Unit trusts are a popular investment vehicle for SMSFs, as they allows for SMSFs to enter into investments with both related and unrelated parties. However, there are various risks that must be managed when an SMSF invests in a unit trust, and these are often overlooked.
In a recent DBA Lawyers technical podcast, lawyer Shaun Backhaus said that when considering the complexities and tricky situations SMSFs find themselves in, there is a need to “delicately” approach 50/50 unit trusts especially with the relevant tests it faces that can easily give rise to a related trust relationship and related flow-on consequences.
Common situations that arise often include SMSFs having a 50 per cent interest in a unit trust, with another unitholder holding the remaining 50 per cent interest, which invariably is an unrelated SMSF.
The primary consequence of the related trust relationship is that once this relationship arises, the in-house asset rules limit each fund’s investment to no more than 5 per cent of the market value of each fund.
When looking at this from a legal perspective, Mr Backhaus said it is all about control, with the legislation highlighting about “being a trust that a member controls” as defined in section 70e of the SIS Act.
“The first requirement there is that a group in relation to the member has a fixed entitlement to more than 50 per cent of the capital or income of the trust. If it’s only a strict 50/50 unit trust, that means they won’t have more than 50 per cent of the capital or income, so it will meet that definition,” he said.
“The third one is that a group in relation to the member is able to remove or appoint the trustee or a majority of the trustees of the trust, and that forms the other control requirement.
“That can be managed as well by ensuring that all the documents are suitable and to make sure that there isn’t anything weird in your trust deed or your constitution or something. Things such as casting votes is usually the one to be aware of.”
The second one known as the “sufficient influence test”, however, is the harder one to plan and manage for, according to Mr Backhaus.
“This is the test that says that the trustee or a majority of the trustees is accustomed or under an obligation, whether formal or informal, or might be expected to act in accordance with the directions, instructions or wishes of the group in relation to the member,” Mr Backhaus noted.
“The key is it’s more of a test about what’s actually occurring. If there is that figurehead of the family or the group or the person who is really calling the shots and everyone does what they say, then that’s the situation where the trustee would probably be accustomed informally or be expected to act in accordance with that member’s wishes.
“This one is a bit harder to manage and it’s something that anyone investing in these 50/50 arrangements needs to be aware of, and even any arrangement when it’s not 50/50, it all goes back to that issue of control.”
With the significant influence and control test, Mr Backhaus warned that one of the traps to be aware of is that a lot of people assume they’re going into a 50/50 unit trust with all the tests covered, but it can be easy to overlook some issues from the influence and control test that can easily go wrong when navigating the trust structure further down the line.
Recent case law example from the BHP Billiton Limited v FCT [2020] HCA 5 decision considered “sufficient influence” for the purposes of identifying “associates” of a company under s 318 of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936).
The BHP decision held that for a company to be “sufficiently influenced” by another entity under s 318(6)(b), it was not necessary to show “effective control” or a causal link between the entity’s “directions, instructions or wishes” and the company’s actions (as BHP had contended), according to DBA Lawyers.
While the BHP decision related to a different legislative test in relation to a company and its associates for tax purposes to the test in s 70E(2)(b) of the SISA that relates to a unit trust, the decision is relevant, as it provides meaning to the similar legislative text/test.
Mr Backhaus said that, ultimately, the situation is often fact dependent and it’s going to depend on a variety of circumstances and that’s why it’s probably harder to manage.
“If you’ve got someone investing in this where they’re expecting to run the show and just have investors involved but they’re not ‘actively involved’, then obviously that’ll breach that requirement,” he said.
“What you want to have is everyone involved who is a director is actively considering and engaging in the unit trust. They’re signing resolutions and they’re involved with the investment.
“Those are the requirements and it’s really about explaining what the obligations are to your clients, and if it’s something that’s not going to suit them, it will be important to let them know clearly that you either need to get people involved or this is not the structure for the SMSF.”
