Unit trusts for co-owners and joint ventures

When two or more unrelated parties go into business or buy property together, a discretionary trust rarely fits. Nobody wants their share of the profit to depend on a trustee's discretion each year. A unit trust offers fixed, measurable entitlements while keeping some of the tax features of a trust, which is why it is a common choice for joint ventures and co-owned property.

How a unit trust works

A unit trust is a trust in which the beneficial interest is divided into units, much as a company's ownership is divided into shares. Each unitholder is entitled to income and capital in proportion to the units they hold. A trustee, usually a company, holds the assets and runs the business under the terms of the trust deed.

If you hold 40 of 100 units, you are entitled to 40% of the trust's distributable income each year and 40% of its capital when the trust is wound up. The trustee does not get to choose.

The deed must be prepared by a lawyer, and it matters more than people expect. The deed decides how units are issued and redeemed, how income is calculated, what happens when a unitholder wants to leave, and whether the trust is treated as a "fixed trust" for various tax and duty purposes.

Why co-owners choose unit trusts

Certainty. Each party knows exactly what share of income and capital they own.
Flexible ownership. Each party can hold its units through its own vehicle, such as a family trust, a company or, in limited cases, a self managed super fund.
The CGT discount. Gains on assets held for at least 12 months can generally flow through with the 50% discount to unitholders who are individuals or trusts. A company cannot claim that discount itself.
Income flows out. Like other trusts, the unit trust itself does not usually pay tax if all income is distributed. Each unitholder pays tax on its share.
Transferable interests. Units can be sold or transferred, subject to the deed and any agreement between the owners.

An illustration

Two families want to buy a commercial property for their businesses to share. Each family holds 50 units through its own discretionary trust. Rent paid by both businesses flows into the unit trust, and the net income is distributed 50/50 to each family trust. Each family trust then distributes its share to its own family members or a corporate beneficiary as it sees fit. If the property is sold after several years, each family trust can generally pass the discounted gain on to its individual beneficiaries.

This is a simplified example. Duty, land tax and lending conditions all depend on the state and the details.

What a unit trust does not solve

Losses stay in the trust

A unit trust cannot distribute losses. Early losses, for example during a property development or start-up, are trapped in the trust until it earns future income, subject to the trust loss rules.

State duty and land tax

States treat unit trusts differently. Some charge land tax at higher rates, or deny the tax-free threshold, unless the trust meets their definition of a fixed trust. Transfers of units can attract landholder duty in some cases. Check the position in your state before you buy, not after.

Distribution and integrity rules

The trust income rules, section 100A and the rules about trust income versus taxable income still apply. A unit trust is generally simpler to administer than a discretionary trust on distributions, because the entitlements are fixed, but it still needs proper accounts and timely decisions by the trustee.

Liability

Like any trust, a unit trust acts through its trustee. A corporate trustee limits the exposure of the individuals involved, but lenders will often ask for guarantees from the unitholders or their directors.

The unitholders agreement

The trust deed sets out the legal mechanics. A unitholders agreement, also prepared by a lawyer, sets out the commercial deal between the owners. Without one, co-owners discover their disagreements at the worst possible time. It should cover at least:

Decision-making. Which decisions need a simple majority, which need unanimous agreement, and who sits on the trustee company's board.
Funding. How further capital is raised, what happens if one party cannot contribute, and whether loans from unitholders are allowed.
Distributions. Whether income must be paid out or can be retained for working capital.
Exit. Pre-emptive rights, drag-along and tag-along rights, and how units are valued when someone leaves.
Trigger events. Death, incapacity, insolvency, a breach of the agreement or a relationship breakdown between the parties.
Deadlock. What happens when the owners cannot agree, such as mediation or a buy-sell mechanism.

The same issues arise in companies with more than one owner; see Why every company with two or more owners needs a shareholders agreement.

In a co-ownership, the structure fixes who owns what. The agreement decides what happens when the owners stop agreeing. You need both.

Unit trust, company or partnership?

A unit trust often suits co-owned investment property or ventures expecting capital growth, where owners want flexibility in how they each hold their interest.
A company often suits an operating business that wants to retain profits at the company tax rate, bring in investors or employees as shareholders, or prepare for a share sale.
A partnership of entities can work for some joint ventures, but carries broader liability; see Partnerships: when they work and when they don't.

The right choice depends on what the venture will own, whether it will retain or distribute profits, how each party wants to hold its interest and how you expect it to end.

Questions to answer before you set one up

What will the trust own, and will it run a business or simply hold assets?
Through what entity will each party hold its units?
Which state's duty and land tax rules apply, and does the deed meet them?
How will the venture be financed, and what guarantees will lenders want?
How will a party exit, and how will its units be valued?

How we can help

We work with co-owners to compare structures, model the tax outcome for each party and coordinate with your lawyer on the deed and the unitholders agreement. If you are planning a joint venture or co-owned property, contact us or read about our business structuring services.

This article is general information only and does not take into account your circumstances. Speak to a qualified adviser before acting on it.