Rights attaching to units in a unit trust

A unit trust divides the beneficial interest in the trust fund into units, much as a company divides its capital into shares. The fund itself can hold any legally recognised form of property — land, money, shares, and contractual rights — and it grows as unit holders subscribe for units and the trustee acquires further assets. What a unit actually entitles its holder to is not fixed by the label “unit”; it is determined by the rights the trust deed attaches to that class of unit. A well-drafted deed therefore sets out, class by class, the rights to income, to capital, to vote, and to have units issued or redeemed.

Ordinary units are the standard case. A registered holder of ordinary units has a beneficial interest in the unit trust as an entirety, proportionate to the number of units held, rather than an interest in any specific asset within the fund. This reflects the High Court’s decision in Charles v Federal Commissioner of Taxation (1954), which held that a unit confers a proprietary interest in all the property subject to the trust, unlike a company share, which confers no interest in the company’s assets. The later decision in CPT Custodian Pty Ltd v Commissioner of State Revenue (2005) confirmed that whether unit holders have a present proprietary interest in the underlying property depends on the precise terms of the deed, so it is the deed’s drafting, not the general nature of unit trusts, that governs the outcome.

Deeds commonly allow the trustee to create special units, often called special income units, that carry rights quite different from ordinary units. Typical features are that the trustee sets the issue price; the trustee may direct net income to the holders of that class to the exclusion of other unit holders, regardless of the proportion of units held; the units are redeemable at the trustee’s discretion, frequently at par or the original subscription amount, on written notice; the holders have no voting rights at meetings of unit holders; the holders have no entitlement to capital beyond a return of their subscription; on a winding up of the trust that subscription is repaid in priority to distributions on ordinary units; and further special units can be issued without the consent of existing holders. Because these rights are creatures of the deed, its wording controls exactly what each class receives.

These discretionary features carry a tax consequence that the mechanics alone do not reveal. A trust is only a “fixed trust” for the purposes of the trust loss rules in Schedule 2F of the Income Tax Assessment Act 1936 where the beneficiaries have a vested and indefeasible interest, a “fixed entitlement”, to all of the income and capital. Where the trustee can stream income to a chosen class, redeem units at a price it sets rather than net asset value, or issue further units at its discretion, unit holders’ entitlements may not be vested and indefeasible, and the trust may fail to qualify as fixed. That matters well beyond trust losses: fixed status also affects the ability to pass through franking credits, the CGT small business concessions, and the “fixed unit trust” concessions in state land tax regimes (for example, the special trust rules in New South Wales). The Commissioner has a discretion to treat a trust as fixed and has published guidance on how it will be exercised, but it should not be assumed. Unit class design is therefore a tax question as much as a drafting one.

A deed will also usually let the trustee create new classes of units carrying preferred, deferred, or other special rights, and reclassify existing units, generally by special resolution. Two cautions apply. First, the trustee can only do this if the deed actually confers the power; acting outside the deed can be a breach of trust. Second, varying the rights of existing units, or reclassifying them, can amount to a resettlement of the trust or otherwise trigger a CGT event, and may attract stamp duty in some jurisdictions. Changes to unit rights should not be made without confirming both the deed’s authority and the tax and duty consequences.

At CoSec Partners, unit trust deeds are individually drafted and signed off by Key Legal, an independent external law firm, and cost $264 including GST, with Key Legal responsible for its legal review and holding professional indemnity insurance. Where a structure calls for special or multiple classes of units, we recommend obtaining tax advice on how the proposed rights affect the trust’s fixed status before the deed is settled.