Tread carefully after new ATO decision on loans
ATO ID 2014/23 confirms that a loan to an unrelated trust will not constitute an in-house asset of an SMSF. However, all is not as simple as it seems.
Facts of ATO ID 2014/23
The facts of ATO ID 2014/23 are as follows:
· an SMSF advances funds to a property trust (‘Property Trust’);
· a related party of the SMSF (‘Unit Trust’) holds less than 10 per cent of the issued units in the Property Trust;
· the Unit Trust has, as members of the class of general beneficiaries, members of the SMSF (this fact suggests the Unit Trust may not be a fixed unit trust and may have a hybrid or discretionary element. However, this issue is not further discussed by the ATO); and
· the loan was made under a commercial loan agreement.
The issue raised was:
Will a loan from an SMSF to a Property Trust be treated as an in-house asset?
The decision was provided as follows:
A loan from an SMSF to a Property Trust will not be treated as an in-house asset if the Property Trust is neither a related trust (a trust controlled by a member or a standard employer sponsor of the SMSF) nor a related party of the SMSF.
Reasons for decision
The ATO’s reasoning is far from controversial.
The analysis begins with the ‘financial assistance’ provision in s.65(1) of the Commonwealth Superannuation Industry (Supervision) Act 1993 (‘SISA’). Broadly, this subsection provides that the trustee of a regulated superannuation fund must not lend money of the fund to a member or a relative of a member of the fund. A ‘relative’ is defined in s.10(1) of the SISA and only includes ‘natural persons’. Accordingly, as the Property Trust is not a natural person — it is a trust — s.65(1) will not apply to this course of action.
However, the substance of the analysis focuses on the in-house asset provisions.
ATO ID 2014/23 begins this part of the analysis with reference to the definition of an in-house asset in s.71(1) of the SISA, which provides that an in-house asset includes ‘a loan to ... a related party of the fund’. The term ‘related party’ is defined in s.10(1) as a member of the fund, a standard employer-sponsor of the fund or a Part 8 associate of either of those entities. As the Property Trust is not a member or a standard employer-sponsor of the SMSF, the analysis turns to whether the Property Trust is a Part 8 associate of the SMSF members. More specifically, the key question is whether the trustees of the Property Trust or any of the other unit holders of the Property Trust are Part 8 associates of the individual members of the SMSF?
The Part 8 associates of a member are found in s.70B. Among other things, they include trustees of trusts that are ‘controlled’ by the members of the fund. Under s.70E(2) of the SISA, a trust is ‘controlled’ if:
(a) a group in relation to the entity has a fixed entitlement to more than 50 per cent of the capital or income of the trust (as discussed above, the related parties of the Fund held only 10 per cent); or
(b) the trustee of the trust, or a majority of the trustees of the trust, is accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of a group in relation to the entity (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts); or
(c) a group in relation to the entity is able to remove or appoint the trustee, or a majority of the trustees, of the trust.
A ‘group’ in relation to an entity is defined in s.70E(3) of the SISA to also include the Part 8 associates of the entity:
(a) the entity acting alone; or
(b) a Part 8 associate of the entity acting alone; or
(c) the entity and one or more Part 8 associates of the entity acting together; or
(d) two or more Part 8 associates of the entity acting together.
Applying the legislative framework to the facts, the trustee of the Property Trust is not a Part 8 associate, as:
· the related parties (ie, the Unit Trust that is held by the members of the SMSF) holds less than 50 per cent of the capital or income of the trust; and
· the related parties have no control over the Property Trust.
Therefore, the loan has not been made to a related party of the SMSF and does not constitute an in-house asset.
Naturally, this may seem to provide a positive result for taxpayers.
However, there are many ‘traps’ that exist that advisers must be aware of, due to the oversimplified nature of ATO ID 2014/23.
50-50 unrelated unit trust
The related parties of the SMSF considered in ATO ID 2014/23 only hold a 10 per cent interest in the units issued in the trust. However, practically, there are many SMSFs that own a 50 per cent or greater interest in a unit trust (including through their associated entities). Many have wanted to implement arrangements whereby an SMSF and its related entities owns exactly 50 per cent of a unit trust and therefore argue that the unit trust is not related. The ATO publicly acknowledged in 2013 (in its NTLG minutes) that this could be possible.
However, without careful drafting of the deed of the trust and the constitution of the trustee of the trust (if a company), there is no guarantee that the trust will not be ‘controlled’ under s.70E(2) of the SISA. In particular, how matters such as director votes are determined is critical in ensuring that the trust remains an ‘unrelated’ party. Many constitutions, for instance, provide a casting vote to the chair.
There are various other elements that can bring the trustee of the Property Trust under the ‘control’ of the members of the SMSF, including:
· whether the entitlements of the trust are varied and provide an entity with more than 50% of the income or capital of the trust in certain circumstances;
· the deed includes an ‘appointor’ role where the appointor has the ability to remove or appoint the trustee of the trust; and
· other matters, eg, the Unit Trust, in this ATO ID did not appear fixed, and accordingly, all distributions could be non-arm’s length income taxed at 47 per cent (even if the SMSF is in pension mode) under s.295-550(4) of the Commonwealth Income Tax Assessment Act 1997.
Further, a link many overlook is where members have some joint receipt of income with other unitholders in a Unit Trust and their unit holdings are grouped together in determining whether a related trust relationship exists, eg, jointly-owned investments.
At the risk of sounding like a ‘broken record’, ATO ID 2014/23 answers a fairly uncontroversial question. However, advisers must exercise caution and seek proper advice before advancing funds to what they consider ‘unrelated trusts’.
Krishna Skandakumar, lawyer, and Daniel Butler, director, DBA Lawyers