Which structure is best for you? – Unit Trusts

Following on last issue’s article on discretionary trusts we now discuss another type of trust,  that is,  the unit trust.

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 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 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 of the trust 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 so as to protect the individual.

Advantages

  • Limited liability is available if a corporate trustee is used;
  • Succession planning is available as new owners can be admitted easily 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.

Disadvantages

  • 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 property to the unitholder will decrease the cost base on their units which will lead to increased CGT being payable when they sell their units.
  • As a unitholder in a UT you have a proportionate entitlement to the assets of the trust, so 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 on distribution depending on the circumstances.

Recommendation

UT are less popular than discretionary trusts due to them being less flexible and the asset protection issue. UT’s still have their place where you require a structure with limitation of liability, succession planning alternatives, distribution of income to unitholders with access available to CGT general discount and possible access to CGT small business concessions. Your individual circumstances will govern whether a UT suits your purposes.