How Do Unit Trusts Work in Australiaamir@propertytaxspecialists.com.au
A unit trust is a common type of investment structure that allows unrelated parties to pool their money together to either operate a business or invest in real property or securities.
They also offer investors access to the diversification of assets that they otherwise wouldn’t have been able to invest in alone.
Beyond that, a unit trust offers several tax benefits, such as the fact that the trust’s income or capital is distributed pre-tax, and is taxed in the hands of the ultimate beneficiaries at their marginal tax rates.
However, as with any investment structure, there are a few things you need to consider so that you can make an informed decision on how to proceed.
So, in this article, we break down everything you need to know about unit trusts in Australia, including how they work, how they are taxed and how to establish one.
What Is a Trust?
Before probing into unit trusts and how they work, it’s essential to have a foundational understanding of what a trust is.
A trust is a legal relationship governed by a trust deed between a trustee and beneficiaries. The trust assets are entrusted to the trustee, who legally owns the assets but holds them for the benefit of the trust beneficiaries.
The two most common forms of trusts include discretionary trusts and unit trusts.
To learn more about discretionary trusts (or family trusts), check out our family trust guide, where we explain the characteristics of discretionary trusts and how to set one up.
What Are Unit Trusts in Australia and How Does it Work?
A unit trust is an investment structure that allows investors to pool their money together in one pot. This means instead of each investor having to buy the assets they want individually, like a property or shares.
For example, two medical professionals may set up a unit trust through which they can hold their medical practice.
So, the trust beneficiaries hold a defined entitlement to trust capital and income. The defined entitlements are typically referred to as units. For example, Beneficiary A holds 35 units in the unit trust, and Beneficiary B holds 65 units. Their legal or equitable interest in the unit trusts’ capital and income is therefore 35% and 65%, respectively.
The beneficiaries are also known as unit holders.
The main difference between a unit trust and other discretionary trust structures is that the trustee has no discretion regarding distribution and each unit holder has a defined entitlement to trust capital and/or income.
Who Is Eligible to be a Unit Holder?
Various people and entities can hold units in a unit trust, including:
- superannuation funds (have restrictions),
- companies, and
- other trusts such as discretionary trusts.
Generally, individuals and companies don’t opt to be unit holders because a company doesn’t qualify for the 50% capital gains tax (CGT) discount (see discussion below), and individual assets aren’t protected in a unit trust structure (see discussion below).
What Are the Benefits of a Fixed Unit Trust Structure?
There are several potential advantages of investing in a unit trust, including:
- Income tax advantages: the most attractive advantage of a unit trust compared to other trust structures is that the net income and capital gains are distributed to the unit holders pre-tax. In other words, the unit trust doesn’t pay tax. Instead, according to the Income Tax Assessment Act, each unitholder is taxed for their distribution derived from the trust at their own marginal tax rate.
- 50% CGT discount: only applicable to individual unit holders where a unit trust disposes of its assets, it will be subject to CGT. However, if the asset is held in the trust for 12 months or longer, it is typically eligible for a 50% CGT discount. This can be streamed to the individual unit holders not companies.
- Fixed interest: unit holders have a fixed interest in the income of the unit trust. So unlike a discretionary trust where the trustee has the discretion to distribute income how he sees fit, unit holders have a defined interest in all the property and assets the unit trust holds.
Are There Potential Pitfalls of Using a Unit Trust Structure?
As with any investment structure, there are several potential disadvantages that you would have to weigh up in relation to your circumstances. Here are some considerations you should factor in before investing in a unit trust:
- Net loss is trapped: if the trust assets run at a loss, the loss can’t be distributed to the unit holders, so the loss is essentially trapped within the trust.
- Undistributed income is taxed: the trustee will be taxed at the highest marginal rate if the unit trust retains any income.
- Fund loan limitations: because the trustee will generally distribute all the trust income to avoid being taxed at the highest marginal rate, it may be more difficult to secure a loan for fund expansion because there are no funds retained in the unit trust.
- Limited asset protection: unlike discretionary trusts, a unit trust doesn’t offer unit holders the same asset protection strategies. If a unitholder is declared bankrupt, their units are treated similarly to all their other assets, and their creditors can access them if they are in their individual name.
A unit trust is a great investment vehicle for joint investment ventures or business endeavours because they allow individual investors to pool their resources together.
Each investor, or unitholder, will then hold a fixed interest (i.e. units) in the trust, and their income is distributed according to that interest.
The most appealing factor of a unit trust is the fact that it is not considered a separate legal entity, and income is therefore distributed pre-tax. Unlike company structures, a unit trust also has access to a 50% CGT discount on the disposal of assets held for longer than 12 months which can flow through to the beneficiary if they are eligible for the discount.
However, a unit trust structure isn’t necessarily ideal for everyone because they lack flexibility and asset protection strategies if the units are owned by the individual.
And while there are several potential benefits to investing in a unit trust, you need to establish whether they suit your particular circumstances. The best way to establish whether a unit trust is a viable investment structure for your personal situation is to seek professional advice from an investment specialist or property tax specialists.
At Property Tax Specialists, our focus is on helping and supporting clients interested in property investment, maximising their opportunities and protection while legally minimising their tax liabilities.
If you have any questions relating to using a unit trust as an investment structure, get in touch today.
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.