If you are getting into property (and you are worried about tax deductions and property tax), you will want to know about this in detail. You will have many other valid reasons to do so, below – but also, please know that a large proportion of people who get serious with property use unit trusts.
First of all, what is a unit trust?
In Australia, a unit trust is a type of trust where the beneficial interest in the trust is divided into units that are owned by the unit holders. A unit holder is an individual or entity that holds one or more units in the trust, and the value of the units is determined by the net asset value (NAV) of the trust.
Unit trusts are commonly used in a range of investment structures, such as managed funds, real estate investment trusts (REITs), and infrastructure funds. They are also used in joint venture arrangements, where the unit holders can pool their resources and share in the profits and losses of the venture.
What is unit pricing?
One of the key features of a unit trust is the concept of unit pricing, which is used to determine the value of the units in the trust. The unit price is calculated by dividing the NAV of the trust by the number of units on issue. As the NAV of the trust fluctuates over time, the unit price will also fluctuate, and unit holders can buy or sell their units at the prevailing unit price.
Another important feature of a unit trust is the concept of limited liability. As unit holders only own the units in the trust and not the underlying assets, they have limited liability for any debts or obligations of the trust. This means that their liability is limited to the value of the units they hold and they are not personally liable for any debts or losses incurred by the trust.
Overall, unit trusts are a popular investment structure in Australia due to their flexibility, simplicity, and tax efficiency. They are regulated by the Australian Securities and Investments Commission (ASIC) and are subject to various laws and regulations to ensure that they operate fairly and transparently for the benefit of investors.
That may sound a bit stuffy – here’s a more casual take on it. Picture this – a trust that’s been cut into a bunch of itty-bitty pieces, like a trust jigsaw puzzle! Each piece is called a unit, and the beneficiaries buy these units just like they would buy shares in a company. But don’t be fooled, these units come with benefits that make a Costco membership look like small fry.
For example, a beneficiary who holds a unit in a unit trust gets a slice of the income and capital of the trust that’s proportionate to the number of units they hold. It’s like owning a slice of a pizza, only instead of pizza toppings, it’s money and assets. Yum!
But wait, there’s more! Some unit trusts have different types of units that come with different perks, just like those fancy credit cards with the exclusive memberships. And unlike a beneficiary in a discretionary trust, a unit holder may actually own a piece of the property that the trust holds – like a little square of real estate heaven.
Now, if you’re a fan of tax lingo, you’ll be pleased to know that a unit is a CGT asset, which means that when you sell it, you’re selling the unit itself and not your interest in the underlying trust property. Confused yet? Don’t worry, it’s a bit like buying a collectible toy and then selling the toy itself, rather than the joy it brought you. It’s all good fun, and don’t forget to check out TD 2000/32 for the full scoop.
What is TD 2000/32 – CGT and unit trust tax?
TD 2000/32 is a Taxation Determination issued by the Australian Taxation Office (ATO) that provides guidance on how to determine the cost base and reduced cost base of a unit in a unit trust for capital gains tax (CGT) purposes.
The determination addresses two specific scenarios: the first is where a unit holder acquires units in a unit trust, and the second is where a unit holder disposes of some or all of their units in a unit trust. In both cases, the determination provides guidance on how to determine the cost base and reduced cost base of the units, which are used to calculate any capital gains or losses that may arise from the disposal of the units.
The cost base of a unit is the amount that a unit holder has paid to acquire the unit, plus any incidental costs associated with the acquisition, such as brokerage fees. The reduced cost base of a unit is the cost base of the unit minus any non-deductible costs associated with the acquisition, such as stamp duty.
The determination provides detailed guidance on how to calculate the cost base and reduced cost base of units in various scenarios, such as where the units are acquired at different times or at different prices, or where there are different classes of units with different rights and obligations.
The determination also addresses the issue of how to apportion the cost base and reduced cost base of units where the units are held for both income-producing and non-income-producing purposes. In general, the cost base and reduced cost base of the units are apportioned based on the proportion of the trust’s income that is derived from income-producing activities, such as rent or interest.
Finally, the determination provides guidance on how to calculate the capital gain or loss that arises from the disposal of units in a unit trust. This involves comparing the sale price of the units with the cost base or reduced cost base of the units, and applying various adjustments for any incidental costs associated with the disposal, such as brokerage fees.
Overall, TD 2000/32 is an important document for unit holders in unit trusts as it provides detailed guidance on how to calculate the cost base and reduced cost base of units for CGT purposes, which is essential for determining any capital gains or losses that may arise from the disposal of the units. While it is a technical document that may be difficult for the average person to understand, it provides valuable guidance for those who are required to calculate capital gains and losses in relation to their investments in unit trusts.
Introducing new people to the trust?
However, it is easier to introduce new partners to unit trusts, because of the value shifting rules gap. That is because the introduction of new equity partners into a business can be made easier in certain circumstances when there are no value shifting rules that apply. Value shifting rules are tax rules that are designed to prevent the transfer of value between entities without a corresponding transfer of ownership, which can potentially reduce the amount of tax that is payable by one or more parties.
When value shifting rules do not apply, it can be easier to introduce new equity partners into a business because there are fewer tax consequences to consider. For example, if a new equity partner is introduced by issuing additional shares in the company, and there are no value shifting rules that apply, then the introduction of the new equity partner will not trigger any capital gains tax (CGT) or income tax consequences for the existing shareholders.
Value shifting rules can apply in a range of scenarios, such as when there is a change in ownership of a company or when there is a restructure of a business. These rules are designed to prevent certain transactions that may shift value between entities, such as the transfer of assets or the provision of services, which could reduce the amount of tax that is payable by one or more parties.
For example, if a company transfers an asset to another entity for less than its market value, the value shifting rules may apply to prevent the company from claiming a tax deduction for the loss on the transfer, and to require the other entity to include the value of the asset in its assessable income. This can make it more difficult to introduce new equity partners into a business because the tax consequences of the transfer may make it less attractive for the parties involved.
In summary, the introduction of new equity partners into a business can be easier when there are no value shifting rules that apply because there are fewer tax consequences to consider. This can make it more attractive for businesses to bring in new partners and can help to facilitate the growth and development of the business over time. However, it is important to note that value shifting rules can apply in many scenarios, and it is essential to seek professional advice to determine whether these rules apply in any specific situation.
In many instances, unit trusts are also perceived to have less regulation than companies, but that does vary from situation to situation. Unit trusts are regulated under the Corporations Act 2001 (Cth) and the Australian Securities and Investments Commission (ASIC) Act 2001 (Cth), and are required to comply with various laws and regulations to ensure that they operate fairly and transparently for the benefit of investors. This includes requirements relating to disclosure, financial reporting, governance, and the management of conflicts of interest.
Companies, on the other hand, are subject to similar laws and regulations as unit trusts, but may also be subject to additional requirements depending on their size and structure. For example, large proprietary companies and public companies are subject to more rigorous reporting and disclosure requirements than small proprietary companies, and are also subject to various corporate governance requirements, such as the requirement to have a board of directors and hold regular shareholder meetings.
Furthermore, each beneficiary has a specific share or percentage of the trust property that they are entitled to receive, and this share is fixed and cannot be changed without the agreement of all the beneficiaries.
This is in contrast to a discretionary trust, where the trustee has the power to distribute the income and capital of the trust to the beneficiaries in their discretion, without any fixed entitlements. In a discretionary trust, the trustee may choose to distribute the income or capital of the trust to different beneficiaries each year, or to the same beneficiaries in different proportions, based on their individual circumstances or needs.
In a fixed trust, each beneficiary has a defined entitlement to a specific share of the trust property, and this entitlement cannot be varied without the agreement of all the beneficiaries. This can provide greater certainty and stability for the beneficiaries, as they know exactly what they are entitled to receive from the trust, and their entitlement is not subject to the discretion of the trustee.
Unit trusts can also claim the 50 percent capital gain discount. The 50% discount method is a tax concession available to Australian residents for capital gains tax (CGT) purposes. When an asset is sold and a capital gain is made, the discount method allows the taxpayer to reduce the amount of the gain that is subject to tax by 50%.
This concession is available to taxpayers who have held the asset for at least 12 months before disposing of it, and applies to most assets, including shares and property. However, there are some exceptions, such as assets held by companies or trusts, which are not eligible for the discount method.
In the context of unit trusts, the availability of the 50% discount method for CGT purposes depends on a number of factors, including the structure of the trust and the nature of the asset that is being sold. In general, if the unit trust holds assets that are eligible for the discount method and the units have been held for at least 12 months, then the discount method can be used to calculate the CGT liability.
However, if the unit trust holds assets that may not be eligible for the discount method, potentially property used for income-producing purposes or shares in a company, then the discount method may not be available. In addition, if the units in the trust are held for less than 12 months, then the discount method cannot be used to reduce the CGT liability.
Overall, the availability of the 50% discount method for CGT purposes in relation to unit trusts depends on a range of factors, and it is important to seek professional advice to determine whether the discount method can be applied in any specific situation.
If you are looking at unit trusts, you can’t get past Capital Gain Tax Events, CGT events for short. Specifically, E4.
But first what is Capital Gain Tax?
Capital gains tax (CGT) is a tax that is applied to the profit or gain that is made when a capital asset is sold, gifted or otherwise disposed of. In Australia, CGT is generally payable on the sale of most assets, including real estate, shares, business assets, and personal assets such as artworks and collectibles.
Under the Australian tax system, CGT is calculated by subtracting the cost of acquiring and maintaining the asset from the sale price or market value of the asset at the time of its disposal. The resulting amount is the capital gain, which is then added to the individual’s taxable income for the year in which the asset was disposed of. The amount of CGT payable depends on the individual’s marginal tax rate and the length of time that the asset was held, with a lower tax rate applied to assets that have been held for more than 12 months.
There are certain exemptions and concessions available under Australian law that may reduce or eliminate the amount of CGT payable on the sale of certain assets. For example, the family home is generally exempt from CGT, as are assets held by individuals with a total capital gain of less than $10,000 in a financial year. Other concessions are available for small businesses, such as the small business CGT concessions, which can reduce the amount of CGT payable on the sale of eligible business assets.
It is important for individuals to be aware of their CGT obligations when disposing of assets, and to seek professional advice to ensure that they are claiming all available exemptions and concessions, and that they are meeting all of their tax obligations under Australian law.
Now, that’s covered. Let’s look at specifics.
What are CGT events & how do they apply to Unit trusts?
A CGT event is a transaction or event that triggers the calculation and potential liability for capital gains tax (CGT) on a particular asset.
There are a number of different types of CGT events that can trigger a CGT liability, including:
Selling or disposing of an asset: This is the most common type of CGT event, and occurs when an individual sells or otherwise disposes of an asset, such as real estate or shares.
Transferring an asset: This type of CGT event occurs when an individual transfers an asset to another person, either as a gift or as part of a business transaction.
Ceasing to own an asset: This type of CGT event occurs when an individual ceases to own an asset, such as when an asset is destroyed or lost.
Changing the ownership structure of an asset: This type of CGT event occurs when an individual changes the ownership structure of an asset, such as transferring an asset from personal ownership to ownership by a company or trust.
Granting or creating a lease: This type of CGT event occurs when an individual grants or creates a lease over an asset, such as a commercial property or a vehicle.
Compulsory acquisition of an asset: This type of CGT event occurs when an individual’s asset is compulsorily acquired by a government or other authority, such as in the case of land acquisitions for public works.
When a CGT event occurs, the individual must calculate the capital gain or loss on the asset, which is the difference between the asset’s cost base (i.e. the cost of acquiring and maintaining the asset) and its sale price or market value at the time of disposal. The amount of capital gain or loss is then added to the individual’s taxable income for the year in which the CGT event occurred, and may be subject to CGT at the individual’s applicable tax rate.
So how about Unit Trusts?
For unit trusts, CGT events can occur when a unit holder sells or disposes of their units in the trust. In this case, the unit holder is required to calculate the capital gain or loss on the units, based on the difference between the sale price of the units and the cost base of the units (which includes the cost of acquiring and maintaining the units). The resulting capital gain or loss is then added to the unit holder’s taxable income for the year, and may be subject to CGT at the unit holder’s applicable tax rate.
In addition, certain CGT events can occur within the unit trust itself, such as the disposal of assets held by the trust, the transfer of units between unit holders, or the restructure of the trust. In these cases, the trustee of the unit trust is responsible for calculating the capital gain or loss on the relevant assets or units, and the resulting gain or loss may be distributed to the unit holders in proportion to their holdings.
It’s important to note that the rules and requirements for calculating CGT events in unit trusts can be complex, and can vary depending on the specific terms of the trust deed and the nature of the assets held by the trust. As such, it’s recommended that unit holders seek professional advice to ensure that they are meeting their tax obligations and claiming all available exemptions and concessions when it comes to CGT events and unit trusts.
What about E4?
CGT event E4 is a type of capital gains tax event that occurs when a trust disposes of a CGT asset and makes a capital gain. It is specifically applicable to unit trusts in Australia, and refers to the disposal of an asset that is used in the business of the trust and has been owned for at least 12 months.
When a unit trust disposes of such an asset, a capital gain is made and this is required to be reported on the trust’s tax return under label E4. The net capital gain, which is the capital gain made from all CGT events minus any capital losses incurred during the same financial year, is then added to the trust’s assessable income and taxed at the applicable rate.
It’s important to note that the calculation of the capital gain for CGT event E4 can be complex, and may require the assistance of a tax professional to ensure that it is calculated correctly and all available concessions and exemptions are claimed. Failing to report a capital gain from CGT event E4, or incorrectly calculating the capital gain, can result in penalties or fines from the Australian Taxation Office.
A bit more about unit trust tax & CGT event E4?
CGT event E4 is a special little rule that only applies to fixed or hybrid trust interests. That’s right, folks – it’s a trust thing.
So, let’s say your trust makes a distribution and some of that payment is non-assessable income. What does that mean? Well, it means that part of the payment won’t be counted as taxable income, which is great news for you. But wait – there’s more!
That non-assessable part will actually reduce the cost base of your trust interest, or could even result in a capital gain. It’s like a tax magic trick – now you see it, now you don’t!
Some common situations that trigger CGT event E4 include distributions from a fixed trust for the small business 50% reduction, or depreciation of furniture and fittings in Div 40 and building structures in Div 43. Because nothing says fun like depreciating furniture and fittings, am I right?
Think of it like this – let’s say your trust made a cool $1 million in profit, but then claimed $100,000 in Div 43 depreciation. Now your net income is only $900,000, but you still have that $1 million sitting in the bank. So when you pay out that $1 million to your unit holders, they only have to pay tax on $900,000. It’s like getting a discount, but for taxes!
So, there you have it – CGT event E4 is all about that sneaky little gap between what you earned and what you actually have to pay tax on. Just don’t try to pull any trust-related magic tricks without a tax professional on hand, or the ATO might have a few tricks of their own up their sleeves.
I have done a larger article on E4. https://www.mytaxguy.com.au/which-cost-base-elements-apply-to-you/
If you still more information on this (be warned unit trust and tax can get very complex – and it is strongly recommended to get the advice of a tax or legal professional e.g. none of the above could be applicable to your individual case):
Unit Trusts – CGT: https://www.taxtalks.com.au/articles/cgt-event-e4/
Unit trusts – overview: https://www.ato.gov.au/Business/Structures/Unit-trusts/
Taxation of unit trusts: https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Calculating-a-capital-gain-or-loss/Taxation-of-unit-trusts/
Taxation Ruling TR 2010/3: Income tax: the taxation of capital gains of non-resident beneficiaries of non-fixed trusts: https://www.ato.gov.au/law/view/document?docid=TXR/TR20103/NAT/ATO/00001
Taxation Ruling TR 2004/15: Income tax: capital gains tax: meaning of the words ‘absolutely entitled to a share of a trust estate as against the trustee’ in section 97 of the Income Tax Assessment Act 1936: https://www.ato.gov.au/law/view/document?docid=TXR/TR200415/NAT/ATO/00001
Taxation Determination TD 2008/25: Income tax: capital gains: are capital gains or losses made by a fixed trust with an interposed company distributed for the purposes of Division 7A of Part III of the Income Tax Assessment Act 1936?: https://www.ato.gov.au/law/view/document?docid=TXD/TD200825/NAT/ATO/00001