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 unitholders 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’s in-house assets.
A non-geared unit trust works best holding real-estate with no borrowings against the title deeds.

Non-arm’s length income vs Unit Trusts

Now we know thanks to LCR 2021/2 the ATO’s views on duties carried out in the capacity of a trustee of an SMSF do not suffer non-arm’s length income (NALI). This is for services performed out other than as trustee.

But what about a unit trust that an SMSF invests in? Does that suffer NALI?

Unit Trust and SMSF trustee services

Consider these LCR 2021/2 comments:

Capacity in which activities are performed – self-managed superannuation funds

  1. In the context of SMSFs, it may be necessary for an individual to ascertain whether they are performing an activity as a trustee of the superannuation fund or whether they are acting in a different capacity.
  2. Given the statutory restrictions that prevent a trustee or director of a corporate trustee from receiving remuneration, paragraphs 295-550(1)(b) and (c) will not be enlivened due to the trustee or director not charging for the services performed in relation to the fund when acting in a trustee capacity. For example, the non-arm’s length expenditure provision will not apply where a trustee, acting in that capacity, performs bookkeeping or accounting services for the fund for no remuneration.
  3. However, when the trustee or director of a corporate trustee operates in another capacity and either does not receive remuneration for those services or receives remuneration in accordance with the exceptions in section 17B of the SISA, paragraphs 295-550(1)(b) or (c) may apply where the fund incurs non-arm’s length expenditure.
  4. A trustee or director of a corporate trustee of an SMSF will be required to perform particular actions in order to satisfy obligations imposed on them, including:
    • any conditions imposed by statute (for example, the SISA and the Corporations Act 2001),
    • any fiduciary conditions imposed under the law, and
    • any duties or obligations imposed under the trust deed of the SMSF.
  5. The trust deed of the SMSF may also provide the trustee or director of the corporate trustee the power to perform certain actions.
  6. An individual’s business, profession, life experiences or employment may result in the individual having skills and knowledge that can assist the individual perform their duties in their capacity as trustee, or as a director of a corporate trustee, of an SMSF. Utilising such skills and knowledge of itself does not indicate that the individual is not acting in their capacity as trustee or as a director of a corporate trustee. For example, a financial adviser who is a trustee of an SMSF can utilise their skills and knowledge in deciding the investment strategy of the SMSF in their capacity as trustee.
  7. In the context of applying paragraphs 295-550(1)(b) and (c), it is appropriate to presume that an individual is acting in their capacity as a trustee, or director of a corporate trustee, where the actions are consistent with a duty, obligation or power referred to in paragraph 44 of this Ruling, unless there are factors that suggest a contrary conclusion. Factors that indicate that the individual is performing their activities in their individual capacity and not in their capacity as a trustee, or a director of a corporate trustee, include:
    • The individual charges the complying SMSF for performing the services. However, there can be circumstances where the individual can be acting in their individual capacity even though they do not charge the SMSF for performing the services.
    • The individual uses the equipment and other assets of their business, or equipment and other assets used in their profession or employment in a material manner. However, minor, infrequent or irregular use of equipment or assets will not, of itself, indicate the individual is acting in their individual capacity. For example, in the absence of any other factor indicating otherwise, minor, infrequent or irregular use of a business computer at the office by an individual would not, of itself, indicate the individual is acting in their individual capacity.
    • The individual performs the activities pursuant to a licence and/or qualification relating to their business, or their profession or employment. That is, the activity can only be performed due to the individual or business holding the relevant licence and/or qualification.
    • The activity is covered by an insurance policy relating to their business, or their profession or employment (for example, indemnity insurance).

Application to unit trusts

A lot of Legal Consolidated clients who are SMSF trustees invest in unit trusts.

The Unit Trust usually has a company as a trustee. This is called the corporate trustee. Often the SMSF members are directors of the unit trust trustee. (However, for asset protection, it is better to have only one director.)

Such a director has the same obligation as set out in the above paragraph 44. This is to manage and oversee the trust’s investments. The duties and time involved depends on the unit trust’s investments. For example, a real estate development is a hands-on enterprise. This is when compared to the unit trust holding say a balanced share portfolio index. 

Usually, the directors in the Unit Trust do not get paid. So are the directors (members of the SMSF) doing free work for the SMSF. Are they enriching the SMSF? Is that a ‘contribution’ to the SMSF? And this falls within the problems that NALI throws up.

Legal Consolidated has approached the ATO on this but to no avail.

However, see example 9. A rouseabout does free handyman work. That is enriching the SMSF. Such blue colour work offends NALI.

Perhaps white colour work, like brokering a property development, is acceptable for NALI. Legal Consolidated does not believe so. If a director of the corporate trustee of the Unit Trust provides services without pay, this must surely provide income to the SMSF.

SMSF owning shares in a Unit Trust – the danger of NALI

Is your SMSF buying or getting units in a Unit Trust? Talk with your accountant and financial planner first. And get their written sign off. This written advice costs money. But is worth it.

Are the directors of the Unit Trust corporate trustee providing services over and above what is ‘usual’? And here we are not sure what ‘usual’ means. But the threat of NALI is real and you need to cleave to the breast of your accountant and financial planner every step of the way.

Legal Consolidated’s Unit Trusts are designed for SMSF investments. So when your accountant and financial adviser recommend that you build a Unit Trust on our law firm’s website. Take their advice. Yes, of course, there are cheaper Unit Trusts.

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