SMSFs warned on common issues with unit trust deeds

However, Mr Backhaus warned that trust deeds for unit trusts can sometimes overlook some critical provisions.

“Where a unit trust is lacking some of the key provisions, the deed should be varied to minimise the risk moving forward.”

Mr Backhaus noted that there are many unit trust deeds that were prepared many years ago and do not reflect the range of trust, tax, and other legal developments since they were originally prepared.

It is also important to be aware, he said, that unless a unit trust qualifies as a fixed trust, the trust will be treated as non-fixed.

“The ordinary and statutory income of a non-fixed trust distributed to an SMSF can be taxed at 45 per cent instead of the concessional tax rate of 15 per cent and 0 per cent if the SMSF is in pension mode,” he warned. 

“The ATO’s current administrative practice generally accepts that many unit trusts should not be subject to non-arm’s length income at 45 per cent provided distributions of distributable income are made in proportion to each unitholder's equity ownership and there is no exercise of discretion regarding distributions. [However], this current ATO administrative practice could change without notice, and accordingly, should not be relied upon.”

In order to check whether a unit trust satisfies a fixed trust definition, Mr Backhaus said SMSF professionals should check the voting threshold to vary the unit trust deed.

“Unless 100 per cent of unitholders must consent to a variation, the unit trust may not qualify as a fixed trust for the purposes of Schedule 2F of the ITAA 1936.”

Mr Backhaus also noted that as is no fixed or normative definition of unit trust, there is also no normative definition of fixed trust.

“In particular, the type of fixed trust that is needed depends on the purpose and intended use of the trust, eg, NSW land tax has its unique definition of ‘fixed trust’. The NSW definition of fixed trust differs to the definition of fixed trust for Schedule 2F of the ITAA 1936 purposes and these two definitions differ to the meaning of fixed trust for trust law purposes.”

“Thus, when referring to a fixed trust, you need to be more specific in relation to what type of fixed trust you need.”

Despite the complexity of the law in this area, Mr Backhaus warned that some suppliers market their unit trusts as fixed trusts but include discretionary classes of units with flexible distribution entitlements which would make them non-fixed.

If a trust does not qualify as a fixed trust under the legislation in the relevant jurisdiction, Mr Backhaus warned there may be higher land tax payable.

“For example, New South Wales has a very strict definition of fixed trust in order to obtain the land tax threshold, the threshold is $822,000 for the 2022 calendar year.”

“A discretionary or non-fixed trust (referred to as a ‘special trust’ in NSW) is not entitled to any land tax threshold and therefore pays an extra $13,152 per annum in land tax for 2022 compared to a fixed trust (based on a 1.6% land tax rate on the unimproved value of land).”

Given that unitholders can also be liable for trust liabilities depending on the wording of deed, this is another critical thing to review, said Mr Backhaus.

“As a principle of law, the trustee’s right of indemnity against liabilities properly incurred in the execution of its duties is not limited to the trust property but extends, where the trust assets are insufficient to satisfy the indemnity, to a right of indemnity against the beneficiaries.”

“Given this principle, to afford unitholders with protection against personal liability, appropriate wording must be included in the deed to limit the liability of unitholders to the assets of the trust. Otherwise, unitholders’ personal assets may be exposed to risk.”

Mr Backhaus said its therefore very important that each unit trust deed is examined to ensure it is appropriate and does not expose unitholders to unwanted liabilities. 

Where the unit trust deed does need to be varied, Mr Backhaus warned that great care and caution need to be exercised as a resettlement can give rise to significant tax and duty liabilities.