Operating your business or real estate interests through a unit trust can deliver a range of advantages and challenges. Here’s what you need to know about these trusts.
There are many different ways to structure a business in Australia. Some businesses choose to structure themselves as a company, or a sole trader, but these are not the only options. It’s possible to set up a unit trust to run a business, which can deliver a range of benefits.
Operating a business through a unit trust shares some of the benefits of a company structure but can, in some scenarios, deliver additional tax benefits.
If you’re interested in the potential benefits of operating a business through a unit trust, there are a number of important advantages and disadvantages you should be aware of. This article will break down the primary features of this sort of trust and explain in detail how this type of trust operates in comparison to a discretionary trust or a company.
What is a Unit Trust?
A unit trust is a relationship between at least two parties — a trustee and beneficiaries. This relationship is governed by a trust deed. The trustee in this relationship is typically a trusted individual or party. It’s also possible for companies to operate as corporate trustees. In this case, the corporate trustee is controlled by trusted directors, which can include beneficiaries.
Compared to discretionary trusts, in which the trustee is able to distribute income as see fit, unit trusts feature unitholders holding fixed units or parcels in the trust.
In a unit trust, a unit is an asset or a piece of property, such as shares or a specific amount of income. Unitholders are individuals that possess a fixed interest in the trust. The trustee is tasked with proportionately distributing income or assets to the units of unitholders.
A unit trust functions in a different manner than a discretionary trust, in which income or assets are distributed at its discretion as long as the distribution is in the best interests of the beneficiaries of the trust.
What is the Purpose of a Unit Trust?
- Unit trusts are used for two primary purposes:
- As a means of investing in either shares or property by a group of unrelated parties; or
- The operation of a business that intends to raise capital by a group of unrelated business owners
There are a number of advantages and disadvantages presented by unit trusts that should be assessed when considering using this type of trust to structure your business:
1. Liability Minimisation Advantages
Operating a business through a unit trust minimises liability. If an individual sues a company that is operated through such a trust, for example, only the trustee is sued on behalf of the trust.
This means that only the assets held by the trust itself are at risk — any assets held by unitholders are free from liability. If the trustee breaches its fiduciary duties to the unitholders, however, the assets of the company could be at risk.
2. Investment Challenges
The structure of a unit trust can attract specific types of investment. Units within a trust, for example, can be subscribed to in order to raise funds. A business that operates through a unit trust, however, is less likely to capture investor attention than a company structure.
Angel investors or VC funds are less likely to invest in a business operated through a unit trust.
3. Financing Challenges
A unit trust, in most cases, distributes any income it generates. This income distribution is also taxed at the highest marginal income rate. This can often make it difficult for these trusts to retain funds, or anticipate payments.
Financial institutions or lenders, therefore, may be less likely to lend money to businesses that operate through a unit trust. A unit trust can, however, make distributions to a separate company that can hold funds and make payments on behalf of the trust.
4. Tax Advantages
A unit trust benefits from a wide range of tax advantages and is not subject to many types of tax. A unit trust is able to retain an asset and sell it after it has held it for over 12 months, potentially making the disposal eligible for the 50 percent capital gains tax discount.
Distributions made are classified as part of the income of a unitholder, and is therefore taxed at the unitholders’ marginal tax rate. Franking credits are available to unitholders.
What is the Difference Between a Unit Trust and a Company or Discretionary Trust?
There are a number of reasons a business may choose to operate through a unit trust rather than a discretionary trust or a company. Discretionary trusts and companies, however, can also deliver a number of unique advantages.
A discretionary trust provides a greater degree of control over assets held by beneficiaries when compared to a company structure — beneficiary-held assets in a discretionary trust are not at risk if the trustee is sued, whereas company assets are at risk in a company structure.
A company structure is more suitable for business entities that are seeking investors or aim to borrow from a financial institution. Discretionary trusts, however, provide greater tax advantages over company structures.
For more information on discretionary trusts or business incorporation in Australia, see Fullstack’s guide on Discretionary Trust or Family Trust Setup in 5 Easy Steps or How to Incorporate a Company in Australia.
Unit trusts are a tax-effective business structure alternative that are suitable for business entities that seek to protect assets and manage tax obligations. Operating a business through this sort of trust can reduce liability and, in specific cases, access capital gains tax discounts.