Fund structures: choosing a unit trust or company

A unit trust is, in the ordinary case, transparent for tax purposes. If the trustee distributes the trust's full taxable income to unitholders each year, the trust itself is not the taxpayer; the income retains its character (interest, rent, a capital gain, a franked distribution) as it passes through to the investor, who is taxed according to their own circumstances. This is what practitioners mean by flow-through: the fund is a conduit, not a tax paying entity in its own right, provided income is not retained inside it.

A company is different in kind. It is a separate taxpayer. Profits are taxed at the company level, and if those profits are later paid out as dividends, the imputation system (franking credits) is designed to relieve double taxation on the distributed portion, though the mechanics and the investor's own tax position determine how much relief actually results. Losses are trapped inside the company rather than flowing through to shareholders, and the character of underlying income does not pass through as it does in a trust; a dividend is a dividend, whatever generated it.

This single distinction, transparent conduit against separate taxpayer, is the reason so much of the Australian funds industry defaults to the trust for income oriented, distributing vehicles and reserves the company for a narrower set of purposes.

A trust has no independent legal personality; the trustee holds the assets and administers the arrangement on the terms of the trust deed, owing fiduciary duties to beneficiaries under general trust law. Where the trust is a managed investment scheme with more than one member and centralised management, and particularly where it is offered to retail investors, the trustee typically takes the form of a responsible entity holding an Australian Financial Services Licence authorising it to operate a registered scheme under Chapter 5C of the Corporations Act 2001 (Cth), with duties to act in members' interests, keep scheme property separate from its own and comply with the scheme's constitution and compliance plan.

A company has its own legal personality. It is governed by a board of directors who owe their duties to the company itself, not directly to any individual shareholder, a materially different structure from a trustee's duty running to the beneficiaries. Shareholders' rights are defined by the company's constitution and the general member protections in the Corporations Act; a shareholder cannot compel a distribution the way a properly drafted trust deed can require distribution of trust income.

In a unit trust, a unitholder holds a beneficial interest in the trust assets, proportionate to the units on issue, with entitlements to income and capital defined by the trust deed. In a registered scheme that is liquid, members typically have a statutory right to withdraw on the scheme's terms. In a company, a shareholder holds a share, a form of personal property carrying voting rights and a right to a dividend only once and if the board declares one, subject to solvency. There is no equivalent statutory withdrawal right; exit ordinarily happens by transferring or selling the share, or through a buy back if the company undertakes one.

The practical consequence: investors who want a direct, tax transparent claim on underlying cash flows and periodic liquidity tend to be unitholders. Investors comfortable with an intermediated, board controlled claim on residual value, more typical of a trading or holding entity than an income distributing pool, tend to be shareholders.

Income distributing strategies, unlisted property, private credit, infrastructure income and similar pooled vehicles that exist to pass rent, interest and capital gains through to investors each year are naturally suited to a trust. Investors want the character of the underlying income preserved, a capital gain taxed as a capital gain, potentially eligible for a discount investors could not access through a company, and want distributions to happen as a matter of course under the deed rather than at a board's discretion. Open ended vehicles that admit and redeem investors on a rolling basis also sit more naturally in a trust structure with a defined unit pricing mechanism than in a share structure built around a fixed number of shares on issue.

A company suits strategies built around reinvestment rather than distribution: growth or early stage vehicles where the intent is to compound value inside the entity rather than distribute income annually, joint ventures where a shareholders' agreement and distinct share classes are the more familiar mechanism to counterparties, and structures that need to be recognised in a straightforward way by offshore investors or lenders more accustomed to corporate entities than trusts. A company is also commonly used as the corporate trustee of a trust, or as a special purpose co-investment vehicle sitting alongside a trust in a layered structure, rather than as the primary fund vehicle itself.

Before settling on a vehicle, a promoter needs answers to a short list of questions, because each one changes the licensing, disclosure and governance burden that follows.

The vehicle decision is made once, early, and is expensive to unwind once investors are admitted and assets are held in the structure's name. It should follow from the investment strategy and the investor base actually being targeted, income distributing or reinvesting, retail or wholesale, liquid or fixed term, rather than from habit or precedent. Getting the mechanism right at formation avoids restructuring a live fund later, which is materially harder than choosing correctly the first time.