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’.

View here:

What are the broad alternatives for professionals not wanting to use service trusts?

As set out in earlier posts, and with thanks to the Television Education Network, today’s post addresses the issue of ‘What are the broad alternatives for professionals not wanting to use service trusts?’. If you would like a link to the video please let me know.

As usual, a transcript of the presentation for those that cannot (or choose not) to view the presentation is below –

There's the ability to completely restructure the existing arrangements and move into a new structure and if that alternative was to be taken, there are then a series of different arrangements that might be entered into, and that can include a new structure in total, or some sort of hybrid arrangement. 

The types of structures that are available are only really limited by your imagination in terms of what may or may not be useful. 

Obviously, there are also a number of commercial issues that need to be taken into account.  Many of those will be driven by the actual underlying nature of the partnership that’s involved, but generally there are two alternatives if you're moving out of an individual structure, and that can be to incorporate or to form some sort of trust arrangement. 

Within those two parameters or those two goalposts, there's quite a large playing field in terms of what that might look like.  So in some instances, there's a hybrid between both companies and trusts.  In other instances, there are trusts which are of a hybrid nature.  So in other words, a unit trust or some sort of partnership of trusts or a blended discretionary trust.  Again the common theme is that it’s largely driven by what's going to be most useful for the underlying partners involved.

Until next week.

Prohibitions on trust deed variations

As mentioned last week, we often find trust deeds have prohibitions on a trustee’s ability to vary the document.

Some of the issues to be aware of in this regard include:

1    Often variations can only be made with the consent of someone other than the trustee, for example an appointor, guardian or even the settlor.

2    In some cases, variations can only be made to the core (or trust) provisions of the deed, as opposed to the more general powers, which will usually limit the ability to vary the income provisions.

3    Alternatively, while powers can be added to a trust, a deed will sometimes provide that any existing powers cannot be varied – this can be particularly problematic where there is a desire to update the income distribution provisions.

4    There are countless other examples of restrictions on variations and indeed, we have come across deeds where there is a blanket prohibition on making variations to the deed, or at least on variations to particular clauses in the deed.

While there are often workarounds no matter what restriction is imposed, the fundamental rule to remember is that each and every deed must be read before embarking on a variation.

Until next week.

Settlement sums

Last week, following on from the post before Easter, we had a enquiry about the consequences of a failure to deposit the settlement sum on the establishment of a discretionary trust.

This area of the law is potentially complex, however ultimately the conservative position is that the settlement sum should always be deposited into the trust’s bank account, and ideally, it should in fact be the first deposit.

The approach of placing the settlement cheque (or a cash equivalent of it) on the file for the trust can be problematic for a range of reasons, including:

1. Where the settlement sum is by way of cheque, the cheque will normally go stale after 13 months; and

2. Even where cash is stored with the trust, it is difficult to provide documentary evidence of the settlement sum forming part of the trust if the cash is lost.

Ensuring that the settlement sum is deposited into the bank account of the trust at least avoids each of these two issues.

Until next week.

Trust establishment 101

With thanks to co View Legal director Patrick Ellwood, this week’s post concerns a recent land tax case (Aston (Aust) Properties Pty Ltd v Commissioner of State Revenue, for a full copy of the judgment follow this link – http://www.austlii.edu.au/au/cases/vic/VCAT/2012/48.html) that highlights how critical it is to ensure that new structures are established correctly.

In this particular instance the taxpayer was arguing that group land tax assessments were incorrect due to the ownership of various landholdings being via separate trusts.

The trusts that were alleged to exist were prepared by the taxpayer himself and he gave evidence that he had ‘become convinced that the process of creating multi tiered trust structures could be undertaken in an efficient manner without the need to purchase off the shelf trust deeds from solicitors’.

For a myriad of reasons the court held that the grouped land tax assessment was valid and that the purported trusts simply did not exist.

Some of the reasons the court concluded no trusts existed included:

1. there was no evidence of any settlement sum being contributed on the initial creation of the trusts;

2. no evidence could be shown in relation to funds changing hands or creation of bank accounts;

3. while the trusts were purported to be created via schedules that were recreated on numerous occasions with reference to ‘standard terms’, the link to the standard terms could not be shown;

4. of the documents that could be produced, there were a significant number of errors and inconsistencies; and

5. some transactions that had purportedly been entered into were by entities that did not exist.

With the aid of hindsight each of these difficulties identified by the court could have been very easily addressed by getting some level of specialist advice prior to the creation of the trusts.

Given the Easter break there will be no post for the next two weeks.

'Colonial' decision released

Earlier in the month the long awaited 'Colonial' decision was released by the Federal Court.

Although, unlike other tax cases last year (such as Bamford and Thomas), the taxpayer was largely unsuccessful, the Colonial decision again reinforces that the provisions of the trust deed are critical.

For those interested the full title of the case is 'Colonial First State Investments Limited v Commissioner of Taxation [2011] FCA 16' (Federal Court of Australia, Stone J, 18 January 2011).

In brief terms, the key aspects of the decision were as follows:

1. The main interest in the decision will be for the Australian funds management industry as it focussed on the tax effect of provisions in a unit trust that sought to allocate part of the taxable income to a unitholder redeeming units.

2. The tests that must be satisfied to meet the definition of a 'fixed trust' for tax purposes will be difficult for many unit trusts. Here the unit trust was held not to constitute a fixed trust, primarily due to the wide amendment power that allowed changes to be made to unitholders' entitlements. The ability to satisfy the Tax Act definition of fixed trust is important in a number of areas including -

(a) to carry forward tax losses;
(b) passing through franking credits to unit holders; and
(c) where superannuation funds are unitholders, avoiding application of the ‘non-arm’s length income’ rules (note that prior to 1 July 2007, these rules were called ‘special income’).

3. The attempt by way of variation to provide the trustee the discretion to allocate discounted and non-discounted capital gains to unitholders on redemption was ineffective.

As set out in the post on 17 December 2010, it has been confirmed that there will be a full review of the way in which trusts are taxed.

The Colonial decision further highlights the need for a comprehensive review of the existing rules and Stone J mentions the need for legislative change in this regard.

A number of commentators also believe the proposed managed investment trust attribution regime (due to take effect on 1 July 2011) may address many of the concerns raised in Colonial.
Until next week.

Complete unity in relation to tax reform for trusts

Many of you will have seen the announcement last week that each of the major taxation professional bodies have called for proper reform to the taxation of trusts.

Undoubtedly, the ongoing angst caused by the ATO’s approach on UPEs has been a significant catalyst for the call, however the reality is that the piecemeal approach to taxation of trusts has been a longstanding problem.

A full copy of the press release providing more context in this regard is set out below.

Until next week.


Four of Australia's leading professional tax and accounting bodies, representing over 100,000 accountants and tax advisers, have united to call for sweeping reforms of the antiquated laws governing the taxation of trusts.

In 2009 the ATO introduced a controversial crackdown on "unpaid present entitlements" – distributions by trusts to associated private companies that were not paid, but remained intermingled with other funds of the trust.

The professional bodies believe the Tax Commissioner's technical interpretation of the taxation laws (Division 7A of the Income Tax Assessment Act 1936) that apply to unpaid present entitlements is not supportable and is at odds with the original policy intent.

While the practice statement on unpaid present entitlements released by the ATO last week embraced some of the practical recommendations put forward by the professional bodies, the fundamental incorrectness of the ATO interpretation remains. This will increase the cost of a major source of financing typically employed in the SME market.

The professional bodies have called for an urgent test case to challenge the Tax Commissioner's interpretation of the laws that apply to unpaid present entitlements, and will raise the issue again at a meeting today in Canberra of the ATO's peak external stakeholder forum, the National Tax Liaison Group.

The recommendation is for the test case to be heard by the Federal Court and funded under the ATO's test case funding program, to provide judicial guidance on whether the Commissioner's position on this important aspect of the law is correct. The Tax Commissioner has accepted the proposition that a test case is an appropriate vehicle through which to resolve this issue.

The unpaid present entitlement issue, alongside a High Court decision earlier this year on the taxation of trust income and distributions, highlights the need for major review into the taxation of trusts. The Henry tax review, along with recommendations made recently in Treasury’s "Red Book," both indicate that the government should re-write the trust laws which are more than 50 years old and are not adequate to deal with the modern use of trusts as trading and investment vehicles.

Institute of Chartered Accountants in Australia National Institute of Accountants Taxation Institute Taxpayers Australia