Setting up a trust can bring many financial and business benefits. However, choosing the right structure is essential to ensure the growth and security of your business into the future. The two main trust structures are unit trusts and discretionary trusts. While they have similarities, understanding their differences is crucial when setting up a trust. This article will set out the key differences between unit and discretionary trusts.
What is a Trust?
A trust is a relationship where the controller of the trust (the trustee) holds and manages assets for the benefit of individuals or companies that are parties to the trust. These individuals or companies are the trust’s beneficiaries. The trustee has a responsibility to administer the assets of the trust (the trust fund) to the beneficiaries in accordance with the trust’s governing document (the trust deed).
The trust deed will generally outline:
- the applicable parties;
- the length of time the trust will exist;
- purpose of the trust;
- the trustee’s powers;
- rights and obligations of the trustee and beneficiaries;
- process of selling units; and
- process of closing the trust.
Who Are the Parties to a Trust?
The two main parties are the trustee and the beneficiary.
The trustee is the legal owner of the trust and is the individual or entity that has the obligation to hold the property. This obligation carries an array of strict duties in managing the assets held in the trust, including paying any applicable tax and distributing the assets to the beneficiaries.
The beneficiary is the individual or entity that the trust deed explicitly identifies as receiving the benefit of the trust. For unit trusts, beneficiaries are referred to as unitholders.
Continue reading this article below the formUnit Trusts
A unit trust is a fixed, express trust. The trust deed will explicitly identify the beneficiaries and their interests according to the proportion of ‘units’ they hold. The benefit that the unitholder receives is proportionate to the number of units they hold, often compared to shares in a company. For example, if you have two unitholders who each own 50% of the units, they each receive 50% of the distribution.
A unit is a piece of property that allows the unitholder to buy and sell units. The value of a unit is determined by the value of the trust as a whole. Unit trusts may also have different classes of units that provide varying rights and value to the unitholders. Similarly, trustees can buy back units under a trust.
Benefits
A key benefit of unit trusts is that they give the unitholders certainty as to the benefit they will receive. These trust structures are common for property and investment or where readily transferable interest in the trust is desirable.
Unit trusts also have significant tax advantages as the unit trust is not considered a separate taxable entity in the way that a company is. Therefore, the trust’s income or capital is distributed before any applicable tax is deducted.
Unitholders should carefully consider the tax, stamp duty and estate planning implications of the trust structure and the trustee’s decisions. It is important for the unitholder or trustee to seek accounting and tax advice on these matters.
Discretionary Trusts
Discretionary trusts differ from unit trusts as the beneficiary’s entitlements are not fixed and are left to the trustee’s discretion. The trustee can choose how much and which beneficiaries will receive interest from the trust property. This ability to freely determine where the trust income or assets are distributed allows the trustee to distribute funds that will provide the most tax-effective solution.
While discretionary, the rules of the trust deed will limit the distribution of trust income. For example, this might include the discretionary trust’s investment guidelines and how the trustee must distribute income amongst the beneficiaries.
Discretionary trusts may also have different classes of beneficiaries, including:
- primary and general beneficiaries;
- income beneficiaries;
- capital beneficiaries; and
- default beneficiaries.
Primary beneficiaries are the individuals that the trust deed explicitly identifies and are entitled to undistributed capital and income on winding up the trust.
How Do You Set Up a Discretionary Trust?
In general, a discretionary trust is set up by a contribution being made to the trust by a party that is unrelated to the beneficiaries. This small gift may be just $10 and the party who makes it is referred to as the settlor.
Once the settlor has made the contribution, most of the trust property will come from loans or gifts made by the party who sought to establish the trust. This party is also generally a beneficiary of the trust.
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Key Takeaways
There are key differences between discretionary trusts and unit trusts that are important to consider before making any business decisions. These differences concern the:
- trust establishment process;
- daily running of the trust; and
- tax considerations.
You should seek specific advice about the implications of holding particular assets in a trust.
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Frequently Asked Questions
Unit trusts are a type of fixed trust where the trustee holds the assets of the trust for the benefit of unitholders. This benefit will be in proportion to the number of units that each unitholder acquires.
A discretionary trust where the trustee has the discretion to decide which beneficiaries (if any) will benefit from the trust’s income or capital from year to year. The trustee can determine which beneficiaries receive distributions and to what extent.
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