Welcome to part three on forming a Unit Trust. Here we will discuss the process of distributing the income of a Unit Trust along with the likely impacts of the capital gains tax on the Trust Fund.

Distribution of Income

As you might expect, the income earned by the Unit Trust is divided in accordance with the proportion each unitholder owns.

In some situations, the income earned as a unitholder to the Unit Trust will form part of the unitholder’s total taxable income for that year. This occurs when the unitholder is an adult. For example, if a unitholder has a $30,000 salary and makes an extra $10,000 as a beneficiary under the trust, the total taxable income for that year would become $40,000.

Sometimes the Unit Trust will earn income in several different ways. Trust income, for example, can encompass taxable capital gains, franked dividends and income from interest. These separate income distributions can be divided accordingly, which will come in handy in particular when franking credits are meant to be passed on to the beneficiaries.

Capital Gains Tax

Capital gains tax can affect the Trust in any number of ways. If the Trustee decides to sell off an asset of the Unit Trust to another person “at arm’s length” (meaning there was no undue influence and that the commercial transaction was fair and reasonable) and then discovers a capital gain on the disposal, this gain will then be added to the total income earned by the Unit Trust.  This is apportioned and dispersed like any other income. Before calculating the net amount of assessable income to the Unit Trust, any capital losses may be accounted for (subtracted from the gain).

Another situation where the effects of capital gains need to be taken into account involves the assets of the trust being distributed or appointed to a particular beneficiary. In this scenario, the Trustee is taken to have sold the assets to the Unitholder at the present market value for the asset. At this point, a capital gain might follow, but it will depend on the adjusted “cost base” of the asset after accounting for inflation.

For the purposes of calculating capital gains tax, the units that make up the Unit Trust are regarded as assets. This means that by disposing of these units, the Trustee is disposing of assets, which could attract capital gains tax consequences. Legislation dealing with capital gains tax provides for deemed disposal of units in certain circumstances, such as when tax-free distributions are made on units which amount to more than the “indexed cost base”.

As such, seeking legal advice beforehand is highly recommended before committing to any sizeable investment transactions under a Unit Trust business structure. Typically, any borrowings should be undertaken by the unitholders of the Unit Trust. Then, the unitholders would usually invest these funds and any other capital into unit capital subscriptions, which ensures the ‘cost base’ on the unitholder’s total holdings is maximised. This can assist in protecting the unitholders from having to pay additional tax in the years to come.

What is meant by a ‘distribution’ to a Unitholder?

A distribution does not mean that the Trustee physically pays the unitholder. If, however, the Trustee is looking to retain the untiholder’s distribution, it may seek the consent of the unitholder to create a loan account in the name of that unitholder and credit the distribution amount to the loan account.

After this point, the Trustee will have powers under the Trust Deed to deal with that loan in any number of ways, i.e. investment etc. Unless the Trust Deed or some other agreement says otherwise, the unitholder will retain the right to recall the distribution at any time. It is worth noting that the amount that is put into the loan account will form part of the unitholder’s taxable income.

Conclusion

For more information on setting up a Unit Trust, contact a commercial lawyer and seek legal advice. Setting up a trust can be a complex venture, and getting it right from the start is hugely important.

Get in touch with LegalVision on 1300 544 755 for assistance in setting up a trust. We provide all our clients with obligation-free consultations and fixed-fee quotes for advice.

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