complete the process, after the unit trust has been established, an individual can proceed to open a dedicated bank account specifically for the trust.
Additionally, further registrations may be required by relevant authorities or regulatory bodies to ensure the trust’s operational and legal compliance.
Advantages and Disadvantages of Investing in a Unit Trust
Investing in a unit trust presents several compelling advantages that make it an attractive option for individuals looking to enhance their wealth. Here, we outline the key benefits:
Diversification: Unit trusts offer an inherent diversification strategy. Investors’ capital is distributed across a diverse array of assets, including stocks and properties. This diversified approach helps mitigate risk by reducing exposure to the fluctuations of any single investment.
Professional Management: Unit trusts are under the stewardship of seasoned fund managers, complemented by expert teams. These experienced professionals make well informed investment decisions, leveraging their knowledge to optimize returns and effectively manage risk.
Liquidity: Most unit trusts provide convenient withdrawal options, ensuring investors have access to their funds as needed. This liquidity feature allows for more flexible financial management.
Affordability: Unit trusts offer an accessible entry point to investment markets that might typically demand substantial capital. Even with a modest investment, investors can participate in diverse portfolios managed by seasoned professionals.
Transparency: Regular reports and updates keep investors well informed about the status of their investments. Investors can easily track the allocation of their funds and monitor performance, fostering transparency and accountability.
Income Tax Advantages
One of the most appealing aspects of investing in a unit trust, particularly when compared to other trust structures, lies in the favorable treatment of income tax. Here’s how it operates:
- The unit trust itself is exempt from paying taxes on its net income and capital gains.
- Instead, in accordance with the Income Tax Assessment Act, individual unit holders are subject to taxation based on the distributions they receive from the trust, taxed at their respective marginal tax rates. This approach often results in more tax efficient income distribution.
Access to the 50% Capital Gains Tax Discount
When a unit trust divests its assets and realizes capital gains, it becomes subject to CGT. However, a notable advantage comes into play:
If the trust holds the asset for a period exceeding 12 months, it usually qualifies for a 50% CGT discount. This discounted rate can be applied to individual unit holders, enhancing the tax efficiency of capital gains.
Fixed Legal or Equitable Interest
In contrast to discretionary trusts, where trustees have discretion in income distribution, unit holders within a unit trust possess a well defined and fixed interest in all the property and assets held by the trust. This arrangement guarantees clarity and certainty regarding their ownership stake in the trust’s income and assets, providing investors with a heightened level of security and predictability.
Before individuals invest in a unit trust, it’s crucial to weigh the potential disadvantages against their individual circumstances.
Here are some factors to consider:
Trapped Net Loss: In cases where the trust’s assets incur a loss, the loss cannot be distributed to unit holders, effectively trapping it within the trust and affecting overall performance.
Taxation on Undistributed Income: If the unit trust retains income that is not distributed to unit holders, the trustee may be subject to taxation at the highest marginal tax rate. This can reduce the trust’s overall tax efficiency.
Challenges in Securing Fund Loans: Unit trusts often distribute most of their income to optimize tax efficiency. However, this distribution strategy may make it more challenging to secure loans for fund expansion, as there are limited funds retained within the trust for such purposes.
Limited Asset Protection Features: Unlike discretionary trusts, unit trusts do not provide the same level of asset protection. In the event of a unit holder’s bankruptcy, their units are treated similarly to other assets, potentially making them accessible to creditors if held in their individual name.
So, every individual should carefully consider these factors within the context of their financial goals, risk tolerance, and investment strategy before committing to a unit trust.
Distinguishing Fixed and Non fixed Unit Trusts
Unit trusts can be categorized into two distinct types for tax purposes: fixed unit trusts and non fixed unit trusts.
Fixed Unit Trusts
A fixed unit trust is characterized by the clear and absolute interests held by unit holders in both the trust’s income and capital.
In such trusts, the entitlements of unit holders are well defined and unambiguous. These trusts are often referred to as “fixed trusts” for tax purposes.
Criteria for Fixed Unit Trusts
To be recognized as a “fixed trust” under the Australian tax laws, the following conditions must be met:
- Entities, such as individuals, companies, or other trusts, must hold unwavering entitlements to the entire income and capital of the trust.
- The trust deed must contain a provision specifying that units can only be redeemed or issued at a rate consistent with the unit trust’s net asset value, as defined by Australian accounting standards at the time of redemption or issuance.
If the trust deed allows for alternative valuation methods for new units or unit redemptions, even in the absence of discretionary components, such a trust will be categorized as a “non fixed trust” concerning the trust loss regulations. Non fixed trusts must satisfy additional criteria to rollover their losses for tax purposes.
Non fixed Unit Trusts
In contrast, any trust that does not meet the criteria of a fixed unit trust is classified as a non fixed unit trust. These trusts are sometimes termed “hybrid trusts” because they exhibit a blend of both fixed and non fixed interests.
Non fixed trusts can arise for various reasons. For example, the trustee may have the authority to selectively distribute specific income or capital among unit holders.
Alternatively, the trustee might have the flexibility to issue or redeem units at prices that differ from the market value, resulting in variations in value among unit holders.
It’s important to note that non fixed trusts may encounter certain tax related challenges, including limitations on rolling over losses, the distribution of taxed dividends from stock investments, and ineligibility for certain capital gains tax benefits.
Why Choose a Fixed Unit Trust for Your Investments?
Investors often consider fixed unit trusts as an attractive choice due to several compelling reasons. These investment structures offer a clear framework for managing assets and distributing income, making them a favored option for those seeking stability, tax efficiency, and asset protection.
Here’s why you might want to opt for a fixed unit trust:
Clear Income Tax Benefits
Simplified Income Allocation: Fixed unit trusts streamline income allocation, ensuring that only the net income generated in a financial year is distributed to unit holders. This straightforward approach simplifies tax reporting.
Tax Reporting Clarity: Unit holders can easily report different types of trust income, such as dividends and capital gains, on their tax returns. Imputation or foreign tax credits are allocated based on the trustee’s decisions.
Tax Free Threshold Access: Unit holders aged 18 and above can benefit from the tax free threshold when receiving income distributions.
Superannuation Contributions: Fixed unit trusts can contribute to unit holders’ superannuation accounts proportionate to their unit holdings. This strategy can cap the tax on trust income at the favorable 15% superannuation rate.
Loss Utilization: If the trust incurs a loss but receives imputation credits within the same year, the trustee can carry the loss forward and seek an imputation credit refund.
Family Trust Benefits: Fixed unit trusts within family trusts offer a range of tax benefits, asset protection advantages, and estate planning opportunities.
Capital Gains Tax Advantages
Fixed unit trust unit holders can enjoy a 50% discount on capital gains when selling trust assets, provided these assets have been held by the trust for at least one year before the sale.
Enhanced Asset Security
Bare Trust Distributions: Fixed unit trusts allow unit holders to receive distributions in the form of a bare trust. This arrangement enhances asset security, as the trustee establishes a bare trust to safeguard designated funds.
Underage Unit Holder Protection: In cases where a unit holder is underage or legally incapacitated, the trustee can hold designated funds in a bare trust until the individual reaches the age of 18.
Land Tax Advantages
Equitable Ownership Recognition: In certain states, unit holders within a fixed unit trust are recognized as equitable owners of the trust’s land. This recognition offers land tax advantages, especially in jurisdictions like New South Wales, where the trustee’s interest is disregarded.
Rights to Trust Assets: The trust deed explicitly outlines unit holders’ rights to the trust’s income, capital, and the option to request the trust’s dissolution and asset distribution.
The benefits mentioned above make fixed unit trusts an appealing choice for investors looking for stability and tax efficiency in their investments.
Common Challenges in Unit Trust Investments
Like all investments, unit trusts come with their set of challenges. Being aware of these pitfalls can save individuals from potential heartaches.
Here are common pitfalls and strategies to avoid them:
Over relying on Past Performance: Investors should remember that the financial market is ever evolving, and past performance is not a guarantee of future success. Diversifying investments and considering long term trends is advisable.
Neglecting Research: Blindly following popular investment trends can be detrimental. Conducting thorough research on the specific unit trust, its underlying assets, and the fund manager’s track record is essential before making an investment decision.
Overlooking the Fee Structures: High management fees and expenses can erode returns over time. Investors should be mindful of the fees associated with the unit trust and choose options with transparent and competitive fee structures.
Being Impatient: Investments require time to mature, and individuals should avoid the temptation to engage in frequent buying and selling. Taking a long term approach is generally more beneficial.
Duration of a Unit Trust and Its Conclusion
The duration of a unit trust’s existence is contingent on its location and the location of the assets it holds. In South Australia, for instance, a unit trust can potentially last indefinitely, while in other states, its lifespan is typically limited to 80 years.
How to Wind Up a Unit Trust
The process of concluding a unit trust is outlined in the Unit Trust Deed.
Generally, the trust concludes when the trustee, acting either independently or following the direction of Unit Holders, formally declares in writing that the trust is to “vest” at a specific time, with the remaining assets to be distributed among the Unit Holders.
The Trustee is responsible for collecting all trust assets and converting them into cash, unless an in specie distribution is planned.
Prior to any final distribution to the unit holders, all trust debts, including taxes, must be settled. The remaining assets, whether in the form of cash or other assets, are subsequently distributed among the unit holders in accordance with their respective entitlements.
This article is for general information only. It does not make recommendations nor does it provide advice to address your personal circumstances. To make an informed decision, always contact a registered tax professional.