How Does a Unit Trust Work?

In Australia, unit trusts are a popular investment option. Unrelated people can join forces to operate a business or invest in 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.

Additionally, A unit trust has tax benefits. Income or capital is distributed pre-tax and taxed at beneficiaries’ rates. 

However, as with any investment structure, there are a few things you need to consider to make an informed decision on how to proceed. 

What Is a Trust?

Before probing into how these structures 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 trust include discretionary trusts and unit trusts. 

What Are Unit Trusts and How Do They 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, they can buy them together. 

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 has 65. Their legal or equitable interest in the capital and income is, therefore, 35% and 65%, respectively. 

The beneficiaries are also known as unit holders. 

A unit trust is different from other discretionary trust structures. In a unit trust, the trustee cannot decide how to distribute money. Instead, each unit holder has a specific right to trust capital and income.

Who is Eligible to be Unit Holders?

Various people and entities can hold units in a unit trust, including: 

• Individuals
• Superannuation funds (have restrictions)
• Companies 
• Other trusts 

Most people and companies don’t become unit holders because the company doesn’t qualify for the 50% capital gains tax discount. Also, individual assets aren’t protected in a unit trust structure. 

 

What Are the Benefits of a Fixed Unit Trust Structure?

There are several potential advantages to investing in a unit trust.

Income Tax Advantages

The most attractive advantage 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 unit holder is taxed for their share of the distribution derived from the trust at their own marginal tax rate. 

Access to the 50% Capital Gains Tax Discount

Where a unit trust disposes of its assets and makes a capital gain, 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 Legal or Equitable 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 to Using a Unit Trust Structure? 

Like any investment, there are downsides you must consider based on your situation. 

Here are some considerations you should consider 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. 

• Limited asset protection advantages: a unit trust doesn’t offer unit holders the same asset protection strategies. If a unit holder goes bankrupt, their units are treated like their other assets. Creditors can access them if the units are in the unit holder’s name. 

Key Takeaways

• A unit trust is a good investment for joint ventures or business projects, as it lets people combine their resources. 
• Unit holders 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 that it is not considered a separate legal entity, and income is therefore distributed pre-tax. 
• A unit trust, unlike company structures, can give a 50% CGT discount to beneficiaries. The discount applies when assets are sold after being held for 12 months or more. 
• Not everyone may find a unit trust structure ideal because it lacks flexibility and asset protection.

Before investing in a unit trust, determine if it’s right for your circumstances and has potential benefits. To determine if a unit trust is right for you, ask an investment or property tax expert. 

At Property Tax Specialists, we help clients with property investment, maximising opportunities and protection while minimising tax liabilities. 

If you have any questions about using a unit trust as an investment structure, get in touch today.

FAQs

How Do Trusts Work?

Trusts are legal structures that allow assets to be held by a trustee on behalf of beneficiaries. The trustee legally owns the assets but holds them for the benefit of the beneficiaries. Trusts are established by trust deeds, which set out the rules for how the trust assets are managed and distributed. 

The two main parties in a trust structure are the trustee, who controls the assets, and the beneficiaries, who benefit from the assets.

What Are The Differences Of A Unit Trust Vs Discretionary Trust?

The main difference between a unit trust and a discretionary trust is how the income and capital gains are distributed. In a unit trust, each unit holder has a defined interest in the trust assets and income. 

The trustee distributes the income pre-tax to the unit holders based on the number of units they hold. In a discretionary trust, the trustee has discretion over how income and capital gains are distributed to beneficiaries. The beneficiaries do not have a fixed entitlement.

What Can A Unit Trust Do?

A unit trust allows multiple investors to pool their funds together to invest in assets such as property or shares. Each investor holds ‘units’ in the trust, which entitles them to a proportionate share of the income and capital gains. 

A unit trust can operate a business, own real estate, or hold other investments. The main benefit is allowing smaller investors to access investments they couldn’t afford individually.

Are Unit Trusts A Good Investment?

Unit trusts can be a good investment vehicle because income is taxed by the unit holders, allowing them to benefit from tax rates and thresholds. If the unit holder is an individual, they can access the 50% capital gains tax discount on assets held over 12 months. 

Unit trusts also provide access to diversified investments. However, some limitations exist, like the inability to distribute losses to unit holders. Professional advice is recommended to determine if a unit trust is suitable.

Do Unit Trusts Benefit from CGT Concessions on a Capital Gain?

The unit trust itself does not get the benefit of the CGT discount. Only the eligible unit-holder beneficiaries can access the discount on their share of the capital gain distributed to them. For example, individual unit holders are eligible for the 50% CGT discount on the sale of an asset held for more than 12 months. Companies who are unit holders, however, don’t benefit from this discount. 

What is a Fixed Trust for Land Tax Purposes in NSW?

The NSW Office of State Revenue defines a fixed trust for land tax purposes as one where the beneficiaries have fixed entitlements to the trust income and capital. This gives the beneficiaries effective ownership of any NSW land held by the trust.

If the trustee can vary the beneficiaries’ entitlements, it is considered a ‘special trust’ by NSW. Special trusts don’t qualify for the regular land tax thresholds and rates but instead, pay at flat rates up to a premium threshold.

So, to be a fixed trust, the deed must contain specific provisions approved by NSW Revenue. These provisions ensure the beneficiaries retain their fixed entitlements to income and capital and prevent the trustee from altering these.

Does a Unit Trust Have a Trust Deed?

Yes, a unit trust requires a trust deed. The trust deed is the legal document that establishes the unit trust and sets out its operational rules and framework.

Some key elements that are normally included in a unit trust deed are:

• Appointing the initial trustee and outlining their powers and responsibilities
• Defining the beneficial interests in the trust as ‘units’ and specifying the number of units on the issue
• Setting out the process for issuing new units, transferring units, and redeeming units
• Stipulating how income and capital will be distributed to the unit holders (based on the units they hold)
• Outlining the process for adding and removing beneficiaries
• Specifying how the unit trust will be wound up if required in the future
• Detailing how the trust deed can be amended
• Identifying an appointer who can appoint new trustees if required

A comprehensive and well-drafted unit trust deed is important for providing certainty around the ongoing operation and management of the unit trust. The deed forms the trust’s constitution and provides the rulebook for the trustee and unit holders.

Disclaimer

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.