A dummies guide to unit trusts

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‘.

A unit enables the interests of the Unit Holders to be divided into neat fixed percentages. For example, if one Unit Holder holds 60 units, and another holds 40 units, then the first holds a ‘60% interest’ in the trust, and the other holds the remaining ‘40% interest’ in the trust.

Units can be issued (i.e. created), redeemed (i.e. cancelled), and transferred.

Why do people use unit trusts?

Unit trusts are commonly used for people to ‘pool’ their money together and make investments. Most of the retail investment funds in Australia are set up as unit trusts.

Smaller investors also use unit trusts for small scale property investments and developments. For example, two business partners may set up a unit trust through which to hold their business premises.

How do you set up a unit trust?

There are two ways to set up a unit trust:

  • The first is if someone (i.e. the Settlor) contributes an initial sum (the Settled Sum) to another person or company (the Trustee) for the Trustee to then hold the Settled Sum on terms of a unit trust deed (the Unit Trust Deed). After the trust has been established, other persons subscribe for units in the trust; and
  • The other is when one or more persons (the Initial Unit Holders) subscribe for initial units in the trust by paying the subscribed amount to the Trustee.

We prefer to set up unit trusts by having one or more initial Unit Holders subscribe for initial units. In this way, there is no person who has settled money on the trust who is not also a Unit Holder.

As noted above, the Trustee can be one or more individuals and/or companies. We generally recommend that a company act as Trustee, as this avoids having to keep track of individual Trustees coming and going, and provides a better governance regime for the unit trust. We also recommend that the Unit Trust Deed provides that the Unit Holders are entitled to hold shares in the trustee company in the same proportion as they hold units in the trust.

Units and ‘Unit Holders’

There is no minimum number of units that must be issued, and the trust may have one or more Unit Holders.

A unit trust looks like this:

Unit Trust Diagram

How do people hold units in a unit trust?

Individuals, companies, super funds and other trusts can hold units in a unit trust. The more common way to hold units in a unit trust is either through a super fund or through a family discretionary trust.

It is less common to hold units in an individual’s name. If the individual is sued, then the units are available as an ‘asset’ to the Unit Holder’s creditors. It is also less common to hold units in a company, because a company does not qualify for the general 50% CGT discount on any capital gain that arises from selling the units, or any capital gain that flows through to the Unit Holders from the unit trust itself.

Before acquiring units into a super fund you need to ensure that the Superannuation Industry (Supervision) Act 1993 (SIS Act) rules and regulations are complied with.

How long does a unit trust last?

The length of time that a trust can stay in existence depends on where the trust is set up and where the property that the trust is holding is based. For example, if the unit trust is set up in South Australia it can last indefinitely, whereas in other States, the life is usually limited to 80 years.

How is a unit trust wound up?

The Unit Trust Deed will specify how the trust is to be brought to an end. As a general rule the trust ends when the Trustee (either alone or acting on the direction of Unit Holders) makes a declaration in writing that the trust is to ‘vest‘ at a certain time, and for the residual assets to be distributed to the Unit Holders.

The Trustee must collect all of the trust assets and then convert them into cash (unless the Trustee proposes to make an in specie distribution). All debts of the trust (including tax) must be paid before any final distribution to the Unit Holders. The residual assets (or cash) are then distributed amongst the Unit Holders in accordance with their relative entitlements.

‘Fixed’ and ‘non-fixed’ unit trusts

For tax purposes, there are two broad categories of unit trusts – fixed and non-fixed. In a fixed unit 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).

A trust can be non-fixed for a number of reasons, including:

  • The Trustee having a discretion to allocate certain income or capital to one or more Unit Holders in preference to other Unit Holders; and/or
  • The Trustee having a right to issue or redeem units at a price other than market value – and thereby ‘shift’ value from one Unit Holder to another.

If a unit trust is a non-fixed trust then it will be more difficult for the trust to carry forward losses, distribute franked dividends from underlying share investments, and to qualify for certain CGT concessions.

What is a ‘fixed unit trust’ for NSW Land Tax purposes?

If you are going to hold land in NSW in a unit trust then you need to ensure that it qualifies as a ‘fixed unit trust’ for the purposes of NSW Land Tax.

To qualify as a fixed unit trust, the Unit Holders must at all times be entitled to the income and capital of the trust (after the payment of normal expenses). They must be entitled to have the trust wound up at any time, and upon winding up the trust the Unit Holders must be entitled to request for any land owned by the trust to be transferred to them. The Trustee must not have any discretion as to the distribution of income or capital. There may only be one class of units.

If a trust meets the ‘fixed unit trust’ requirements in the Land Tax Management Act (NSW) then the trust will not be treated as a ‘special trust’ for land tax purposes, and will be entitled to the benefit of the land tax threshold available in NSW. If the trust is entitled to the land tax threshold, and a Unit Holder owns other taxable land (or is a special trust), the Unit Holder will be assessed for land tax on the combined value of the Unit Holders’ interest in the land held in the trust and in their own name.

What are some benefits and pitfalls of a unit trust?

A unit trust can offer several potential benefits:

  • Unlike a ‘discretionary trust’, Unit Holders have a fixed and discrete interest in the assets and income of the unit trust. This fixed interest is an ‘asset’ of the Unit Holder, and this asset can be dealt with, such as being sold or gifted to others;
  • A unit trust is a better entity to use to hold assets with other unrelated parties, such as co-investors. Once again, this is because both parties have a fixed and defined interest in the assets and income – so they can ‘pool’ their resources but still have a distinct interest;
  • A unit trust is a ‘flow-through’ entity for tax purposes. This means that any net income and capital gains flow directly through to the Unit Holders, and are not subject to tax in the hands of the Trustee. Each Unit Holder is then responsible for their own tax. This flow-through treatment means that the underlying Unit Holders may qualify for the 50% CGT discount, whereas this concession is not available to a company; and
  • It is generally easier to issue and redeem units, than it is to issue and cancel shares in a company.

However, there are some potential downsides to using a unit trust. These include:

  • If you make a net loss from the trust assets, this loss is ‘trapped’ in the unit trust, and cannot be used to offset other net income in the hands of the Unit Holders. Furthermore, it is very difficult to ‘inject’ new sources of income into a unit trust to offset accumulated losses, especially when there are unrelated Unit Holders;
  • It is more difficult to retain surplus money within a unit trust for working capital or reinvestment purposes. This is because all the income is distributed for tax purposes to the Unit Holders each year. If this net income is needed to be retained in the unit trust, then the Unit Holders need to ‘lend it back’ to the trust, or leave it as an outstanding present entitlement;
  • Because a unit trust is not a tax-paying entity, the effective rate of tax on its income will be equal to the rate of tax applicable to its Unit Holders. If the Unit Holders are individuals, then the rate could be significantly higher than the flat company tax rate. If the Unit Holders are companies, and undistributed income is retained in the unit trust, then Division 7A ‘deemed dividend’ implications can arise; and
  • 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.

The bottom line is that most people do not fully appreciate the complexities involved in successfully involving a unit trust within your business and investment structures. However, when used appropriately, with a quality tailored Unit Trust Deed, they can be a very useful addition to your structure.

If you would like help getting the right structure for your business and investment activities, call us now on 1300 654 590.

Our Great Lawyer Guarantee

We want to be part of your team over the long term. We'll achieve this by sticking closely to the following principles:

  • We'll listen carefully to understand what you want to achieve. Then we'll thoroughly explain our advice and step you through the documents. You can be sure you'll know the full consequences.
  • Our lawyers work as a team, so someone will always be available to answer your questions, or point you in the right direction. You will also benefit from a range of perspectives and experience.
  • One of our key goals is to pass on as much knowledge as we can, so you can make your own informed decisions. We want to make you truly independent.
  • We only do what we're good at. You can be confident that we know what we're doing and won't pass on the cost of our learning.
  • For advice and documents, we provide a fixed or capped quote so you don’t take price risk. If you're in a dispute, we'll map out the process and costs so you know what to expect.
  • We're not in this game for our egos. We're in it for a front row seat to witness your success

We measure our success on how efficiently we have facilitated your objectives, enhanced your relationships, and reduced the level of stress for all involved.

If we sound like people you can work with, call us now on 1300 654 590 and speak directly with a great lawyer.

Call 1300 654 590 and speak with a lawyer

You’ll be put straight through to a great lawyer who will guide you to the right solution.

Who owns the IP?

Who owns the IP?

So, you’re running a business and need to develop a system to identify trends in customer activity on your website. You’re about to hire a software engineer to lay some code, and the question of who will own the IP comes up in your negotiations over the Software Development Agreement…

read more