Law firm outlines danger areas with UPEs for SMSFs

Mr Butler said the controversy surrounding UPEs started back in 2009 when the ATO issued the ruling SMSFR 2009/3.

SMSFR 2009/3 states that where an SMSF is presently entitled to a distribution from a related or non‐arm’s length trust, and  payment of this amount is not sought, contraventions of one or more provisions of the SISA may occur.

“The ATO basically came out and said that they didn’t want to see SMSFs having a UPE that grows from one year to the next,” he said.

“The ATO’s theory was that if it was an arm’s length investor or unit holder and they weren’t paid their entitlement, they’d be demanding their [payment]. So the ATO [warned] that this could give rise to certain contraventions.”

The Commissioner’s view in SMSFR 2009/3 outlines that when an overall consideration of the factors surrounding the non payment of the trust distribution is seen as an arrangement for the provision of credit or financial accommodation, it will satisfy the extended definition of ‘loan’ in s 10(1).

“Consequently, the [UPE] will be included in the in‐house assets of the SMSF, where the trust in question is a related party of the SMSF and the circumstances indicate that a loan agreement has been entered into, or that a consensual agreement for the provision of credit or other form of financial accommodation has been reached between the parties,” the ruling states.

Mr Butler said this means that where there is a related party involved and the circumstances indicate that a loan agreement has been entered into or that a consensual agreement for the provision of credit or other forms of accommodation has been reached, then the SMSF trustee may be entering into in house asset territory.

He noted that there is a slight distinction between a loan agreement and the provision of credit of other forms of financial accomodation.

“If there is a loan agreement that has been entered into, then the SMSF will have an in house asset from the get do,” he warned.

“If its credit or another form of financial accomodation and that could be where, for instance, the UPE has been sitting on the books of that unit trust being payable to the SMSF for some time, that in itself will not be an in house asset. [However], it could be after a period of time

The ATO also raises concerns about the sole purpose test in relation to UPEs in SMSFR 2009/3, Mr Butler noted.

The ruling states that where an SMSF trustee maintains a substantial proportion of the assets of the SMSF in a related trust as [UPEs], upon which no or below market rate interest is being paid, this suggests that the fund is not being maintained in a way that satisfies the ‘Sole Purpose Test’ in s 62.

While the Commissioner doesn’t specify exactly what a substantial proportion is, said Mr Butler, over 50 per cent could certainly be regarded as a substantial portion

“However, the Commissioner’s threshold may be lower than that,” he said.

Mr Butler said SMSF clients that are “sitting on their UPEs” need to watch out for the types of risks raised by the Commissioner in this ruling.

He noted that the ATO has been paying particular attention to UPEs recently and published TD 2022/11 this year which reflects the ATO’s latest views on to UPEs owed by discretionary trusts to companies  for div 7A ITAA 1936 purposes.

“This was focused on UPEs from the discretionary or family trust over to the corporate beneficiary. Some people refer to the corporate beneficiary as the corporate bucket company where you throw the balance to at a lower tax rate,” he said.

“The corporate bucket company often isn't paid that money and therefore, the non payment of the money from the Family Trust across to the company can give rise to a division 7A problem when the family trust then lends that money to a beneficiary or related party, who is a shareholder or an associate of the private company.”

The commissioner has similarly taken a very broad view in this ruling of what is the provision of credit and the provision of other forms of financial accommodation, Mr Butler said.

Mr Butler said SMSF professionals should be reviewing any SMSFs with unit trusts that have UPEs to assess any risks.

He also stressed the importance of ensuring that UPEs are paid on a timely basis before the next 30 June, especially if related parties are involved.

“Do not allow UPEs to accumulate. If you allow UPEs to accumulate from one year to the next you are really running your client into problems,” he advised.

Mr Butler said SMSF professionals should also be very careful not to incorrectly label a UPE as a loan in the accounts as this could create issues.