A unit trust is an investment vehicle established under a trust deed. Professional fund managers use them to pool collective money from various investors. The fund’s assets can include shares, bonds, property, and other securities. Investors are issued “units,” which represent their proportional ownership of the trust’s assets.

Who Uses Unit Trusts and Why?

Unit trusts are a popular choice for a wide range of investors, from individuals to self-managed super funds (SMSFs) and business partners.

• Individual Investors: Unit trusts provide a way for smaller investors to access a diversified portfolio of assets that they might not be able to afford or manage on their own. This allows for risk management and the potential for higher returns by spreading investments across different asset classes.
• Business Partners and Joint Ventures: When unrelated parties want to co-own assets or operate a business, a unit trust provides a clear and predictable structure. Each partner’s entitlement to income and capital is fixed based on the number of units they hold, avoiding the potential for disputes that can arise with more flexible trust structures.
• Self-Managed Super Funds (SMSFs): SMSFs often use unit trusts to diversify their retirement investments, giving them access to a broader range of assets and professional management.

Pros and Cons to Be Aware Of

As with any investment vehicle, unit trusts have distinct advantages and disadvantages that investors should consider.

Pros:

• Diversification: By pooling funds, unit trusts can invest in a wide range of assets, reducing the risk associated with a single investment.
• Professional Management: A fund manager with expertise and access to research and market information handles the investment decisions, which can be beneficial for investors who lack the time or knowledge to manage their own portfolios.
• Liquidity and Flexibility: Units can be easily bought and sold, making it relatively simple to enter or exit the investment. They also allow for flexible contributions.
• Tax Efficiency: In many jurisdictions, unit trusts are considered “flow-through” entities for tax purposes. This means that income and capital gains are passed directly to the unitholders, who are then taxed at their individual marginal rates, avoiding the double taxation that can occur with companies.

Cons:

• Loss of Control: Unitholders typically have no say in the day-to-day investment decisions, which are left entirely to the trustee and fund manager.
• Costs and Fees: Investors must pay management fees and other charges, which can reduce overall returns.
• Tax Inflexibility: Unlike discretionary trusts, where the trustee can choose how to distribute income to minimize tax, a unit trust must distribute profits proportionally to each unitholder’s fixed unit holding.
• Trapped Losses: If a unit trust incurs a net loss, this loss is often trapped within the trust and cannot be distributed to unitholders to offset other income.

Unit Trusts vs. Other Trusts for Tax Structuring

The key difference between a unit trust and a discretionary trust lies in the fixed nature of beneficiary entitlements.

• Unit Trust: Unitholders have a fixed and specific entitlement to the trust’s income and capital, which is proportional to their unit holding. This provides certainty and is often used for joint ventures or investment groups with unrelated parties
• Discretionary Trust: The trustee has the discretion to decide how and to whom to distribute income and capital among the beneficiaries each year. This is a highly flexible structure often used by families and small businesses to optimize tax outcomes by directing income to beneficiaries in lower tax brackets.
• For tax structuring, a discretionary trust offers more flexibility, particularly in a family context, as it allows for strategic income distribution. However, for non-related parties, a unit trust provides the clarity and certainty of a fixed ownership structure, which is a significant advantage. The choice of trust depends on the specific goals, relationships of the parties involved, and the desired level of tax planning flexibility.
• Caution should be exercised with Discretionary and Unit trusts that hold property in Australia. Each tax has different treatment in terms of land tax on property held in a Unit trust compared to a Discretionary trust. Expert advice should be sought.

Summary of Tax Impacts from a Unit Trust Distribution

When you receive a distribution from a unit trust, a portion of it is considered taxable income and must be included in your tax return. The specific items to report will be outlined in the Statement of Distribution or Tax Statement provided by the trust.

Here is a summary of the common components that impact your tax:

• Income: Your share of the trust’s income is typically separated into non-primary and primary production income.
• Capital Gains: If the trust sold assets, you will be allocated a share of any capital gains, which must be reported on your tax return.
• Franked Dividends and Credits: Your distribution may include franked dividends and a share of the franking credits, which can help offset your tax liability.
• Tax Withheld: Any tax withheld by the trustee because you didn’t provide your TFN can be claimed as a credit.

The Australian Taxation Office (ATO) may pre-fill some of this information for managed funds, but you should always verify the pre-filled data against your distribution statement to ensure accuracy.

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