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SMSF investing in unit trusts — proposed tax changes

SMSFs investing in unit trusts that develop property

Proposed changes in the exposure draft Tax Laws Amendment (New Tax System for Managed Investment Trusts) Bill 2015 (‘ED Bill’) will impact on the tax treatment of unit trusts that are currently taxed as companies under div 6C of the Income Tax Assessment Act 1936 (Cth) (‘ITAA 1936’).

Currently, under div 6C, the 20% tracing rule for public trading trusts broadly specifies that if exempt entities (such as SMSFs) holds more than 20% interests in a trust, the unit trust can be a public trading trust (‘PTT’) and taxed as a company unless the unit trust invests in real estate primarily for rental income or a range of passive investments such as financial instruments and securities.

The ED Bill will amend div 6C so that membership interests held in a trust by tax exempt entities and complying superannuation entities which are entitled to a refund of franking credits will be disregarded for the purposes of applying the 20% tracing rule. In particular, s 102MD of the ITAA 1936 currently includes complying superannuation funds in the definition of an exempt entity. However, the revised s102MD in the draft legislation provides:

For the purposes of this Division, treat an exempt institution that is eligible for a refund (within the meaning of the Income Tax Assessment Act 1997) as not being an exempt entity.

Thus, SMSFs will no longer be included in the tracing rule once the ED Bill is passed as law. This should result in unit trusts with SMSF investors as not invoking div 6C. Therefore, for example, a unit trust that is owned by an SMSF that owns real estate that is primarily used for development purposes (rather than only rental income) will not be taxed as a company when the proposed ED Bill is finalised as law.

The ED Bill will have a number of ramifications as some existing PTTs will exit the corporate tax environment shortly after the legislation is finalised and there may be limited transitional time to utilise available franking credits.

The changes once enacted, will also reduce the need for SMSFs to claim a refunds of franking offsets where PTT distributions are received by an SMSF in pension mode.

Conclusions

Currently, where an SMSF invests in a unit trust which undertakes a property development or other trading business, div 6C results in the unit trust being taxed as a company. This will change once the ED Bill is passed as law, and accordingly, SMSF advisers should monitor these changes in the lead up to 1 July 2016.

Further training and reading

DBA Lawyers has prepared a comprehensive training course to assist in understanding investments in trusts. Unit 9 of this course focuses on ‘SMSFs investing via unit trusts, companies and other structures’ which also covers the superannuation and tax aspects of SMSFs investing in unit trusts.

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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

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