SMSFs and public trading trusts: More** lessons from days gone by

A unit trust is often an attractive investment vehicle for taxpayers, as it can offer many similar benefits to a corporate structure, with the following additional benefits not available to companies:

1. access to the general CGT 50% discount (33% for unit trusts where units are owned by SMSFs);
2. the ability to issue units with different rights to income and capital;
3. no requirements for formal disclosure to ASIC and other regulatory bodies;
4. ensuring asset protection risks are isolated from other assets; and
5. no requirements for a formal audit.

In particular, unit trusts are often viewed as the preferred structure for holding capital appreciating assets where there are unrelated third party investors.

Traditional unit trusts provide that the beneficial interest in the trust property is held in proportion to the units held by each unitholder.

It is important however to understand that under the Tax Act, a unit trust may be deemed (for tax purposes) to be a ‘public trading trust’.

Where a unit trust is deemed to be a public trading trust, the trust is taxed as if it were a company, and all of the tax advantages outlined above will effectively be lost. For example:

1. the trust’s income (regardless of whether it is distributed or not) is taxed at the corporate tax rate;
2. specifically, capital gains are taxed at the corporate tax rate, with no access to the general CGT discount;
3. there may be insufficient franking credits for intended distributions due to (for example) depreciation rules;
4. if the trustee of the trust is unaware that it is in fact a public trading trust, it may be held that all distributions are unfranked dividends causing significant excess tax to be paid; and
5. there will be a timing delay for the unitholder in receipt of income, as the tax paid by the unit trust is refundable via a franking credit when the unitholder ultimately lodges its tax return.

A unit trust may be deemed to be a public trading trust where it is a ‘public unit trust’ (a term defined under the Tax Act).

Historically, a unit trust could be deemed to be a public trading trust where one or more SMSFs held a right to 20% or more of the income or capital of the trust and a number of other technical rules were satisfied.

Changes in 2016 however removed the 20% tracing rule for public trading trusts for SMSFs. This means, a unit trust where units are owned via one or more SMSFs should never be taxed as a company.

Generally unit trusts owned by SMSFs avoiding being treated as a company for tax purposes will be a preferred outcome.

There are however a range of issues that need to be managed, including the non-arm’s length income rules that may mean that if the unit trust is not ‘fixed’ (an issue explored in many other View posts), any income derived by the SMSF will be taxed at penalty rates.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Sisters of Mercy song 'More’.

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All of this; and nothing** - Default beneficiaries and bankruptcy

Following on from the posts over the last few weeks, it is important to be aware that some commentators argue that the interest of a default beneficiary constitutes property that may vest in the trustee in bankruptcy if a default beneficiary is declared bankrupt.

It has generally been argued that the interest of default beneficiaries is of a different character from that of a discretionary object and may well be property of a bankrupt (see - Dwyer v Ross (1992) 34 FCR 463).

However, it has also been argued that the interests of takers in default do not have a vested interest in the assets of the trust until the trust vests, and until that event occurs, the assets of the trust have not been the subject of an effective appointment.

That is, such interests can be deferred or taken away at any time prior to vesting or termination of the trust and, accordingly, such interests are ‘mere expectancies’ in respect of property that is not capable of vesting in a trustee in bankruptcy.

The preferred position adopted by the cases remains that a default beneficiary does not have an interest in trust assets that amounts to property that is attackable by a trustee in bankruptcy.

This said, it is always appropriate, when establishing a trust, to consider carefully who should be nominated as the default beneficiaries to ensure that the assets of the trust do not become unnecessarily exposed to claims against those beneficiaries if the law in this area changes.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Psychedelic Furs song 'All of this and nothing’.

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A room without a door** - Default income provisions for family trusts

Following last week’s post, another issue that arises relatively regularly in relation to family trusts is the trust deed not containing a default provision for the distribution of trust income.

While there are many competing arguments, the preferred position appears to be that the absence of such a clause should not make the trust invalid.

This said, without the inclusion of a default income provision, it will generally be the case that a failure by a trustee to validly distribute income in any particular year will mean that the income is accumulated and the trustee will be taxed.
An earlier post, explains that where the trustee is liable to tax this will generally be at the maximum rate of personal tax – that is including the Medicare levy and similar surcharges and without access to the general 50% CGT discount.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Psychedelic Furs song 'Love my way’.

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Trust deeds and default provisions – (Forever) Now:** who wants to be the test case?

We have received some feedback about the following comment in a recent post, namely:

‘There is also a risk that if there is no valid default or gift over provision, then the assets of the trust pass on a resulting trust to the settlor. This outcome is at best problematic, particularly given that the settlor is often an unrelated third party such as an accountant or lawyer.’ (extracted from an earlier post)

The debate about whether discretionary trusts need provisions that detail how assets will be distributed in the event of a trustee failing to make a decision is longstanding, and arguably unresolved.

For those wishing to avoid being the subject of the next test case to resolve the issue, the conservative view appears to be that the lack of a default provision for capital means the trust may be held to be void. If this is the case, the invalidity will be deemed to be from the date of creation of the trust, however only if the trustee fails to make a determination to distribute all of the capital on or prior to the vesting day.

While it is often possible to amend a trust deed to insert a default provision for capital, this amendment can potentially result in capital gains tax and stamp duty being payable on the gross assets of the trust – generally an unacceptable risk.

Specific advice should always be obtained, however practically the approach adopted is often as follows:

1. continue to use the trust for the assets that it already owns;
2. take all reasonable steps to ensure that the trustee exercises its discretion prior to the vesting day to distribute the capital of the trust to any of the named beneficiaries;
3.  where possible (once the lack of a default provision is identified), ensure that the trust does not acquire any further assets; and
4. if the group wishes to acquire further assets within a trust structure, a new trust should be established ensuring that it has none of the technical deficiencies the problematic trust deed contains.

As usual, please make contact if you would like access to any of the content mentioned in this post.

** For the trainspotters, the title of today's post is riffed from the Cold Chisel song 'Forever Now’.

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