In this article, we will now delve into the topic of unit trusts, exploring another form of trust with the guidance of a tax advisor, following our previous discussion on discretionary trusts.
A unit trust (UT) is not a separate legal entity but is recognised separately for tax purposes. In a UT, the unitholders have a fixed right to the income or capital of the trust and will receive the same in the proportion of units they hold compared to the total units on the issue (on a similar basis to a company and its shareholders).
Where the UT is different to a company is that a UT is not taxable in its own hands on the income it earns. All taxable income is distributed to the unitholders pre-tax, and they are taxable in their own hands at their own tax rate. The workings of the UT are governed by the trust deed, which is similar to the constitution of a company.
The trustee who makes all the decisions on behalf of the trust can be an individual or a company. If limitation of liability is important then the trustee should be a company to protect the individual.
- Limited liability is available if a corporate trustee is used;
- Succession planning is available as new owners can be admitted readily by selling some of the existing units to them or issuing new units to effect the percentages required;
- Give access to the general 50% discount on capital gains on assets held over 12 months;
- Gives access to the CGT small business concessions, although this is subject to some specific requirements on distribution to unitholders;
- Any tax credits received can be flowed through to the unitholders.
- There is no flexibility in relation to the distribution of income. It must go according to the unitholding;
- It is sometimes harder to borrow in a UT as a lot of banks have difficulty with the structure and will want legal advice as to whether the trust deed gives the power to borrow;
- Losses are trapped in the trust;
- There is no ability to accumulate profits in a UT. All profits must be distributed to the unitholders;
- There is a clawback of tax in the unitholders’ hands on some of the tax concessions received in the UT. For example, the distribution of tax-free building allowances on the property to the unitholder will decrease the unit cost base, leading to increased CGT payable when they sell their units.
- As a unitholder in a UT, you have a proportionate entitlement to the trust assets. Therefore, the trust’s assets are not protected should the individual unitholder go into bankruptcy (this can be solved by having family trusts as unitholders). Discretionary trusts do not have this problem.
- The CGT small business concessions can be diluted in distribution depending on the circumstances.
UT are less popular than discretionary trusts due to their flexibility and asset protection issues. UT still has its place where you require a structure with limitation of liability, succession planning alternatives, distribution of income to unitholders with access to CGT general discount and possible access to CGT small business concessions. Your individual circumstances will govern whether a UT suits your purposes.
*Correct as of October 2014
*Disclaimer – Kreston Stanley Williamson has produced this article to serve its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas in this article, you must seek advice about your circumstances. Liability is limited by a scheme approved under professional standards legislation.