A Unit Trust deed sets out the Unit Trust rules. It is the Unit Trust’s rule book.
Commonly, a Unit Trust either holds assets or runs a business: never both.
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, you have 150 units and I have 50 units. Therefore, you own 75% of the Unit Trust assets. I own 25% of the assets in the Unit Trust.
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. This is in exact proportion to the Units that you hold.
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. In other words, the company pays tax on income. In a Unit Trust, the Unit Holders generally pay the tax.
Each financial year the company pays tax on its profit. The tax paid attracts an ‘imputation credit’. The company may retain this 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. The paying of a dividend is 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.
In contrast, a Unit Trust has to distribute all of its income to the Unit Holders at the end of each financial year. (Any income not distributed is taxed automatically at the highest marginal tax rate.) 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. But if the Unit Holder 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 often you hold the Units in a Family Trust: rather than in your own name.
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. This 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.
The Unit Trust trustee is liable for the Unit Trust liabilities. The trustee has the right to indemnity. This is against the Unit Trust’s assets. If there is a shortfall the Unit Holders may also be personally liable.
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 liabilities incurred by the business of the Unit Trust. 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. Today you issue Units for $1.00 each. 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 are updated on average every 5 – 8 years, Unit Trust Deeds do not usually need updating 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.
Want to formalise the relationship between the unitholders? Build a Unitholders Agreement.
Unitholders may debate on what the Unit Trust will do and invest in. But this 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 do not usually update the company Constitution or the Shareholders Agreement.
The Government does not want you to have too many members of the public involved in a Trust. Therefore, the Government regulates the number of Unit Holders. A Unit Trust is classified as a Public Unit Trust. This is if there are 50 or more Unit Holders: s 102P(1)(c) Income Tax Assessment Act (1936).
For example, the Australian Medical Unit Trust has 500 Units. It gives Units to 52 separate people. In this example, the Trust is a Public Unit Trust as it has more than 50 Unit Holders.
Becoming a Public Trust allows you to have an unlimited number of Unit Holders. But it increases administration and taxation. Your Trust is potentially taxed as a company.
A Public Unit Trust is avoidable if 20 or fewer Unit Holders own 75% of the units.
In this example, the Australian Medical Unit Trust has 500 Units. When they sell these Units they sell 375 of them to 18 Unitholders. The remaining 125 is distributed amongst the other 42 Unit Holders. This means that the first 18 Unit Holders own 75% of the overall units (375/500 = 75%).
Do you have more than 20 Unit Holders? Under the Corporations Act (2001) are liable for $22,000 and five years’ imprisonment. This is if your Unit Trust is a Managed Investment Scheme (MIS) – and you don’t register it. In an MIS the investments are pooled together to produce a beneficial interest for the Unit Holders.
How does a Unit Trust turn into an MIS?
Your Unit Trust is NOT an MIS if your Unit Holders have control of the day-to-day operations of the Trust. However, what if your Unit Holders only share in the profit? Then your Unit Trust is an MIS. If you have more than 20 Unit Holders, you are required to register your MIS. Failure results in penalties.
If you have more than 20 Unit Holders, you are required to register your MIS. Failure results in penalties. Registration as an MIS is with ASIC. It may require a Product Disclosure Statement and other formalities.
The ATO in 2017 released a Decision Impact Statement (DIS) on the High Court decision in ElecNet (Aust) Pty Ltd (as trustee for the Electrical Industry Severance Scheme) v FCT  HCA 51.
In its decision, the High Court unanimously dismissed the taxpayer’s appeal and confirmed that the Electrical Industry Severance Scheme (EISS) was not a “unit trust” within the meaning of Div 6C of Pt III ITAA 1936. It was, therefore, not entitled to be taxed like a company.
It did so on the basis of finding that the interests of the electrical industry workers in the scheme could not be characterised as “units”. In arriving at its decision, the High Court also indicated that the workers’ interests were “discretionary” in nature. This is contrary to the concept of a fixed “unit” interest.
The ATO considers that the High Court’s decision is consistent with its view of the law. (I am sure that the High Court of Australia takes great solace that the gathering of bureaucrats running the ATO agrees with the Court.)
The issue before the Court was whether the severance scheme was a unit trust. This is under Div 6C of Pt III ITAA 1936. The Court held that the rights conferred on employees by the Deed did not support the conclusion that the EISS was a unit trust for the purposes of Div 6C.
But why? The ATO said that the Court considered:
The Court found that there was no reason in the text or context of Div 6C to attribute to the undefined expression “unit trust” any meaning. This is other than the meaning from the language of Div 6C
The ATO also notes the High Court’s concern. This is the unattractive consequence that severance payments made to workers under the scheme are taxable. This is in the hands of the recipients as unit trust dividends.
Like all good things, Unit Trusts have to come to an end. They end no later than the ‘vesting day’. On vesting, the assets then transfer to the Unit Holders.
On vesting two taxes apply:
All Australian Unit Trusts suffer CGT and (stamp) transfer duty. Therefore, Unit Trusts try to defer this liability by making the Trust exist longer.
The Government does not want assets tied up in Trusts indefinitely. The Government seeks to prevent assets from falling into disrepair. A Trust can not go on longer than 80 years. This is called the Rule Against Perpetuity.
This Rule comes from English law. The 22nd Earl of Arundel in 1682, wanted to control how his titles pass for thousands of years. The Courts refused to grant an indefinite Trust. The Court limited the life of the Trust.
The 80-year Rule applies in all Australian States except one. South Australia has not adopted a Rule Against Perpetuities. Here, you do not need to have a Unit Trusts lasting 80 years. They can exist indefinitely.
There are two Westfield Trusts:
They are both Unit Trusts. The Unit Trusts are governed by New South Wales law.
Collectively they are worth AUS$58 Billion. Surely they can’t be subject to the 80-year period? Because the Trusts are governed by New South Wales they are subject to the Rule Against Perpetuities. Both Unit Trusts suffer the 80-year rule. The Westfield Unit Trust started in 1982. The Westfield American Unt Trust started in 1996. Both terminate on their respective 80th anniversary.
Legal Consolidated continues to lobby the States and Territories to remove the rule of perpetuity. No doubt the lawyers for Westfields, and similar, are doing the same thing. There is a strong movement to abolish these rules.
If they are abolished then Legal Consolidated’s Unit Trusts, Family Trusts, Family Trust updates, and Bare Trusts are drafted to extend the vesting period to infinity. This is automatic if the law is abolished.
Under South Australian law, a Unit Trust can potentially exist indefinitely. When building a Trust Deed on Legal Consolidated put in a South Australian address for the Trustee. If you have no such address then put in: Care of General Post Office Adelaide, 141 King William Street, Adelaide SA 5000.
Example: The Australian Medical Unit Trust is located in Brisbane. There is concern that Unit Trusts lasting 80 years is not long enough to fulfil the Trust’s purpose. When they sign the Trust Deed they elect to have South Australia’s laws apply to their Trust. Now the Trust can exist indefinitely?
Although South Australia may seem like a blessing, it could end up more like a curse. Here are the few issues you should be aware of if you don’t want your Unit Trust lasting 80 years.
Example: The Australian Medical Unit Trust has operated for 80 years. The Trust is able to live on indefinitely. However, any Unit Holder can direct the Trustee to wind up the Trust.
In practice, choosing South Australia’s laws has little value. It’s usually more trouble than its worth. Any legal issues that arise are dealt with in South Australian Courts. You have to travel to South Australia and brief lawyers in that State. This is inconvenient and costly.
If you do make it to 80 years with no problems the Court may order the Trust to wind up anyway. There is no guarantee that a court gives effect to your choice of law: Akai Pty Ltd v The People’s Insurance Co Ltd (1996) 188 CLR 418.
This is especially when the Trust has chosen South Australia to avoid the laws that otherwise apply. Instead, they apply the State’s laws that have a close and real connection to the Trust.
Over the years we have set up many Trusts governed by the laws of South Australia. This escapes the Unit Trusts lasting 80 years rule. To date, we have not had an attack by the ATO regarding those Trusts.
Would the ATO argue that the choice of law was a breach of Part IVA Income Assessment Act (1936)? Part IVA is the general anti-avoidance provision. If you do something contrived primarily to reduce tax then the ATO disregards what you do and inflicts the tax you should pay.
Legal Consolidated’s view is that Part IVA is difficult for the ATO to sustain. There is no ‘scheme’ or convoluted array of activities. However, it is a threat.
Before choosing South Australia’s laws to govern your Trust, ask yourself these questions:
Thankfully most of us are dead before an 80-year Trust ends. So Unit Trusts lasting 80 years may not be an issue.
The High Court states in Charles v FCT  HCA 16, 90 CLR 598 that the interposition of a unit trust between an income source and a beneficiary does not change the character or source of the income in the hands of the beneficiary. This is for tax purposes.
In my lecturing as a professor at a number of Australian Universities, since the 90s, I have named this the “trust conduit theory”. The term seems to now be widely used. My theory asserts that an amount distributed by the trustee to a beneficiary retains in the beneficiary’s hands the specific character. For example, as dividends or interest income. Therefore, it has the same source that it had in the trustee’s hands.
Subsequent cases have limited my theory in its purest form to the point that save in the case of a bare trust (eg, FCT v Tadcaster Pty Ltd (1982) 13 ATR 245) or a trust in which a beneficiary has an interest in possession in the income of the trust estate as it arises, it has not been embraced.
For example, in Executor Trustee & Agency Co. of South Australia Ltd v DCT (SA)  HCA35; 62 CLR 545, Latham CJ rejected the argument in favour of the theory in its purest form based on Baker v Archer-Shee where the trustee, pursuant to the exercise of a discretion, and after the payment of fixed annuities to the beneficiaries, paid the whole of the surplus net income from the trust real estate to the same beneficiaries. In his Honour’s words (at 558):
“In view of the fact that a discretion exists, and that the exercise of it is interposed between the receipts of rents and profits of the land by the trustee and the payment of income to the beneficiaries, it seems to me to be impossible to hold that the latter are entitled specifically to the rents and profits”.
Charles is the high-water mark of the theory in Australia. That case involved a unit trust conferring on unitholders fixed entitlements. But even in the case of the unit trust before the Court, it is clear that their Honours only embraced my theory in a modified form. At 609, their Honours said:
“…a unit under the trust deed before us confers a proprietary interest in all the property which for the time being is subject to the trust of the deed: Baker v Archer-Shee; so that the question whether money’s distributed to unit holders under the unit trust form part of their income or their capital must be answered by considering the character of those moneys in the hands of the trustees before the distribution is made.”
Clearly, the Court did not go so far as to say that what was received by the unitholders was the actual income that the trustees received. The Court merely said that the character of the moneys received by the unitholders is determined by its character in the hands of the trustees. If it was a capital profit in the hands of the trustees, it was a capital profit in the hands of the unitholders. If it was a revenue profit in the hands of the trustees, it was a revenue profit in the hands of the unitholders.
But in that modified form, the theory does not of itself determine the source of the income. Other factors such as whether it is passive income or from the carrying on of a business and if the latter, where the business is carried on, the activities and functions of the trustees and the terms of the trust instrument impacts on the source of the income. This is in the hands of the unitholders as a practical, hard matter of fact: Nathan v FCT (1918) 25 CLR 183.
Even more so in the case of a discretionary trust where a discretionary beneficiary (not being a taker in default) having no interest in the assets of the trust estate but merely a right to require the trustee to carry out the terms of the instrument constituting the trust estate, is only entitled if the trustee exercises its discretion in the beneficiary’s favour.
While Memec Plc v Inland Revenue Commissioners  BTC 590, on appeal  BTC 251 (CA) concerned the transparency of a German silent partnership in the sense of whether dividends paid by trading subsidiaries to the partnership of which the taxpayer was the silent partner were paid to the taxpayer, Robert Walker J considered by way of analogy whether a trust was transparent. After referring to Baker v Archer-Shee, his Lordship said (at 603):
“Under an English trust with an interest in possession the life tenant has an equitable interest in the trust property and the trust income as it comes into the trustee’s hands, even though the trustees have a lien on capital and accruing income for their expenses. Such a trust is transparent for income tax purposes. A discretionary trust, on the other hand, is not transparent. No beneficiary is entitled unless and until the trustees exercise their discretion in his or her favour, and the trustees’ exercise of discretion is regarded as having(in Lord Asquith’s words) independent vitality and creating a new source of income, although the effect of this may be tempered by specific enactment…”
Build your Unit Trust deed on our law firm website. Telephone us for help answering the questions.
After you build your Unit Trust deed you may wish to build a Unitholders Agreement.
Adj Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, Dip Ed, BArts(Hons), LLM, MBA, SJD
Legal Consolidated Barristers and Solicitors
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