Shorte said the strategy where an SMSF can be involved in owning a business or property through an unrelated unit trust or company structure is ideal for an early-stage business expected to grow rapidly over time and where income and growth can be captured tax effectively in the SMSF.
“It is most suited to those who do not need access to the capital and profits until retirement or where you want some in the SMSF and some personally but your shared ownership, between your related parties, does not exceed 50 per cent,” Shorte said.
He said the first and most important compliance question that needs to be answered before considering the strategy is whether the company is a related party.
“The answer determines almost everything else. Under the SIS Act, a ‘related party’ of your SMSF includes the fund’s members, their relatives, their business partners, and companies or trusts they control. Control means holding the ability to determine more than 50 per cent of the voting rights or being entitled to more than 50 per cent of dividends or capital,” he said.
“With a genuine 50/50 split between two unrelated SMSFs, neither fund’s members control the company outright. Neither party can determine outcomes alone. Accordingly, the company is generally not a related party of either SMSF or this single fact unlocks the structure.”
He added that a structure of three unrelated entities with roughly even ownership would make this type of arrangement safer as there is less chance of one exceeding 50 per cent.
The next issue, he said, relates to the in-house asset rules and whether the asset would exceed more than five per cent of the fund’s total assets.
“As the trading company is not a related party, the shares the fund holds do not count as in-house assets based on the ownership relationship alone,” he said.
“However, it is important to note that regulation 13.22C provides a separate exclusion from the in-house asset definition for investments in certain closely held entities and that exclusion is only available if the entity does not conduct a business. As this is an actively trading company, reg 13.22C is irrelevant.”
One of the most advantageous elements of this strategy is that it can be “exceptionally” tax-efficient, particularly for SMSF members approaching or in retirement phase, Shorte added.
“For example, at a company level a small trading company with turnover below $50 million will typically qualify as a base rate entity and pay company tax at 25 per cent. This tax gives rise to franking credits attached to any dividends paid to shareholders,” he said.
“At the SMSF level in accumulation phase a fund’s effective tax rate on investment income is 15 per cent. When the company pays a franked dividend, the SMSF includes the grossed-up dividend in its assessable income, pays 15 per cent tax, and offsets that liability with the franking credit. Because the company already paid 25 per cent tax, the franking credit typically exceeds the SMSF’s liability producing a refund.”
Furthermore, he said, when the SMSF enters pension phase, the fund is paying pensions and the income qualifies as exempt current pension income, the effective tax rate is zero per cent and the full franking credit is refunded in cash.
Regarding arm’s-length dealings, Shorte said non-arm’s-length income (NALI) is taxed in an SMSF at a flat 45 per cent, regardless of whether it is in accumulation or pension phase.
“Private company dividends are a known NALI risk area, and the ATO scrutinises them carefully. All dividends must be paid on the same terms to both SMSFs, proportionate to their respective shareholdings, with no preferential treatment flowing to one fund over the other,” he said.
“Arm’s-length requirements also apply to any other dealings between an SMSF and the company including director salaries, lease arrangements, and any services the company provides.”
He added that as part of the strict compliance obligations, annual valuation is essential, and an SMSF must record in its financial statements all assets at their true market value as at 30 June each year.
“Shares in a private unlisted trading company must be independently valued by a suitably qualified person using a recognised methodology typically earnings-based, net tangible assets, or a combination of both. This is not optional; your auditor will require appropriate evidence,” he said.
“Valuation complexity increases over time, particularly if the company retains significant profits, acquires assets, or if the trading environment changes materially. Factor in the annual cost of a formal valuation and the management time required to facilitate it when assessing the overall economics of the structure.”
