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Pros and Cons of Unit Trusts?

Discussion in 'Accounting, Tax & Legal' started by Crusher, 31st Jul, 2008.

  1. Crusher

    Crusher Well-Known Member

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    I am looking at starting an investment club and i've read up on these unit trusts.. Anyone had much to do with these? Seem to be pretty easy to follow and calculate?
     
  2. DaveA

    DaveA Well-Known Member

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    except tax liability when units are redeemed... It can effectively be double taxation. Ie unit trust buys a property and issues 1000 units to 10 people (100 units each). The trust has a life of 8 years. After 4 years Mr Jones thinks he is very happy with the profit made to date, so he redeems his units. The property bought for 100k is now worth 200k. So Mr Jones gets double his investment back, pays his cgt and is on his merry way.

    Problem is, the cost base for the asset hasnt been reset even though someone has paid his share of tax. For this to be effective, the asset needs to be sold before anyone redeems there units....
     
  3. Crusher

    Crusher Well-Known Member

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    Thanks for the heads up. What about a unit trust that invests in shares? Am i on the right track with this example:

    10 investors, all put in say.. $1000 each. a unit is equal to $1 for now.

    $10000, then buys say 10,000 shares in XYZ @ $1 per share.

    The share then goes to $1.10, so each initial investors unit is now worth $1.10 per unit.

    say investor #3 wishes to pull out and is happy with their 10% profit. is there much complication with this? what are some ways of exiting the fund? would you simply sell 10% of the investment to pay his money out? or could you perhaps buy the units off him from another investor within the club / fund?

    And one other thing, am i right of even thinking this is a unit trust? :confused: or is this just more of an investment club / managed fund type setup?

    Any advice would be great, thanks.

    p.s. i will be seeing my accountant in a fortnight and will be discussing potential strategies involved in this method. Thanks
     
  4. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    I guess you could have someone else buy the units off him - assuming the trust deed for the unit trust allowed such a transaction.

    Normally you would sell enough assets to cover the withdrawal of units, but the problem there is that any realised profits need to be distributed amongst all unit holders equally - thus they receive a distributed capital gain without having actually sold anything themselves (you see this with managed funds too).

    For unit trusts with large numbers of unit holders, this is not such a big deal, but it can be quite troublesome for smaller unit trusts.
     
  5. Crusher

    Crusher Well-Known Member

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    Ahh yes, i see what you mean.

    It might be worth making special not within a contract for other members to buy units from each other if they wish to sell.

    Is this a problem many small unit trusts have? people wanting to exit, etc.. ?

    by selling off some of the trusts assests to cover the member wishing to exit, i cannot see how this will affect the current capital gain for the investment?
     
  6. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Using your example:

    10 investors, put in .. $1000 each. a unit is equal to $1 for now. Each investor has 1000 units with 10,000 units in total issued.

    Capital available is $10000, buys 10,000 shares in XYZ @ $1 per share (ignoring brokerage).

    The share then goes to $1.10, so net asset value = $11,000, with unit price now $1.10

    One investor wishes to redeem his 1000 units @ $1.10 ($1100)

    Trust sells 1000 shares (worth $1100 ignoring brokerage again), so trust now has $9900 worth of shares + $1100 in cash.

    Note that in selling those shares, the trust realises a $100 capital gain (cost price $1000, sale price $1100).

    Trust then uses $1100 to fund redemption of 1000 units @ $1.10

    Investor gets $1100 and declares a $100 capital gain from the transaction (bought 1000 units $1.00 = $1000 cost, and sold 1000 units @ $1.10 = $1100 ... $100 gain).

    Trust now has 9,000 units on issue and assets of $9,900, thus unit price remains at $1.10 ... but the trust also has a tax liability of $100 from the realised capital gain.

    Thus come tax time, the trust must distribute $100 between 9000 units = 1.1111c per unit distribution of capital gains. We'll say there has been zero income from the shares this financial year.

    (Note that at this point, I'll also ignore the complication that the trust would have to sell off more assets to be able to pay the distribution, thus realising further capital gains).

    Immediately after distribution, trust has $9,800 worth of assets with 9,000 units on issue, thus unit price drops to $1.0889, and remaining unit holders declare the 1.1111c * 1000 units = $11.11 capital gain they received in their own tax returns.

    Make sense?