Unit trusts

A unit trust is like a company, where the trust’s property (business or investments) are divided into a number of shares called units. The number of units that a beneficiary holds (referred to as unitholder in a unit trust arrangement) will determine the unit holder’s entitlement to the share of income, capital and voting power. Units in a unit trust can also be categorized. For example you can have income units as distinct from capital units. Also unitholders can be individuals, companies or discretionary trusts.

The fundamental difference between a unit trust and a discretionary trust is that a beneficiary/unit holder’s entitlement is fixed in a unit trust and not at the discretion of the trustee as is the case in a discretionary trust . This distinction has a fundamental impact upon the choice of structures from an income tax, asset protection and succession planning perspective. The structure is particularly suitable where the beneficiaries/unitholders are not members of the same family and there is a need for them to have a fixed beneficial  interest in the underlying assets of the trust rather than a discretionary interest only.

The taxation benefits are generally not as flexible as a discretionary trust, in that any income distribution must be distributed to the unit holders in proportion to the number of units that they hold. However if a discretionary trust was a unitholder you can achieve the same flow-through tax benefits.

From an asset protection perspective, unit trusts don’t provide the same asset protection benefits as a discretionary trust. If a unit holder is made bankrupt, that person’s units will be treated like any other assets, and can be sold to raise funds to pay creditors.

The Fixed Unit Trust

The fixed unit trust is essentially a unit trust established to fit the definition of a “fixed trust” pursuant to the trust loss provisions contained in schedule 2F of the Income Tax Assessment Act 1936 (ITAA36).

The benefit of having a unit trust that fits the definition of a fixed trust is that should the trust incur revenue losses and subsequently seek to recoup those losses, in the recoupment year the trust will not need to satisfy the pattern of distribution test. If the unitholders of the fixed unit trust are discretionary trusts and the discretionary trusts each make family trust elections, the discretionary trusts will also not be required to satisfy the pattern of distribution test to be able to recoup the losses of the fixed unit trust.

The pattern of distribution test would otherwise require in relevant years that more than 50% of the income distributions are  distributed to the same individuals as in previous years in order to be able to recoup the losses in the loss recoupment year.

If the trust satisfies the definition of a fixed trust, the primary test that the fixed trust will need to satisfy to be able to recoup the losses in the recoupment year is the “50% stake test”, which requires that the same individuals have fixed entitlements to more than 50% of the income and capital of the trust at the relevant times. This would generally be a much easier test to pass than the pattern of distribution test.

For a unit trust to be a “fixed trust” pursuant to schedule 2F of the Income Tax Assessment Act 1936 (ITAA36), the unitholders must have a fixed entitlement to a share of the income or capital of the trust. To satisfy this requirement any issue of further units or redemption of units by the trustee must occur at a price determined on the basis of the net value of the trust fund according to Australian Accounting Principles. Any other method of valuation will mean that the trust is a non-fixed trust for the purpose of the definition. The power of amendment in the deed is also restricted so that the provisions regarding the calculation of the price for the issue and redemption of units cannot be altered.

The Fixed Non-unit Trust

The fixed non-unit trust is a trust that provides the beneficiaries of the trust with a fixed interest in the trust by the allocation of a fixed percentage in the trust without the allocation of units in the trust.. Under this trust arrangement there are no issued units.

The structure is appropriate where non-assessable income will be derived in circumstances such as the small business 50% active asset reduction being passed through to the trust beneficiaries, which would otherwise be limited by the CGT event E4 and E7  under a unit trust structure. It is also most suited where the proportionate entitlement of the equity participants in the structure is not expected to change, as a change in entitlements would need to be effected by an agreement of all the beneficiaries of that class.

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