By Daniel Butler, Director, DBA Lawyers
A unit trust is a popular structure to hold property and other investments. This article examines numerous methods how an SMSF may invest in a unit trust.
Many publicly offered managed investment funds are structured as a unit trust to allow multiple investors to invest in a diversified investment portfolio. Typically, the units in the trust reflect each investor’s proportionate equity or interest in the trust. The concept of owning a unit in a unit trust is a similar but different concept to owning a share in a company.
While an SMSF investing in a larger unit trust may not have any influence on the trustee or have much opportunity to have any change to the unit trust documents, our firm has acted for numerous SMSFs over the years where we have negotiated changes to reduce regulatory or legal risk.
Closely held unit trusts
On a smaller scale, unit trusts are also popular for self managed superannuation funds (‘SMSF’) to invest in especially to acquire real estate. One or more SMSFs and/or other investors can combine their finances to acquire an investment property via a unit trust structure. In some cases, this may allow each investor access to a better property with considerably more upside potential compared to investing alone.
In particular, an SMSF may only want to hold a proportionate interest in a unit trust to minimise risk. There may be one or more related or other investors that also participate in the same unit trust. Each investor invests in units which, in turn, is used to finance the unit trust’s acquisition of property.
However, an SMSF has to be very careful to ensure it complies with the raft of superannuation rules before investing in a unit trust. Moreover, the quality of the unit trust deed and constitution of the corporate trustee are important to an SMSF’s complying status.
Related unit trusts
An SMSF is restricted to investing no more than 5% of the market value of the SMSF’s assets in ‘in-house assets’ (‘IHA’). The Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’) specifies that IHAs includes an investment in a related trust of the SMSF.
A related party is broadly defined and includes an SMSF member, a standard employer-sponsor of the SMSF, the member’s relatives, a partner in a partnership and a company or trust that is controlled or significantly influenced by an SMSF member and his or her associates.
A related trust includes a unit trust where an SMSF member, a standard employer-sponsor or his or her associates hold more than 50% equity in the unit trust, exercise significant influence in relation to the trust or can remove or appoint the trustee.
Therefore, an SMSF with $1,000,000 of assets could not, subject to s 66 of SISA, invest more than $50,000 (ie, 5%) in IHAs (including any related trust). Such a unit trust could invest in a real estate property where the remaining units were held by others including related parties such as family members, relatives or a related family discretionary trust.
This may not be attractive to an SMSF where it’s likely the 5% limit will be exceeded. For instance, if an SMSF invested more than 5%, this would contravene the SISA and significant penalties could be imposed on an SMSF by the ATO.
Accordingly, to ensure that this test is met it is necessary to identify which assets are considered to be IHAs and then determine the market value of all assets to ensure the 5% limit is not exceeded. The acquisition of a new IHA where the fund is already at the 5% limit is an immediate contravention. Additionally, where the fund is not over the 5% limit, the acquisition of an IHA that would itself cause the fund to exceed the 5% limit is also an immediate contravention.
There is however a possible exception discussed below; involving non-geared unit trusts (‘NGUT’) that allows an SMSF to invest in a related unit trust.
Non-geared unit trust
A related unit trust (often referred to as a non-geared unit trust or ‘NGUT’) allows for one or more related investors to come together to invest in property. A NGUT allows an SMSF to hold up to 100% of the units issued in that ‘related’ unit trust. This is permitted provided the unit trust complies with the strict criteria in the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’) and continues to comply with that strict criteria on an ongoing basis. Failure to comply can result in the units becoming IHAs.
As discussed above, an SMSF cannot hold IHAs that exceed more than 5% of the value of the fund’s assets and may therefore need to dispose of the asset causing the SMSF to exceed this limit. Such a disposal could give rise to substantial transaction costs.
Broadly, a NGUT may be a suitable structure for holding real estate with no borrowings secured on the title to that property and to overcome the IHA prohibition. This is because, the strict criteria in the SISR requires the trust must, among other things, not:
- have any borrowings or charges (eg, a mortgage) on the trust’s assets;
- lease any property to a related party apart from business real property;
- invest in any other entity (eg, the trust must not own shares in a company); or
- conduct a business such as property development.
An SMSF may also be permitted to acquire further units in a NGUT from a related party without infringing s 66 of SISA provided certain criteria is satisfied.
There may also be stamp duty savings on the transfer of units if the value of the property owned by the unit trust falls below the landholder threshold of the relevant State or territory (eg, $2 million in NSW and $1 million in Victoria).
However, care needs to be taken to ensure the unit trust continuously complies with the SISR. Units in a NGUT can readily become an IHA if the strict SISR criteria is not complied with.
Unrelated unit trust
If an SMSF invests in a unit trust that is not a related trust, the SMSF is not limited in how much of the fund’s assets could be invested in such a trust.
For example, an SMSF with $1,000,000 of assets could acquire a 35% unit holding in an unrelated trust; investing the entire $1,000,000 in that unit trust as the trust is not a related party. (The SMSF’s investment strategy must still allow for cash flow and liquidity and may therefore hold some of its assets in cash or deposits to pay for ongoing costs of pension payments, etc). Under this scenario, the SMSF would not have control, nor significant influence in respect of the unit trust and therefore the 5% IHA limit should not apply.
It may also be possible to structure an investment in property that involves two unrelated SMSFs (where each family are not related nor in a close business relationship such as a partnership, etc) so that each SMSF holds exactly 50% of the units. The ATO has confirmed that a 50%/50% unitholding arrangement would not, by itself, give rise to a related trust relationship.
It should be noted, however, that the ATO has broad powers and unless this type of 50%/50% arrangement is carefully implemented and documented, it could result in a contravention of SISA with significant penalties. The constitution of the corporate trustee may, for example, provide a casting vote to a chairperson that can give rise to a related trust relationship. For this reason, it is generally much safer to have, for example, three unrelated SMSFs undertaking such an investment with, say 33.3% of units each.
Thus, where say two or more unrelated investors wish to combine their investments in a common structure such as a unit trust, this could provide a suitable structure for aggregating such investments between two or more SMSFs that are not ‘grouped’ together under the IHA rules.
One example, may be three SMSFs with $333,334 each combining together to invest in a unit trust to acquire a $1,000,000 investment property.
Unit trusts are generally not subject to tax provided the trustee of the relevant unit trust distributes all its net income (including any net capital gain) prior to 30 June each financial year. Trusts therefore are often referred to as flow through structures.
To the extent a trustee of a unit trust fails to distribute its net income prior to 30 June of the end of a financial year, the trustee of the unit trust will generally be taxed at the top personal marginal tax rate (currently, in FY2020, 45% plus applicable levies).
When setting up a unit trust that SMSFs propose to invest in, it is important to select a unit trust that will qualify as a ‘fixed trust’. Broadly, a fixed unit trust has less compliance issues compared to a non-fixed unit trust which may be required to consider, among other things, a family trust election or interposed entity election.
The unit trust deed should also cover a range of other matters that regulate what happens on the admission or departure of a unit holder and how disputes are to be resolved between the parties. A very important point to note here is that unitholders can be exposed and liable for the liabilities of the unit trust including any damages or losses incurred by the trustee. Carefully drafted limitation of liability provisions are required to ensure that unitholders including any SMSFs are not placed at risk from obtaining inferior documents. We also recommend that a suitable buy-sell agreement should be considered where there is more than one unitholder even if that unitholder is a related party to ensure the parties are dealing at arm’s length.
The stamp duty implications of transferring, issuing and redeeming units in each relevant state or territory also need to be carefully managed. We are also aware of numerous unit trusts that have been set up that have incurred considerable extra stamp duty on the acquisition of property as the unit trust had not been set up before the purchase or a change in unitholders occurred after the purchase contract had been executed.
Unit trusts are a popular structure for SMSFs to invest in. It is important that the various rules are clearly understood to ensure that each investment by an SMSF in a unit trust is compliant and effective. Moreover, there are considerable legal and related risks, including the tax effectiveness of the trust and stamp duty costs, that need to be carefully managed.
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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.
Note: DBA Lawyers hold SMSF CPD training at venues all around Australia and online. For more details or to register, visitor call Marie on 03 9092 9400.
17 July 2019