SMSF Unit Trust buys a necklace for wife – now what?

SMSF Unit Trust buys a necklace for wife – now what?

SMSF Unit Trust. Do you operate a Unit Trust where your Self-Managed Superannuation Fund owns some or all the units? If so you have a ‘related unit trust’.

A related unit trust is an SMSF unit trust. An SMSF is not permitted to invest more than 5% in a related trust, including any other “in-house” asset. For example, an SMSF with $1 million of assets could not invest more than $50,000 in in-house assets, including any related trust. A related trust includes a unit trust where an SMSF member and his or her associates hold more than 50% equity, exercise significant influence in relation to the trust, or can hire or fire the trustee. Under the in-house asset rules, if an SMSF held up to 5% of its assets in units, that SMSF unit trust could invest in a real estate property where the other units are held by related parties, such as family members or a family discretionary trust.

This is a common and useful structure for holding real-estate. Through a Unit Trust, individuals and SMSFs can pool their resources to buy a bigger investment property.

However, we are seeing 3 common problems:

  1. SMSF Unit Trust buys a gift for a wife

    Be careful not to pay any personal expenses from the Unit Trust. This creates a non-complying loan from the trust to you. Unless your Unit Trust is pre-August 1999, your SMSF is potentially in breach. The Unit Trust Deeds built on our law firm’s website allow you to rectify. This is, generally, without the Auditor being required to note the matter to the ATO. Just follow the rules set out in the Unit Trust (see our Unit Trust here).
  2. Journal entries instead of actual payments

    The second common issue is failure to physically pay distributions to the SMSF each year. Sure, this is not required under a modern Unit Trust Deed, it is required by the Superannuation legislation. A movement from the Unit Trust bank account to the SMSF bank account is required. Journal entries don’t satisfy the Superannuation law. Failure to physically pay may cause an unpaid present entitlement, which the Superannuation will deem a ‘loan’. And you now have a potential in house asset breach.
    Rectification is possible under our law firm’s Unit Trust Deed, but only if you deal with it in time. Otherwise, the SMSF needs to sell its interest in the Unit Trust.
  3. Members also have units in the Unit Trust

    An SMSF is not permitted to invest more than 5% in a ‘related trust’. If your SMSF has $2m then it can only invest $100,000 in in-house assets, including any related trust.
    A ‘related trust’ includes a unit trust where an SMSF member and associate:
  • hold more than 50% of the units; or
  • exercise significant influence over the trust; or
  • can hire or fire the trustee.

Therefore, if an SMSF held up to 5% of its assets in units, that unit trust can invest in a real estate property – even though the other unit holders are the members, their family and Family Trust (‘associates’).

Non-geared unit trusts permit an SMSF to invest up to 100% of its assets in the related unit trust. This is provided the unit trust satisfies the strict regulations. Failure results in the units becoming in-house assets. Remember an SMSF cannot hold more than 5% of the portfolio in-house assets.
A non-geared unit trust works best holding real-estate with no borrowings against the title deeds.

3 Comments

  1. Martin says:

    You make the comment that if a unit trust pays personal expenses this creates a non-complying loan, unless the trust is pre-August 1999. Does this mean that if a unit trust is pre-August 1999 it could potentially make a loan to a member and the super fund would not be in breach of the in-house assets test, sole purpose test or any other SIS regulation?

    • Brett Davies says:

      Pre-11 August 1999 investments were exempted from the new SMSF rules. They were protected by transitional rules but they finished 30 June 2009. After 2009 these pre-1999 unit trusts may still hold the borrowings. However, they must now distribute all income to the SMSF unitholder by making a physical payment. (They no longer can apply trust income to repay the principal.) Subject to the terms of the pre-99 Unit Trust, consider:
      (i) converting the existing loan to an interest only facility
      (ii) ensuring that the capital repayments are less than non-cash deductions

      The lender did not have to be an unconnected entity, so a related party could advance a new loan. However, it must be on market terms – arms-length interest rate, appropriate loan agreement). Division 7A may be a factor if the lender is a company, as they often were.

      Pre-1999 unit trusts are not completely excluded from the related party rules, so there is scope to not be bound by the in-house asset and other rules. But the area is complex and I would need to look at what you have to avoid an inadvertent breach.

  2. Alexander Fullarton says:

    The question is was this a gift or trinket for personal use or in fact an investment? Perhaps the trust has invested in a collectable with a value in excess of $10 k with a view that it will increase its intrinsic value over time. That expected capital gain could far exceed other income from non-personal exertion. Perhaps the wife is simply hiring the necklace to attend the Governor’s Ball for which she pays a fee.

    Mind you Fullarton would warn of the use of Uses – (Alexander Robert Fullarton, The Artful Aussie Tax Dodger: 100 years of tax reform, 2017). He might suggest that even the existence of a Trust implies the existence of a tax avoidance scheme. (and he would be right).

    If it were a genuine investment then why wasn’t it a 1930 penny – might it be that you can’t wear a penny to the Governor’s Ball? Remember if it waddles like a duck, quacks like a duck, has feathers and flies, chances are – it’s a duck. (Geese and Swans honk).

    We all have to be aware though that tax avoidance per se is not illegal or immoral, it is just inconvenient to Revenuers. Some would say minimising corporate tax burdens is the duty of directors just as cutting any cost of operation. The role of directors is to grow the company and maximise profits for the shareholders. There are some very thin lines between prudent, inconvenient, immoral and illegal..

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