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Trustees may be worried that the government may remove provisions relating to borrowing by a self-managed super fund. Deals which are done may be grandfathered but those which are in the pipeline, e.g. those who have paid a deposit on a property and have not yet settled on it could be in jeopardy. The easy solution is to enter into an LRBA now with a related party and then when it comes to settlement, refinance from a bank.
We are assuming that banks will be still willing to fund these purchases, if this funding is not available, then it is possible that some super funds may end up losing their deposit and if the property market moves downward, it is possible that they may be up for some penalties according to the terms of their contract.
Click here to learn how a SMSF can borrow
Borrowing by a trust where an SMSF invests
This is a very popular strategy, where a SMSF funds invests in a trust and as long as it does not control the trust, the trust is then able to borrow and invest without it being a related trust or becomes an in-house asset of the fund.
The term "related party" is also relevant for the purposes of the prohibition on the acquisition of assets by the fund (under section 66 of SISA a fund cannot acquire from a related party) and the trust becoming an in-house asset investments of SMSF.
If an SMSF invests in a related trust, that investment is typically an in-house asset. Generally no more than 5% of an SMSF can be invested in in-house assets. Whether a trust is a related trust or not, in turn depends on whether an SMSF member controls the trust.
When two people who run a business together, they might want their respective SMSFs to invest 50-50 in a unit trust. In turn, they might want the unit trust to takes out a 'normal' loan (i.e., not a LRBA) to buy say the premises where their business is run.
The term 'related party' is defined in subsection 10(1), SIS Act as any of the following:
(a) a member of the fund
(b) a standard employer-sponsor of the fund, or
(c) a Part 8 associate of an entity referred to in paragraph (a) or (b).
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Can a trust be a related trust?
A 'related trust' is defined in subsection 10(1), SIS Act as a trust that a member or a standard employer-sponsor of the fund controls (within the meaning of section 70E).
Control of a trust is defined in subsection 70E (2), SIS Act. An entity is taken to control a trust if a group:
(a) has a fixed entitlement to more than 50% of the capital or income of the trust, or
(b) has a relationship with the trustee(s) such that the trustee or a majority of the trustees is accustomed or might reasonably be expected, to act in accordance with the directions, instructions or wishes of a group or 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.
Any investment by a self managed super fund, where the members individually or as group control the trust, that trust becomes a related trust.
How does a trust become an in-house asset of the fund?
The in-house asset rules relating to a trust:
- limit the maximum in-house investments by an SMSF to 5% of their total assets by market value (s 82(1), SIS Act);
- require an SMSF with in-house assets in excess of the 5% limit as at the end of the year of income to dispose of the excess in accordance with a written plan (s 82(2) to (6), SIS Act) which must be carried out in the following 12 months;
- prohibit an SMSF from acquiring an in-house asset if the market value ratio of the fund's in-house assets exceed 5% (s 83(2), SIS Act) or would exceed 5% if the asset was acquired (s 83(3), SIS Act), and
- prohibit the super fund from entering into any scheme which would avoid the application of the in-house assets rule (s 85(1), SIS Act). Trustees must also take all reasonable steps to ensure the in-house asset rules are complied with (s 84, SIS Act).
Hence if more than 5% is invested in a trust and if any related party (including Part 8 associates) control that trust, the trust becomes a related trust. This means, if the fund invests less than 5% of its total assets by market value and controls the trust, it would breach the in-house Rules.
Conversely, if it invests up 50% of the equity of the trust and does not control the trust (not a related trust), that trust will not be an in-house of the fund and that trust is able to borrow etc. since it is and becomes an un-related geared trust.
How do you know, who controls the Trust?
The trustees control the trust. If you an SMSF auditor of a fund, which has invested in a trust and if that investment is more than 5% of total assets of the fund, your task is extremely difficult to investigate if the trust is a related trust or not. Since it is possible that other unit holders are related the trustees of the fund you are auditing and they control the trust as a group.
This task becomes additionally difficult as the definition of related party includes Part 8 associates of the individual members of the fund. A Part 8 associate of an individual, whether or not in the capacity of trustee, includes the following
- relatives of that individual
- members of the same SMSF, directors of the trustee and other individual trustees
- a partner of the individual or a partnership in which the individual is a partner, or the spouse or a child of an individual partner
- a trustee of a trust (in the capacity of trustee of that trust) where the individual controls that trust
- a company that is sufficiently influenced by, or in which a majority voting interest is held by the individual, by a Part 8 associate of the individual or by the individual together with Part 8 associates (refer to s 70B, SIS Act).
Since in (1) above, relatives of the member has the extended meaning to include nieces and nephew of not only the member but also of the spouse of the member who may or may not be a member of the fun.
This means if the fund has four members, it is possible that list of part 8 associates may include over 1,000 possible individuals who could be the joint holders or partners of the member.
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Can two partners of a business commence a trust and buy a BRP with their respective super funds - 50-50 unrelated unit trust?
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 an arrangement whereby their SMSF and its related entities own exactly 50 per cent of a unit trust and therefore argue that the unit trust is not related, similarly the other half is owned by their business partner by their SMSF and their related parties.
However, if the members of the two super funds are business associates and have business partnership with the members of other super funds or their part 8 associates, as mentioned above, the trust become related trust and any investment more than the stipulated 5% will breach the in-house asset rule.
There could be situation where there is no relationship at all (e.g. the two separate SMSF members do not even own a property outside super together) between two sets of members of the two (or more) SMSF's and their separate SMSF's invest in a unit trust together. In this situation, the unit is able to borrow and even develop a property under the umbrella of a geared un-related unit trust structure and hence is an opportunity to gear up the SMSF's should borrowing exemption be withdrawn.
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What else can go wrong?
These un-related geared unit trusts may have Individual or a corporate trustee where the two SMSF's invest, care should be taken while drafting the unit trusts deed and the constitution of the company trustee of the trust. As sometimes these trusts give a casting vote to one of trustees in case of a tie in a general meeting.
Many constitution also provide a casting vote to the managing director.
Such provisions, in the constitution of the trustee company or in the unit trust may lead to a controlling interest in the trust under Section 70 E(2) of the SISA.
Hence even in case of a 50% - 50% ownership of a trust owned by two un-related self-managed super fund, due to this casting vote, may establish a controlling interest for one of the of the super fund.
Any such provisions in the constitution or the unit trust deed with regard to casting vote to the Chairperson of the company or the unit trust in case of equality of votes on a particular matter in the company meetings give unequal powers and hence must be removed.
SMSF auditors auditing such funds need to be extra careful about this issue and if you come to our seminar, we will show you, how you can risk manage your audit of funds which invest in unlisted trusts.
If you are an adviser who has one of these trustee company constitution or a unit trust, you can simply remove these clauses by a minute in a meeting to amend the constitution or the trust deed, click here for a sample template, which you can use after taking legal advice regarding as possible re-settlement trust issues.
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