Navigating SMSFs and overpaid present entitlement
Difficulties can arise for SMSF advisers and auditors when an SMSF accepts distributions from a related unit trust in excess of their entitlement.
Are these overpayments considered to be a borrowing by the SMSF and a breach of s.67?
Is the SMSF attempting to circumvent the contributions caps or trying to transfer illegal assets into the fund?
The ATO released SMSFR 2009/3 which outlines their ruling on related unit trusts and the implications associated with distributions. Unfortunately, none of the examples specifically cover overpaid present entitlements.
We need to look at SMSF 2009/2 that addresses the meaning of ‘borrow money’ or ‘maintain an existing borrowing of money’ to shed further light on whether the fund is in breach of the borrowing rules.
A borrowing is an arrangement that exhibits two necessary characteristics:
•A temporary transfer of an amount of money from one entity (the lender) to another (the borrower); and
•An obligation or an intention on the part of the borrower to repay that amount to the lender (which may be satisfied by the provision of an asset).
Such transactions can include a margin lending account once drawn upon, a secured or unsecured loan and a bank overdraft once drawn upon.
Normally, an overpayment of present entitlements doesn’t involve the redemption of capital and the funds are recorded as a credit in the financials. There's no intent to repay the credit and the following documents don't exist:
1. An accompanying loan agreement
2. Interest paid by the fund
3. Contractual agreement that the credit must be repaid.
Additionally, the credit would be reduced as the fund’s present entitlement to distributions actually accrues.
But when an arrangement that’s not described as a borrowing exhibits the necessary characteristics of a borrowing, then it results in a contravention of subsection 67(1).
A good example is when a situation that started without the intent of a loan or borrowing develops into one because of later choices made by the trustees.
It’s therefore important that all circumstances of the SMSF are considered; it's not just the arrangement leading to the credit that's taken into account.
Providing an exhaustive list of conditions for when a credit will be classified as a borrowing is impossible. SMSF advisers and auditors should tread carefully and monitor the situation of their SMSF clients in each subsequent year.
Whilst an overpayment of present entitlements is not considered to be a borrowing, SMSF practitioners are cautioned that any changes to the ATO's current ruling may adversely impact their SMSF clients.
Shelley Banton, director, SuperAuditors