A Unit Trust deed sets out the Unit Trust rules. It is the Unit Trust’s rule book. A Unit Trust holds assets or is used to trade through. A Unit Trust apportions trust assets according to ‘units’. As a Unit Holder, you get beneficial ownership of trust property according to the number of units you own. For example, what if you have 150 units and I have 50 units. You own 75% of the Unit Trust assets. I own 25% of the Unit Trust assets. An Australian Unit Trust is a cross between a Family Discretionary Trust and a company. In a Family Discretionary Trust, the Trustee holds the assets for the Beneficiary. So too, the Unit Trusts’ Trustee holds the assets for the benefit of the Unit Holders.
Australian Unit Trusts are similar to companies. Unit Trusts have Unit Holders like companies have shareholders. Unit Holders hold units in Unit Trusts like shareholders hold shares in companies. Units are capable of fluctuating in value, like shares. The High Court of Australia demonstrates the benefits of Unit Trusts over companies. See Charles v Federal Commissioner of Taxation (1954) 90 CLR 598. This is because, in a company, a shareholder has no interest in company assets. In contrast, a Unit Holder has a proprietary interest in the trust assets.
In the company, there is a fixed tax rate. It is a constant tax rate. In contrast, the Unit Trust’s Unit Holders pay tax on the profit at the Unit Holder’s personal tax rate – which may be zero.
Company: Each financial year the company pays tax on its profit. The tax paid attracts an ‘imputation credit’. The company can retain profit. The company does not have to pay the profit to the shareholders. The company does not have to declare a dividend. At some point in the future, it can pay that profit to the shareholder. This is called a dividend. Only at that time does the shareholder have to pay tax on the dividend. This is because it is now income in the hands of the shareholder. But the shareholder can use the imputation credit to reduce the tax it would otherwise have to pay. For example, let’s say the company has already paid tax on the income at a tax rate of 25%. It then distributes that income to the shareholder. If the shareholder’s marginal tax rate is 45% then the shareholder only pays an additional 20% tax on the dividend.
Unit Trust: in contrast, a Unit Trust has to distribute all of its income to the Unit Holders at the end of each financial year. The Unit Holders then pay tax at their personal marginal tax rate. If the Unit Holder does not earn much income that financial year then the tax on the Unit Trust income may be zero. If the Unit Holder pays earns a lot of money that financial year then its tax rate may be far higher than the fixed (constant) company tax rate. This is why you may wish to hold the Units in a Family Trust.
The advantage of a company is that you can retain the income at a constant tax rate and not distribute to the shareholders. The shareholder’s tax rate may be much higher than the company tax rate. Which sounds good, except that it is difficult to use the money in the company for personal use. The company assets and profit are ‘trapped’ in the company. But you did temporarily save (or rather defer) the higher tax rate.
In contrast, each financial year the Unit Holder pays tax on the income it derives from the Unit Trust. (The Unit Trust is therefore not taxed directly.) Our Unit Trust deed allows you to reinvest the income back into the Unit Trust. But the Unit Holder must still pay tax on the income first. What the Unit Holder then does with the money is up to the Unit Holder. If the Unit Holder wishes to put the after-tax dollars back into the Unit Trust then it may do so.
Unit Trusts and Family Trusts do different things.
Unit Trusts have ‘negotiability’: you can sell and buy units, and fixed annual entitlements to income and capital gains. The Unit Holders of Unit Trusts get 100% of their entitlement. The trustee has no discretion to vary your entitlement.
In contrast, Family Trusts are discretionary. This means that there are no fixed entitlements for the children. Mum and Dad (as the Appointors) direct the Trustee of the Family Trust to distribute income. This is generally to the lowest income earners in the family for the purposes of reducing tax.
Unit Trusts are not a substitute for Family Trusts. Both types of trusts are often used together. For example, a Family Trust often holds units in a Unit Trust.
Family Trusts work for one family. Unit Trusts are appropriate for two or more families – joint ventures, businesses or partnerships in the managing of assets. Instead, if you control assets in a single-family, consider building one of our comprehensive Family Trust Deeds.
A company and a family trust are usually inferior to a Unit Trust. The greatest competition to a Unit Trust is a Partnership of Family Trusts. See here.
A Unit Trust doesn’t get the NSW concessional land tax. This is unless it complies with section 3A Land Tax Management Act 1956 (NSW). Legal Consolidated fixes this. Our special NSW Unit Trust is designed for the land tax concession. If your Unit Trust holds land in NSW, click here. Build your modified Unit Trust for NSW landowners.
We review Unit Trusts going insolvent. Often the Unit Holders are liable to pay for the shortfall of assets. This is when the Unit Trust goes broke.
Unit Holders in a Unit Trust are liable to indemnify the trustees of a Unit Trust. This is for any liabilities incurred throughout the conduct of the Unit Trust business. See Justice McGarvie in Broomhead Pty Ltd (in Liquidation) v Broomhead Pty Ltd (1985) VR 891.
However, this rule does not apply if the right to indemnity is expressly revoked from the Unit Trust deed. Our Unit Trust deed protects unitholders from liability incurred by trustees. Our Unit Trusts deed benefits the unitholders.
Be careful of who drafts your Unit Trust deed. Common faults:
The value of the Units can change over time. You may issue Unit for $1.00 each today. If your business goes well or the value of the assets increase then a unitholder may sell his Units for say $5.00 each. Or the trustee of the Unit Trust may issue new Units at a higher price to people wishing to inject money into the Unit Trust. That is a decision for the unitholders.
While Family Trusts deeds and Self-Managed Superannuation fund deeds need to be updated on average every 5 – 8 years, Unit Trust Deeds don’t usually need to be updated to deal with tax and trust matters. But of course, you can update a Unit Trust, as often as you wish, if all the unitholders agree.
If you want to formalise the relationship between the unitholders consider also building a Unitholders Agreement. This document can also be updated over time. But again it is also not common to update a Unitholders Agreement.
Unitholders debating on what the Unit Trust will do and invest in is not a matter of the Unit Trust deed or a Unitholders Agreement. This is much like a company and shareholders agreement. When shareholders debate on how to run the business they don’t usually update the company Constitution or the Shareholders Agreement.
Build your Unit Trust deed on our law firm website. Telephone us if you need a hand answering the questions.
After you build your Unit Trust deed you may wish to build a Unitholders Agreement.
Adjunct Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, Dip Ed, BArts(Hons), LLM, MBA, SJD
Legal Consolidated Barristers and Solicitors
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