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.

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

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