Unit trusts: when and why to use one
A unit trust is a trust in which the beneficiaries (called unit holders) have fixed entitlements to the trust’s income and capital in proportion to the number of units they hold. Unlike a discretionary trust, where the trustee decides who receives what each year, a unit trust gives each unit holder a defined share.
Unit trusts are commonly used when unrelated parties want to hold an asset together (such as a property investment), when fixed entitlements are required for tax or structuring reasons, or when the investors want a clear and proportionate ownership structure. They are also used in some financing arrangements and joint ventures.
From a tax perspective, the key difference between a unit trust and a discretionary trust is that unit holders have a present entitlement to their proportion of the trust income each year. The trustee does not have discretion to redirect income. This means unit trusts do not offer the income-splitting flexibility of discretionary trusts, but they do provide certainty of entitlement and are simpler from a compliance perspective.
Unit trusts can issue different classes of units with different rights, for example, income units that receive distributions and capital units that receive capital gains on the sale of trust assets. This flexibility makes them useful for structured investments. However, care must be taken with the design of unit classes to avoid unintended tax consequences.
A unit trust deed must clearly define the rights attaching to each class of units, the process for issuing and redeeming units, the trustee’s powers and obligations, and the distribution provisions. At CoSec Partners, unit trust deeds cost $264 including GST, drafted and signed off by Key Legal, an independent external law firm.
Frequently asked questions
When should I use a unit trust instead of a discretionary trust?
Use a unit trust where unrelated parties invest together and each needs a defined, provable share, or where fixed entitlements are required for tax or financing reasons. A discretionary trust suits a single family group that wants flexibility over who receives income each year.
Can units in a unit trust be transferred or redeemed?
Yes, subject to the terms of the deed. Most deeds set out both a transfer process, often with pre-emption rights in favour of existing unit holders, and a redemption process under which the trustee buys units back. The pricing mechanism for redemptions matters, because it can affect whether the trust is a fixed trust for tax purposes.
Is a unit trust a fixed trust for tax purposes?
Not automatically. A trust is fixed for the trust loss rules in Schedule 2F of the ITAA 1936 only where unit holders have vested and indefeasible interests in all income and capital. Trustee discretions over redemption pricing, further issues, or streaming can defeat that, so the deed’s drafting decides the answer. The Commissioner has a discretion under section 272-5(3) to treat an interest as fixed in some cases, but it should not be relied on in place of careful drafting.
This article is general information only and does not constitute legal, financial, or tax advice. While we endeavour to keep content accurate and current, laws and regulations change frequently. For advice specific to your circumstances, please consult a qualified professional adviser. CoSec Partners Pty Ltd accepts no liability for actions taken based on this content.