The landscape of Self-Managed Super Funds (SMSFs) is continually evolving, and a growing trend involves investments in 50/50 unit trusts (or, more technically, an unrelated unit trust).
In this structure, an SMSF holds a 50% interest in a unit trust, with another unrelated person holding the remaining 50%. The other unrelated party can be another SMSF, company, or individual. While this investment strategy has become increasingly popular, it’s essential to understand from your Perth SMSF accountant the nuances and potential risks involved. This guide will explore critical considerations that we, as a Perth SMSF Accountant, can help you navigate.
The Sole Purpose Test
Self-Managed Super Funds (SMSFs) are a powerful tool for managing your retirement savings, offering greater control and flexibility over your investment choices. However, they are also subject to stringent rules and regulations to ensure they serve their core objective—providing retirement benefits. One such regulation is the “Sole Purpose Test,” a critical compliance requirement under Australia’s Superannuation Industry (Supervision) Act 1993 (SISA).
The Sole Purpose Test essentially mandates that all investments and dealings within an SMSF must be made exclusively for the purpose of providing retirement benefits to its members. If the SMSF has an investment with a related party the purpose of the investment no longer has a sole purpose of facilitating retirement. The purpose is now connected to the related party as well – even if that purpose is ancillary to the dominant purpose of the fund (remembering that the test is a sole purpose test).
This stipulation safeguards against potential conflicts of interest, particularly in transactions involving related parties. In the context of SMSFs, ‘related parties’ could include fund members, their relatives, or entities like companies and trusts that the members control.
So while your super fund can help your kids buy a house, the SMSF cannot own a home and rent that home to your children.
Understanding the SMSF ‘Related Trust’ Designation
Self-Managed Super Funds (SMSFs) can be a labyrinth of rules and regulations, especially when they interact with other financial entities like trusts. One area that often creates confusion is the notion of a ‘Related Trust’ as defined under the Superannuation Industry (Supervision) Act 1993 (SISA). Understanding this concept is crucial for SMSFs that may be invested in trusts, as it can affect how the fund is managed and its compliance with various regulations.
A unit trust becomes a ‘Related Trust’ when an SMSF controls it, alone or with its related parties. This control could arise through holding more than 50% of the voting power or more than 50% of the unit capital of the trust. Once the trust is designated as ‘related,’ it is subject to limitations on investment capacity and comes under the scrutiny of the in-house asset rules.
Now, consider a situation where two unrelated SMSFs hold a 50% stake in a unit trust. Generally, this setup would not result in the trust being designated as a ‘Related Trust’ for in-house asset purposes under SISA, as neither self-managed super fund holds a controlling interest individually. However, there can be exceptions. For instance, if the two self-managed super funds were to collaborate in a way that collectively gives them control over the unit trust, it might then be classified as a ‘Related Trust.’
In summary, while having a 50% stake in a unit trust with another unrelated SMSF may seem straightforward, it’s essential to scrutinise the details. This vigilance ensures you understand whether the trust becomes ‘related’ to your SMSF and is subject to further investment limitations and regulatory oversight. Therefore, it’s always advisable to seek professional advice and superannuation services from your SMSF tax accountant or superannuation advisor to navigate these complex areas and maintain the compliance and integrity of your SMSF. This is a necessary decision-making process to determine the benefits and downsides of an SMSF.
The three tests for an unrelated unit trust
Your trust will be a related unit trust if:
- You control more than 50% of the income or capital of the trust
- You can sufficiently influence the activities of the trust
- You control who the trustee is
Test one – You own more than 50%
The superannuation criterion focuses on whether a particular group—such as a member and their related parties—possesses a fixed entitlement to over half of the trust’s capital or income. A stake exceeding 50% of the unit holdings is necessary to meet this condition. So, an ownership of precisely 50% or less does not result in a related trust designation under this section. Ordinarily, establishing this criterion is straightforward when examining the unit trust’s legal documentation and associated records, mainly if all the units are of the same class.
However, it’s imperative for your superannuation services provider to scrutinise each trust deed’s provisions meticulously without making assumptions based on previous knowledge or expectations. Further documentation outside the trust deed, like emails, can start to give ownership of more than 50%.
Test two: Sufficient Influence
If you can sufficiently influence a unit trust, it can be considered ‘related’. The Australian Tax Office (ATO) had noted, in the NTLG Minutes of 2013, that a trustee might be expected to act according to the wishes or directives of a particular group, thereby influencing the trust’s entity.
Previously, there was limited guidance on interpreting this ‘sufficient influence’ test, leading SMSF trustees to exercise caution to minimise potential ‘related trust’ risks. Indicators of influence could include special discretions, powers, or advantages in the unit trust deed or corporate trustee constitution. Moreover, having disproportionate control or influence in managerial roles or financial agreements could signify ‘sufficient influence’.
Test three: The Authority to Control a Trustee
The third criterion outlined in Section 70E(2)(b) of the Superannuation Industry (Supervision) Act 1993 (SISA) focuses on who holds the authority to appoint or dismiss a trustee or a majority of the trustees overseeing the trust. This test can generally be assessed through a comprehensive evaluation of the unit trust’s founding documents and associated records.
As a superannuation services provider understanding who has this authority is crucial for trustees. All SMSF accountants providing superannuation advice, and any parties involved in or considering a unit trust arrangement need to document the third test.
ATO Insights on 50/50 Unit Trusts
The Australian Taxation Office (ATO) wields considerable discretionary authority regarding Self-Managed Super Funds (SMSFs). One area where this discretion is particularly impactful is classifying in-house assets. Although the Superannuation Industry (Supervision) Act 1993 (SISA) provides standard criteria for what constitutes an in-house asset, the ATO can make determinations that diverge from these conventional definitions.
Understanding the scope of the ATO’s discretionary powers by engaging an SMSF tax accountant for superannuation services is vital for anyone managing or investing in a self-managed super fund. Failure to do so can result in unintended regulatory pitfalls with severe repercussions, such as significant financial penalties or even the loss of the SMSF’s compliance status. Consequently, this could jeopardise the concessional tax benefits that are one of the primary attractions of SMSFs.
In most instances, our advice as an SMSF accountant is that anybody looking at creating an unrelated unit trust should have written tax advice from their accountant. Another alternative is obtaining a Private Tax Ruling from the ATO.
Even if an asset doesn’t strictly meet the standard criteria set out in SISA for being an in-house asset, the ATO can still deem it as such if it believes that the rules are being contravened in spirit, if not in letter. For example, suppose an SMSF invests in a complex financial instrument designed to circumvent the in-house asset rules while achieving a similar outcome. In that case, the ATO may still classify it as an in-house asset, affecting the SMSF’s compliance.
Looking beyond the tax structure
Your obligations do not stop there if you have an unrelated unit trust. As a self-managed super fund trustee, you must maintain good records (preferably through cloud accounting), look at valuing your SMSF assets, and adhere to your ongoing tax obligations.
Looking at the underlying investment
You no longer control the investment if you have an unrelated unit trust. So, getting your Perth tax accountant to help you draft a shareholder’s agreement to help you if things go wrong, is a good suggestion.
You should also talk to an investment advisor to see if the investment the unrelated unit trust is making is good for you.
A 50/50 unit trust presents an attractive investment opportunity for self-managed super funds, but it’s not without its risks and complexities. The expertise of an SMSF Accountant is instrumental in navigating this nuanced financial landscape, ensuring tax compliance, and optimising your investment strategy.
Understanding the key considerations outlined in this guide allows you to make informed decisions for your superannuation and SMSF’s investment future. At Westcourt we are experts in helping business families structure their investment portfolio tax effectively through super fund tax law and doing so without conflicts. So, given our deep tax knowledge, global connections, and commitment to families, we are an easy choice – so why not give us a call?