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Reinvesting distributions of unit trust

Discussion in 'General Investing Discussion' started by tommyx, 14th Feb, 2013.

  1. tommyx

    tommyx New Member

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    If I were to set up a unit trust, can you frame it so that the Trustee is obligated to reinvest the annual distributions back into the same unit trust until the trust is vested? The idea being that the investment assets are optimised until the stipulated date of vesting, thereby maximising the potential return of the trust, as opposed to losing capital every time you distribute annually?

    Thanks in advance.
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    That's a good question - I'm not a trust lawyer, so I'm not exactly sure about what is possible and the ramifications of doing so, however, in general it is entirely up to the trust deed to determine the obligations of the trustee and how much discretion they have for certain activities.

    Withholding income might fall into this category - but that's withholding, not distributing income - I believe that once a distribution has been declared, the unit holders have a legal right to claim that money and the trustee must pay it to them.

    There are potentially tax implications for unit trusts not distributing income - I'm not sure how the ATO treats that and whether it is different to discretionary trusts which get taxed at the highest marginal rate for any income not distributed.

    As far as compelling distributions to be reinvested - I really wouldn't think that would be possible - once a distribution has been declared, the unit holder gains a benefit from the trust and is obliged to declare that income for tax purposes. This may lead to a tax burden if they are not able to use the income because they had no choice but to reinvest it.

    So I think the question is - how much discretion can a trust deed bestow on the trustee to NOT declare a distribution and instead reinvest that income, and what are the tax implications for the fund in doing so?

    I'm guessing that some managed investment schemes might use a mechanism similar to this - and they possibly need to apply to the ATO for a special ruling to determine how they are taxed for certain activities.

    I'd be quite curious to know the answer!
     
  3. tommyx

    tommyx New Member

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    Thanks Sim.

    You have basically echoed my preliminary thoughts on the whole idea. I think it would definitely have to be set-up as a discretionary trust, with strict duties imposed upon the Trustee/s to ensure reinvestment.

    At this stage, I cannot see any way to avoid paying tax on annual profit at the highest (individual) tax rate, if you want to insist on reinvesting (as opposed to distributing to low-income beneficiaries, etc.).

    Any other thoughts appreciated.

    Thanks Sim.
     
  4. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    In some circumstances, you can use a company as a beneficiary of the trust, distribute income to the company, pay tax at company rates, and have the company gift/lend money back to the trust for further reinvestment without declaring a dividend to shareholders (who might be the investors, or perhaps a single shareholder being the unit trust which the investors hold units in).

    Some investors might still be worse off if their personal tax rate is lower than the company tax rate, but at least it's not penalty rates.
     
  5. Terryw

    Terryw Well-Known Member

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    I think it is s99 of the ITAA 1936 which makes a trustee liable for undistributed income at the top rate.

    Using a company may be better if this is the intention. A company gifting money could pose a few problems under the Corporations Act
     
  6. GregR

    GregR Reid Consultants

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    The issue is distributing profits from trusts fully or top tax rate applies. That does not mean to say if you use a unit trust, why cannot additional units be purchased with the monies/income distributed? You still run into the individual beneficiaries tax obligations but the additional units purchased could be net of tax.

    If you are using a discretionary trust, then Sims idea of a company as a beneficiary and lend back money could work to reduce the overall tax impost.

    Greg
     
  7. Kelly Black

    Kelly Black Member

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    Hi Tommy,
    As previous replies have stated, leaving the income of the trust undistributed would mean the trustee would be taxed at the highest rate of tax.
    Distributing to a company would work to lower the tax paid. However gifting or lending the money back both have implications that would be better avoided. Your best bet may be to issue further units in the trust each year, which the company can then buy with the prior years distributions after tax. I would think this would work well with a unit trust
    Kelly