Below, we summarise what is a trust before setting out the differentiating features between two main types of trust – a discretionary and a unit trust.
Firstly, What is a Trust?
Put simply, a trust is a relationship whereby an entity known as the trustee (generally being one or more individuals or a company), holds the legal title to property for the benefit of the beneficiaries (being one or more persons, companies or other trusts). The trustee has a fiduciary duty to administer the trust fund (i.e. the assets of the trust) for the benefit of the beneficiaries in accordance with the relevant trust deed.
How Long Does a Trust Last?
A trust runs for the period specified in the trust deed – usually for 80 years which is the maximum time prescribed by law. The trust’s term will obviously be reduced if the trust assets are distributed earlier to the beneficiaries and the trust is subsequently terminated or wound up.
What is a Discretionary Trust?
As the name implies, a discretionary trust gives the trustee discretion to which beneficiary (if any) among a broad class of beneficiaries under the trust deed, will benefit from the trust’s income or capital from year to year. No beneficiary of a discretionary trust has any interest in the assets of the trust or the trust itself other than to the due administration.
The trustee has the discretion from year to year to determine which beneficiaries receive distributions and to what extent. Discretionary trusts are flexible in that the trustee can canvass the tax attributes of the various beneficiaries from year to year and determine where to distribute the trust income in the most tax effective manner.
Family trusts are usually discretionary trusts with a broad range of potential beneficiaries. A discretionary trust can help protect family assets and enable income and capital to be spread among family members.
How is a discretionary trust established?
In general, a discretionary trust is set up by a small gift made by an unrelated party (i.e. unrelated to the trust beneficiaries). This small gift may be $5 and the party who makes it is referred to as the settlor.
Once the settlor has made the contribution to the trust, most of the trust property will come from loans or gifts made by the person who sought to establish the trust. This party is also generally a beneficiary of the trust.
What is a Unit Trust?
On the other hand, unit trusts are a type of fixed trust under which the trustee holds the assets of the trust for the benefit of unitholders in proportion to the number of units held. There may be multiple classes of units on offer with differing rights attaching to each class. Unit trusts are often used by arm’s length third parties as an investment vehicle, such as managed funds.
A unit trust differs from other trust structures in that the property held in the unit trust is divided into fixed and quantifiable parts, called units. Beneficiaries subscribe to these units similar to shareholders subscribing to shares in a company. Unit trusts give the unitholders certainty. The money or property from the unit trust is distributed to the beneficiaries in fixed proportions to the units that they hold. For example, if you have two unitholders who each owns 50% of the units, they receive 50% of the distribution.
Unitholders are the main people or entities intended to benefit from the trust and can be individuals or companies. They are quite often corporate trustees of various family discretionary trusts.
Unitholders should carefully consider the tax, stamp duty and estate planning implications of the trust structure and the trustee’s decisions. It is prudent for the unitholder and/or trustee to seek accounting, tax and legal advice on these matters.
Unit trusts are more appropriate if third parties are investing together, for example, each third party could acquire units in a unit trust which in turn carries on a business or acquires investment assets. Further, unit trusts facilitate the entry and exit of investors without having to sell off fractions of the underlying asset(s).
You should seek specific advice about the implications of holding particular assets or deriving particular income through a fixed (i.e. unit trust) or a discretionary trust. If you have any questions about the most appropriate trust structure for your circumstances, let our commercial and business lawyers know.