Chapter 06 – Unit Trusts

Unit Trusts

A unit trust is a trust where the rights of the beneficiaries to income and capital are fixed. This is in the sense that the rights are not subject to any discretions on the part of a trustee, and are unitised, in the sense that those rights are divided amongst the beneficiaries based on how many units have been issued to them.

The beneficiaries are therefore usually referred to as “unit holders”. Each unit holder’s interest in the trust is fixed. Different unit holders or different classes of unit holders may have different rights to income, capital distributions and voting rights. These rights will be determined at the time the units are issued, or as otherwise agreed by the unit holders and the trustee.

Unlike the beneficiaries of a discretionary trust, unit holders do have rights to the underlying assets of the trust (adjusted for liabilities). These rights are recognised at law as a form of property, can be bought and sold and do have a value. 

What is a unit?

A unit is a piece of property that entitles the unit holder to a specified proportion of the income and capital of the trust. The nature of a unit was considered by the High Court in Charles v FCT where it was said:

A unit held under this trust is fundamentally different from a share in a company. A share confers on the holder no legal or equitable interest in the assets of the company; it is a separate piece of property; and if a portion of the company’s assets is distributed amongst the shareholders the question of whether it comes to them as income or capital depends on whether the corpus of their property (i.e. the shares) remains intact despite the distribution. Units under the trust deed before us confer a proprietary interest in all the property which for the time being is subject to the trusts of a deed; Baker v Archer Shee [1927] AC 844; so that the question were the monies distributed to the unit holders under the trust part of their income or their capital must be answered by considering the character of those monies in the hands of the trustees before the distribution is made.”

In other words, a unit in a unit trust confers on the unit holder an equitable interest in both the underlying capital and the income of the trust. Where an amount is distributed to a unit holder under a trust deed its character as capital or income, and even as different types of capital or income, in the hands of the unit holders will depend on its character in the hands of the trustee. The character will, of course, be the same.

Do unit trusts have asset protection advantages?

Generally speaking, no, they do not. Unit trusts do not have the asset protection advantages for unit holders that discretionary trusts have for beneficiaries. This is because of the nature of the units, as explained above. However, asset protection can be achieved by arranging for your units to be held by a discretionary trust or perhaps some other related person.

Unit holders’ agreements

Because unit trusts are typically used by un-related parties to co-own assets it is possible that a unit holders’ agreement is also required. A unit holders’ agreement sets out the rights and obligations of each unit holder in respect of each other whereas the trust deed sets out the relationship between the unit holders and the trustee. This includes issues like what happens if someone wants to sell their units, or someone wants to sell the underlying assets of the unit trust and wind the unit trust up.

A unit holders’ agreement is a form of co-ownership agreement and is very much like a partnership agreement.

Unit Trust Trustees

The trustee is normally a shelf company owned by the client and set up specifically to act as trustee of the trust. The shareholders and directors control the trustee. The trustee legally owns the trust property but does not beneficially own the trust property. Beneficial ownership of the trust property lies with the unit holders.

The trustee can also be any competent natural person (ie human) over the age of 18 who is not bankrupt or under some other legal disability.

The advantages of using a company as a trustee are that:

  1. having legal ownership of the trust’s assets in the name of the company makes it clear that the assets do not belong to the individuals who control the company;
  2. the company may stay in existence virtually forever. It will not die or become unable to manage its own affairs. This means things are simpler and there is less bother with changing trustees and re-registering ownership with authorities such as the various state Titles Offices;
  3. the directors or other persons who control the company can exercise de facto control without being personally involved in the trust;
  4. unit trusts are relatively simple and cheap to set up and run each year.

If units are owned via family trusts the various income tax, asset protection and estate planning advantages connected to family trusts are also available to you.

The disadvantages of using a company as trustee are largely the extra cost of setting up and running a company each year.

Advantages of unit trusts

Stamp duty savings on property transfers

Where a unit trust owns real estate it can be possible to transfer units in the trust rather than the underlying real estate. This is because stamp duty will be based on marketable security rates, typically about 0.5% of the value of the property, rather than land rates, typically about 5% of the value of the property.

This is particularly the case if it is likely that the underlying property may be transferred to related persons or to persons who are known to you and enjoy a mutual good faith. It may not be practical in the case of a transfer to a stranger, because the stranger may be concerned that the trust has borrowed money or incurred some other liability. This may not manifest itself until after the transfer is completed. This has obvious problems and it is understandable that the stranger would be happier to pay full stamp duty and be assured of full and unencumbered title.

In some cases such a transfer can trigger the so-called “land rich entity” rules. Where this happens the transfer is treated as being a property transfer and stamp duty is assessed at land rates.

Care should be exercised before transferring units in the trust. The procedure for transferring units is usually set out in the trust’s deed. Legal advice is always a good idea here.

Control of unit trusts

The unit holders as a group control the trust. This is because the trust deed gives them the power to direct the trustee and to, if necessary, terminate the trustee’s appointment as trustee and appoint another person to act as the trustee instead.

The deed specifies the percentage vote required for a resolution of a meeting of unit holders to be effective. Usually it is 50% unless decided otherwise as the trust deed is being prepared. 

Corporate unit holders: 30% tax rate

Unit trusts can be combined with private companies to get the benefit of the 30% tax rate currently applying to private companies. Arranging for the units to be held by the private company does this. This means that some or all of the trust’s net income is taxed in the hands of the company each year.

The main rule here is that the cash must be actually paid over to the corporate beneficiary, and then retained in the corporate unit holder. If this does not happen there is a risk that special anti-avoidance rules applying to private company loans may apply.

Specific advice should be sought from your accountant before deciding to distribute net income to a corporate unit holder.

Other advantages of unit trusts

Other advantages of unit trusts include:

  1. confidentiality of information, particularly regarding the financial affairs of the trust. There are no statutory disclosure requirements for trusts in the way that there are for companies under the ASIC database. There is also no requirement for a trustee dealing with other persons to disclose that it is acting as a trustee of a trust and not in its own right. Thus bank accounts can be opened, leases signed, investments made etc for the benefit of the trust without other people needing to know this. In most cases we suggest that they should not know that the trustee is acting for a trust;
  2. there are no formal audit requirements. Accounts have to be prepared but this is only to facilitate the preparation of an annual income tax return;
  3. the absence of any formal legislative framework, such as the Corporations Law, to control the activities of the trustee. Trusts are of course subject to the various Trustee Acts and all other relevant law for example, the Trade Practices legislation and the Income Tax Assessment Act. This makes trusts very flexible entities to use for your business activities);
  4. the easy entry and exit of owners, i.e. unit holders;
  5. trusts are cheap to set up and run each year;  and
  6. trusts are relatively simple to wind up.

Disadvantages of unit trusts

The major disadvantage of a unit trust is that it cannot distribute capital or revenue losses to its unit holders. As a result, should a trust incur a net loss its beneficiaries will not be able to offset that loss against any other assessable income that they may derive.

Expert advice should be sought if it is expected that a trust may make a revenue loss or a capital loss for taxation purposes. For example, it may be wise to have debt held at the unit holder level, rather than the trust level, to avoid negative gearing type losses being locked up in the trust.

The taxation of trusts is discussed briefly below.

Other elements of unit trusts

When does the trust start?

The trust is expressed to start on the date specified in the trust’s deed. More technically, the trust starts on the date that the Trustee first acquires property. This will probably be in the form of a small cash payment from the first unit holders to the trustee in return for the trustee issuing the first units. Something like 10 $1.00 ordinary units is quite common.

The $10.00 will usually be treated as being paid on the date specified as the Start Date in Annexure A. The Trustee will probably issue more units to the first unit holders and new unit holders as the trust gets up and running.

When does the trust finish?

The Trust finishes in 80 years from the Start Date unless the unit holders determine a shorter period or a longer period. 80 years is a conventional period: there is an old rule of equity called the rule against perpetuities, which means it is not possible to set up a trust that runs forever. This reflects a policy desire that at some time property vest in a person who is capable of dealing with it absolutely, and that property is not controlled ‘from the grave’ (that is, people cannot dictate how property is managed for too long after they die).   

Most modern trust deeds specify 80 years as the life of the trust. It appears 80 years is chosen because it is usually longer than the initial unit holders (or the underlying individuals) expected life span. 80 years is also the period used in some related Acts of Parliament, for example, section 209 of the Queensland Property Law Act.

In whose name should assets be held?

The trustee is the legal owner of the trust’s property. This means the trustee’s name should appear on all ownership documents, such as shares in private companies, units in private trusts, or title deeds for land ownership.

You may add the tag “… as trustee for the (name) unit trust” if you wish, and this has the advantage of reminding all concerned that the asset is held on trust and does not belong to the trustee personally. However, in some cases this will not be possible. For example, most Title Offices will only register a title in the name of the trustee, i.e. the legal owner, and will not allow the tag “… as trustee for the (name) unit trust” to be used.

The taxation of unit trusts

Unit trusts are efficient tax planning vehicles. Usually unit trusts do not pay tax themselves. Instead the net income flows through them and is attributed to the unit holders. The amount of tax paid by the unit holders depends on their individual tax profiles. For example, a unit holder with $100,000 of carried forward tax losses will not pay tax on a distribution of $10,000. This is because the unit holder’s taxable income will still be less than nil. Another unit holder may pay up to $4,500 tax, plus Medicare levy on a distribution of $10,000. In this way, the taxation of trust income depends on the tax status of the beneficiary.

The trust deed is drafted so franking credits, dividend rebates, different classes of income, capital gains and other tax amounts having particular tax consequences flow through the trust to the appropriate unit holders.

The taxation of trusts is a very complex area and it is not possible to cover the field in a few short paragraphs, or even pages. Expert advice regarding a specific situation is always a good idea.

The Dover Group