SMSFs cautioned on potential ‘slip-ups’, breaches with trusts

SuperConcepts executive manager, SMSF technical and private wealth, Graeme Colley said that the use of unit trusts as an SMSF investment to increase the value of a fund can be a handy strategy for members that have maxed out their superannuation balances.

Mr Colley said that once a member has a total super balance of more than $1.6 million at 30 June in the previous financial year, they aren’t able to make non-concessional contributions to the fund.

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This limits them to concessional contributions, downsizer contributions or accessing the capital gains tax (CGT) small business concessions.

“Access to some of these concessions may be a long way off if [they] ever qualify,” Mr Colley said in an online article.

The fund may therefore consider investing in related partnerships, trusts, companies or joint ventures as a strategy to increase income.

However, he warned that there are some potential traps to be aware of. All income paid to the fund must reflect a true market rate of return, for example.

“If income received by the fund is more than if all parties are dealing at an arm’s length basis, trustees could be up for penalties and the income may be taxed at penalty rates,” Mr Colley said.

The structure of trust being used is also important, he said.

“The main trust structures are a unit trust or discretionary (family) trust. A discretionary trust does present some problems for an SMSF as any income the fund receives from the trust will always be taxed at penalty rates as non-arm’s length income,” he explained.

“A unit trust is a better choice for an SMSF to make an investment, as income the fund receives from the trust can continue to be taxed concessionally if it’s done correctly.”

By investing in the unit trust, it is possible for an SMSF to own certain assets that can be leased or rented to related parties such as members, trustees, their relatives or related entities, he explained.

“This, for example, may involve the unit trust owning business property which is rented to a related party on an arm’s length basis. The benefit of this is that the unit trust receives rent from the related party which is then distributed to the superannuation fund,” he said.

“The related party may be eligible for a tax deduction for any rent paid on the business premises and the members can increase their superannuation balance irrespective of how much they have in their fund.”

SMSF professionals and trustees also need to be aware of the impact of the Superannuation Industry (Supervision) (SIS) Act and regulations so there is no breach of the rules, Mr Colley cautioned.

“As a rule, units owned by a superannuation fund in a unit trust that is controlled by related parties, including the fund, is treated as an in-house asset which has restrictions applying,” he said.

“A unit trust is controlled, including when related parties hold more than 50 per cent of the units in the unit trust or the trust deed of the unit trust authorises the related parties to appoint or dismiss the trustees. Careful drafting of the unit trust’s deed is essential to make sure there is no slip-up.”

If the units owned by the superannuation fund are in-house assets, he explained, there is a 5 per cent restriction on the proportion of the fund that can be invested in all in-house assets.

“This is measured just before the fund purchases an in-house asset to make sure the fund will not exceed the 5 per cent limit and at the end of each financial year,” he said.

“If a breach occurs at the end of the financial year, the fund must put in place a plan to reduce its holdings of in-house assets to no more than 5 per cent of the market value of the fund.”

He also noted that there is an exception that excludes the fund’s investment in a related unit trust from the in-house asset rules.

“This may apply if the trust has not borrowed, invests in other entities and it does not carry on a business. This exception means the fund can purchase more than 50 per cent of the units in the unit trust without being treated as an in-house asset,” he said.

“However, you need to careful as a minor breach of the exception can end up with the investment in the unit trust being treated as an in-house asset.”