Sole purpose risks flagged with unit trust investment scheme
SMSF trustees have been warned against entering arrangements where loans provided to SMSF members in their personal capacity are conditional upon particular investments being made by the fund.
In a recent article, SMSF Alliance principal David Busoli warned that trustees need to be mindful of the sole purpose test when entering investment arrangements, with sole purpose test breaches one of the more serious types of breaches for SMSFs.
Mr Busoli said he was recently asked to look at a proposed scenario involving a unit trust investment by an SMSF and a loan provided to the SMSF members in their personal capacities which appeared to be a clear breach of the sole purpose test.
In this particular arrangement, Mr Busoli explained that the SMSF members, in their individual capacities, enter a contract to purchase a property of their choice.
“The same individuals, as SMSF trustees, arrange for their SMSF to invest into a widely held unit trust. It should be noted that the unit trust contains bona fide investments, is not focused on SMSF investors and has a history of favourable returns,” he said.
“The unit trust then provides the individuals with an advance of up to 97.5 per cent of the property's purchase price at commercial rates secured by a first mortgage over the property. The LVR is based on the amount invested by the SMSF in the unit trust.”
Mr Busoli said it was argued that this is similar to an SMSF investing in bank shares prior to the trustees, in their individual capacities, approaching the bank for a home loan.
“If the bank regarded the investment in its shares as a basis for their loan approval, then it would be similar - but it doesn’t,” he cautioned.
“As the loan to the individuals is conditional on their SMSF's level of investment in the unit trust it looks like a clear breach of the sole purpose test to me.”
While there have been several SMSF participants involved in this arrangement that have previously passed ATO audit, Mr Busoli said it is likely the ATO had not considered the true nexus between the investment and the loan.
“If a tree falls in the forest and no one saw it, did it happen? Yes, it did. I would not be prepared to enter into an SMSF arrangement with such an embedded flaw on the basis that it might never be seen,” Mr Busoli warned.
SMSF professionals and trustees, he said, should approach these kinds of arrangements with caution with the sole purpose test a strong focus for both auditors and the ATO.
