Valuation of unit trusts imperative: specialist
For SMSFs investing in trust structures, it is important to ensure the issue price of new units are based on the market value of the trust, a leading adviser has said.
Lyn Formica, head of education and content at Heffron, said at the recent Super Intensive Day that whether the investment is with a related or unrelated party, new units need to be issued at a price based on the market value of the trust, not just as a standard $1 unit.
“That issue price should also be the same for all of the investors. It shouldn't be discounted for particular investors based on the value they bring to the table,” she said.
“Investor A should pay the same price as investor B for units with the same rights. So, even if they're providing some services, or they might be able to bring some skill to the table, that shouldn't be something that's provided as a benefit through to the SMSF unit holder.”
Formica continued that if the potential investment is going to be a combination of units and loans, it is important to then make sure there is a documented commercial justification for any interest-free loans or loans where the terms are more favourable to the fund than they otherwise would have been in an arm's length situation.
“Even where there is a loan in proportion to the unit holding, if there is any doubt about the commerciality of the loans, the commercial justification for the loans, then it’s best to give serious consideration to converting those loans into units, again, based on acquisition price, and on the market value of the trust at the time.”
“When you are looking at the trust's gross income, make sure it is no higher than it would have been in an arm's-length situation, and make sure you have got evidence of that. [That means] having a look at the trust's investments and seeing what it is investing in. [Are they] private companies? Is it property? Is it all of those? Are all of those investments on arm's length terms and conditions?”
She added that if the trust leases assets to other parties, it is also necessary to determine if the leases are on arm's-length terms and conditions.
“The same with any loans that the trust may have made to other entities. Again, it doesn't matter whether it's related or unrelated, make sure that it's on arm's-length terms and conditions, because unrelated parties can have situations where they're not acting on arm's-length terms.”
“Also look at the gross expenditure of the trust and make sure it's no less than it would have been in an arm's-length situation, and that you have got evidence of that.”
Formica said the main items to check when investing in unit trusts are to ensure the borrowings are on arm's length terms and conditions, and the trust is charged market rates for any services that are provided to that trust.
“Ultimately, what you’re looking for is making sure that the return that this SMSF is going to get from this trust is not too high given the risk that they've taken.”