Introduction
In the diverse landscape of business entities in Australia, the Fixed Unit Trust stands as a unique and compelling option. This structure, often overlooked in favor of more traditional entities like sole traders or companies, offers a distinct blend of benefits and challenges. From its potential for tax advantages to the complexities of trust loss provisions, a Fixed Unit Trust can be a powerful tool for savvy entrepreneurs. This article aims to shed light on the intricacies of Fixed Unit Trusts, helping you understand if this might be the right choice for your business venture in Australia.
Understanding Businesses in Australia
In Australia, there are four main types of business structures, each with its advantages, disadvantages, and tax responsibilities. Here’s a brief overview:
1. Sole Trader: This is the simplest form of business structure, with lower establishment costs and minimal legal and compliance requirements. A sole trader can trade under their name or a registered business name. The income earned as a sole trader is taxed at the same rate as individual taxpayers. However, a sole trader is personally liable for all obligations incurred in the course of running the business.
2. Partnership: A partnership is made up of 2 or more people who distribute income or losses between themselves. Most partnerships are established by a partnership agreement, which sets out the rights and obligations of the partners. A partnership itself is not taxable, rather each partner pays tax on their share of the net income of the partnership. The downside to this type of business structure is that partners are jointly and severally liable for the obligations of the partnership.
3. Trust: Under a trust, a trustee owns the property or assets of the trust and carries on the business on behalf of the beneficiaries of the trust. A trustee can be an individual or a company. A formal Deed is required to set up a trust and there are annual tasks for a trustee to undertake. Trusts can be costly to set up and there are more compliance and legal requirements. The advantages of a trust are that income distribution and income are flexible and can be streamed to lower-income beneficiaries to take advantage of their lower marginal tax rate.
4. Company: A company is a separate legal entity capable of holding assets in its name. When you set up a company, you create a legal entity that’s separate from you. Companies have more legal and tax obligations.
Remember, the choice of business structure is an important decision to make at the start of a business venture, as the structure can impact tax implications and reporting requirements during the lifetime of the business.
When choosing a business entity in Australia, there are several key factors to consider:
1. Nature of Your Business: The type of business you’re running can influence the best structure for you. It’s important to consider the current state of your business and how it might evolve in the future.
2. Personal Circumstances: Your situation can also affect the choice of business structure. For example, your income, assets, and whether you’re receiving any benefits can all play a role.
3. Liability: The level of personal liability you’re willing to assume is another crucial factor. Some structures, like companies and trusts, offer more protection than others.
4. Tax Considerations: Different business structures are taxed in different ways. Some structures, like trusts and companies, can offer tax advantages.
5. Capital Requirements: If you need to raise capital from investors, some structures may be more appealing than others.
6. Cost and Complexity: The cost and complexity of setting up and managing the business structure should also be considered. For example, a sole trader structure is simpler and cheaper to set up than a company or trust.
7. Control and Decision Making: Your business structure can determine how much control you have over the business and how decisions are made.
8. Ongoing Costs and Paperwork: Different structures have different ongoing costs and administrative requirements.
9. Licenses Required: The business structure you choose can determine the licenses you require.
Before making a decision, it’s recommended to seek advice from a professional business adviser, lawyer, or accountant¹. Remember, you can change your business structure as your business grows and expands.
Choosing the right business entity is a crucial decision for any entrepreneur or business owner. In Australia, the type of business entity you choose can have significant implications on various aspects of your business operations. Here’s a brief overview of why it’s important:
1. Legal Liability: The business structure you choose determines the extent of personal liabilities. For instance, sole traders and partnerships involve personal liability, while companies and trusts offer limited liability.
2. Tax Obligations: Different business entities are subject to different tax rates and obligations in Australia. Your choice can affect your tax planning and compliance.
3. Business Management and Control: The structure can influence how decisions are made and who has control over the business operations.
4. Future Growth and Investment: Some structures are more scalable and attractive to investors. Your choice can impact your ability to grow and raise capital in the future.
5. Regulatory Requirements: Each business structure comes with its own regulatory and reporting requirements. Understanding these can help ensure compliance and avoid penalties.
6. Succession Planning: Your business entity can affect options for transferring ownership or discontinuing the business.
Given these factors, it’s clear that choosing the right business entity is not just a formality, but a strategic decision that can impact the success and sustainability of your business in Australia. It’s always recommended to seek professional advice to understand the implications fully.
Deep Dive into Trusts
In Australian law, a trust is an arrangement where a person or entity, known as the trustee, holds property or assets (e.g., money, shares, or real estate) for the benefit of others, who are called the beneficiaries.
While in legal terms a trust is a relationship and not a legal entity, trusts are treated as taxpayer entities for tax administration. The trustee must manage the trust’s tax affairs, including registering the trust in the tax system, lodging trust tax returns, and paying some tax liabilities.
The trustee holds the trust property for the benefit of the beneficiaries². Where the trust is established by deed, the trustee must deal with the trust property in line with the intentions of the settlor as set out in the trust deed². They must also act under the relevant state or territory law regulating trusts, and with any other applicable law, including tax law.
A trust beneficiary can be a person, a company, or the trustee of another trust. The trustee may also be a beneficiary, but not the sole beneficiary unless there is more than one trustee². Beneficiaries may have an entitlement to trust income or capital that is set out in the trust deed or they may acquire an entitlement because the trustee exercises a discretion to pay them income or capital.
Generally, the beneficiaries are taxed on the net income of a trust based on their share of the trust’s income – regardless of when or whether the income is paid to them.
1. Discretionary Trusts (Family Trusts): These are prevalent types of trusts in Australia. In such trusts, the trustee has discretion in determining which beneficiaries receive the income or capital from the trust and in what proportions. They can offer tax benefits by allowing income distribution to beneficiaries in lower tax brackets.
2. Fixed Trusts: In a fixed trust, beneficiaries have a fixed and defined interest in the trust’s income or capital, set out in the trust deed. This clear and predetermined allocation makes fixed trusts appealing in business contexts, such as investment schemes.
3. Unit Trusts: These are types of fixed trusts. Each unit owned by a beneficiary represents a fixed portion of the trust’s income or capital. Unit trusts are often employed in joint ventures or investment trusts.
4. Testamentary Trusts: These trusts are established by a will and come into effect after the person’s death. They serve to protect assets and control the distribution of wealth to beneficiaries, often minor children.
5. Superannuation Trusts: All superannuation funds within Australia are managed via trusts. The primary purpose of these trusts is to provide retirement benefits to its members.
6. Bare Trusts: In a bare trust, the trustee holds assets on behalf of beneficiaries without any power or discretion over them. Legally, the trustee must transfer the assets to beneficiaries upon request.
7. Hybrid Trusts: These are a combination of discretionary and unit trusts. They offer flexibility in distributing income and capital gains².
8. Charitable Trusts: These trusts are established for charitable purposes. They don’t have a particular beneficiary; instead, they benefit a charitable purpose.
9. Special Disability Trusts: These trusts are for the future care and accommodation needs of a family member with a severe disability.
Each type of trust serves a specific purpose and has its advantages and disadvantages. It’s important to consult with a legal or financial advisor to understand which type of trust is most suitable for your specific needs.
1. Benefits of Using a Trust:
Flexibility in Distribution: A trust, especially a discretionary trust, gives the trustee discretion over what income or capital is distributed to which beneficiary.
Asset Protection: Trusts can provide increased asset protection. The trustee of the trust is the legal entity that owns the assets and enters into contracts on the trust’s behalf.
Limitation on Business Liability: Trusts can limit business liability.
Tax Benefits: A discretionary trust is entitled to a discount on any capital gains made on the disposal of any assets the discretionary trust holds for more than 12 months. Also, the profits of the business can be distributed to a family member(s) so that the lowest possible individual marginal tax rates apply.
2. Drawbacks of Using a Trust:
Complexity and Cost: Trusts can be complex to set up and require the trustee to undertake formal yearly administrative tasks⁹. They can also be more costly to maintain than a sole trader or company structure.
Restrictions: The trust deed restricts the power of the trustees to take decisions.
Losses: The losses are not distributed in trust, so any profit earned will be subjected to increased tax rates.
Difficulties with Loans: Due to the additional complexities of loan structures, it may be difficult for trustees to acquire a loan.
Vesting Date: In NSW, trusts generally end after no more than 80 years; extending this date requires foresight in drafting the trust, otherwise, you may face costly court action.
Please consult with a professional business adviser, lawyer, or accountant before deciding to set up a trust for your business. They can help you understand what’s involved and the registrations you’ll need.
Spotlight on Fixed Trust Units
A Fixed Unit Trust, also known as a “fixed trust”, is a type of unit trust. Here’s a detailed explanation:
1. Basic Concept: A unit trust is a trust where the trust property is divided into many defined shares called units. The beneficiaries, referred to as unit holders, subscribe to the units in much the same way as shareholders in a company subscribe to shares.
2. Fixed Unit Trust: Although the unit holders of a unit trust may assume they have a fixed interest in the income and capital of the trust, the trust will only be considered a “fixed trust” for purposes of the trust loss rules in Schedule 2F of the ITAA 1936 if it can be shown that:
Persons (i.e., individuals, companies, trusts, etc.) have fixed entitlements to all of the income and capital of the trust.
The trust deed contains a clause that states that units can only be redeemed or issued for a price determined based on the net asset value, according to Australian accounting principles, of the unit trust at the time of redemption or issue.
3. Rights and Interests: In an ordinary unit trust, a beneficiary (or unit holder) is entitled to the income and capital of the trust in proportion to the number of units held. Unlike a beneficiary of a discretionary trust, who has no proprietary interest in the property of the discretionary trust, a unit holder in a unit trust may have a proprietary interest in that property.
4. Taxation: For Capital Gains Tax (CGT) purposes, a unit is a CGT asset so that when a unit is sold, it is the unit that is the relevant CGT asset, rather than any interest the unitholder might have in the underlying property of the unit trust.
Remember, the specifics of how a fixed unit trust operates can depend on the terms of the trust deed, and it’s always recommended to seek professional advice to understand the implications fully. This information provides a general understanding and should not be considered legal or financial advice.
A Fixed Unit Trust might be a good fit in the following situations:
1. Property Investments: Unit trusts are often used for property investments in Australia. Investors pool their money to purchase real estate, earning income from rent or through the sale of the property. This is especially beneficial for smaller investors or partners setting up for holding business premises.
2. Tax Advantages: A unit trust doesn’t pay tax itself. The beneficiary has to pay income tax on the proportion of income they receive. This can be advantageous as it allows for a Capital Gains Tax (CGT) discount on the sale of a trust asset.
3. Minimising Liability: Unit trusts can help in protecting unitholders’ assets from lawsuits against the trust.
4. Passing Franking Credits: Unitholders in a fixed unit trust can benefit from passing franking credits from imputed dividends.
5. Value-Shifting Regime: Fixed unit trusts can benefit from the value-shifting regime.
6. Borrowing Deductions: It’s easier for fixed unit trusts to claim for borrowing deductions.
7. Carrying Forward Tax Losses: Fixed unit trusts can carry forward tax losses.
8. Easier Compliance: A trust isn’t as heavily regulated as a company, making compliance easier.
Remember, the suitability of a fixed unit trust depends on the specific circumstances and objectives of the investors. It’s always recommended to seek professional advice when considering this type of investment structure.
Fixed unit trusts offer several benefits, but they also come with potential drawbacks and challenges:
1. Potential Loss of Control: As none of the Unit Trust holders have legal rights over the trust, they are at the mercy of the trustee. A trustee, being the only decision-maker and legal rights holder, might make decisions that the beneficiaries don’t always agree with.
2. Costs: Setting up a Unit Trust could have significant monetary implications. They are traditionally more expensive to set up than a sole trader or even a company. Additionally, the beneficiaries might be subject to PAYG calculations.
3. Complex Trust Loss Provisions: Complex trust loss provisions can be challenging to understand and manage. Losses are trapped in the structure and cannot be transferred to other controlled entities like companies.
4. Understanding the Deed: Clients can have trouble understanding all terms of the deed.
5. Tax Liabilities: Cost-based adjustments could lead to significant capital gains, which may increase tax liabilities.
Before setting up a fixed unit trust, it’s recommended to seek advice from a professional business adviser, lawyer, or accountant. Remember, you can change your business structure as your business grows and expands.
Taxation Considerations
Taxation in Australia is a vital aspect of the nation’s economy and is a mix of direct and indirect taxes levied by both the Commonwealth and State governments. Here’s an overview:
1. Income Tax: Australia has a progressive tax system, which means that the higher your income, the more tax you pay. Income taxes are the most significant form of taxation in Australia and are collected by the federal government through the Australian Taxation Office.
2. Goods and Services Tax (GST): A 10% Goods and Services Tax (GST) is levied on most goods, services, and other items sold or consumed in Australia. Australian GST revenue is collected by the Federal government and then paid to the states under a distribution formula determined by the Commonwealth Grants Commission.
3. Capital Gains Tax (CGT): Capital Gains Tax (CGT) is levied on the profit made from the sale of any asset.
4. Company Tax: Companies are taxed at a rate of 30%, though ‘small-medium business’ entities are taxed at a rate of 25%.
5. Other Taxes: Other forms of taxes include property taxes, departure taxes, excise taxes, fuel taxes, luxury car taxes, customs duties, payroll taxes, fringe benefits taxes, and more.
6. State Taxes: Each state in Australia may levy additional taxes.
The Australian tax system is designed to fund public services and infrastructure, redistribute wealth, and influence public policy. It’s important to note that tax laws can be complex and change frequently, so it’s always a good idea to consult with a tax professional or advisor for the most current and applicable information.
In Australia, different business entities are taxed in different ways. Here’s a brief overview:
1. Sole Traders: As a sole trader, you use your individual tax file number when lodging your tax return. All your income, including income from your business, is reported in your individual tax return. You pay tax on all your income based on your individual tax rate.
2. Partnerships: In a partnership, each partner pays tax on their share of the net partnership income. Each partner includes their share of the partnership net income or loss in their individual tax return.
3. Companies: All companies are currently taxed at a flat rate of 30% on their taxable income unless they are eligible for the lower company tax rate of 27.5% (from the 2018–2019 to 2023–2024 financial years). The lower company tax rate will then be reduced to 25% by the 2026–27 financial year.
4. Trusts; specifically Fixed Unit Trusts:
a. Trusts: The net income of a trust (effectively its taxable income) is its assessable income for the year less allowable deductions. Generally, the net income of a trust is taxed in the hands of the beneficiaries (or the trustee on their behalf) based on their share of the trust’s income (that is, the share they are ‘presently entitled’ to) regardless of when or whether the income is paid to them. If there is any part of the trust’s income to which no beneficiary is presently entitled, the trustee is taxed on the corresponding share of net income.
b. Fixed Unit Trusts: These are a type of fixed trust where each unit owned by a beneficiary represents a fixed portion of the trust’s income or capital. Because a unit trust is not a tax-paying entity, the effective rate of tax on its income will be equal to the rate of tax applicable to its unit holders. Being treated as a ‘fixed trust’ has important tax implications, including the ability to carry forward and utilise tax losses from year to year.
Please note that this is a general overview and the specifics can vary depending on the circumstances. It’s always recommended to consult with a tax professional or advisor for personalized advice.
Managing and planning for taxation for a fixed unit trust in Australia involves several strategies:
1. Utilize Tax Losses: Being treated as a ‘fixed trust’ has important tax implications, including the ability to carry forward and utilize tax losses from year to year.
2. Safe Harbour Compliance Approach: The Australian Taxation Office (ATO) provides a ‘safe harbour compliance approach’, which certain trusts can rely on without having to seek the exercise of the Commissioner’s discretion concerning fixed trust status.
3. Distribute Income Pre-Tax: The net income and capital gains are distributed to the unit holders pre-tax. In other words, the unit trust doesn’t pay tax. Instead, each unit holder is taxed for their share of the distribution derived from the trust at their marginal tax rate.
4. Superannuation Contributions: A trust can also contribute superannuation for all unit holders in proportion to their unit holding, which means that the tax on income of the trust can be limited to the tax rate on contribution to a superannuation fund, which at the time of writing is 15%.
5. Consider the AMIT Regime: For many widely held managed investment trusts, the introduction of the Attribution Managed Investment Trust (AMIT) regime has removed the need to consider this issue on a go-forward basis. Trusts that are eligible for, and elect to apply, to the AMIT regime are deemed to be fixed trusts for tax purposes, and their members are treated as having fixed entitlements to their income and capital.
6. Seek Professional Advice: It’s important to seek professional advice when managing and planning for taxation for a fixed-unit trust. Tax laws can be complex and change frequently, so it’s beneficial to have a tax professional who can provide up-to-date advice.
Remember, these strategies are general and may not apply to every situation. Always consult with a tax professional to understand the best strategies for your specific circumstances.
Case Study
In Australia, unit trusts, including fixed unit trusts, are commonly used for property investments and developments. Here are a couple of examples:
1. Retail Investment Funds: Most of the retail investment funds in Australia are set up as unit trusts. These funds pool money from multiple investors to invest in a diversified portfolio of assets. Each investor holds units in the trust and is entitled to a proportion of the income and capital gains generated by the trust.
2. Property Investments and Developments: Smaller investors also use unit trusts for small-scale property investments and developments. For instance, two business partners may set up a unit trust to hold their business premises. Similarly, a group of investors might pool their money in a unit trust to purchase real estate, earning income from rent or through the sale of the property.
These examples illustrate how fixed unit trusts can be used in real-world business scenarios in Australia. However, the specifics can vary depending on the terms of the trust deed and the nature of the business or investment. As always, it’s recommended to seek professional advice when considering the use of a fixed unit trust for your business.
Consider a property investment business, let’s call it “The Smith Trust”. This business is set up as a fixed unit trust. The trust has four beneficiaries, each holding a different number of units:
- Jenny: 10 units
- Jane: 20 units
- Jeremy: 5 units
- John: 15 units
In a given year, The Smith Trust derives $100,000 in income. The income is distributed to the beneficiaries based on their unit holdings:
- Jenny: $20,000
- Jane: $40,000
- Jeremy: $10,000
- John: $30,000
This structure allows The Smith Trust to distribute income fixedly, providing predictability for the beneficiaries. It also offers potential tax advantages. The trust itself doesn’t pay tax. Instead, each beneficiary pays income tax on their share of the income. This can be advantageous as it allows for a Capital Gains Tax (CGT) discount on the sale of a trust asset.
However, it’s important to note that the suitability of a fixed unit trust depends on the specific circumstances and objectives of the investors. It’s always recommended to seek professional advice when considering this type of investment structure.
Conclusion
A fixed unit trust is a powerful business entity in Australia that offers unique advantages. It provides a structured way to hold assets and distribute income to beneficiaries in a predetermined manner. This can offer significant tax efficiencies and flexibility, making it an attractive option for many businesses. However, like any business structure, it’s important to understand the legal and regulatory obligations involved. Always consult with a legal or financial advisor to ensure that a fixed unit trust is the right fit for your business needs and objectives. Remember, the right business structure can make all the difference in achieving your financial goals.
