Introduction
For SMSF trustees, investing in unit trusts is a common strategy, particularly for property-related transactions. This approach is often considered as an alternative to Limited Recourse Borrowing Arrangements (LRBAs), especially when funds within the SMSF are insufficient for direct property acquisition. However, while potentially beneficial, such investments come with regulatory complexities, primarily due to in-house asset restrictions.
The Concept of Related Unit Trusts
A unit trust becomes a related entity when an SMSF member or their associates exert control over it. This control can manifest in several ways:
- Owning more than 50% of the capital or income entitlements.
- Holding the ability to appoint or remove trustees.
- Trustees acting under the influence of fund members.
If an SMSF invests in a related unit trust, the investment is generally classified as an in-house asset, which means it must not exceed 5% of the fund’s total assets. Exceeding this limit can render the investment non-compliant and necessitate corrective actions.
Exceptions to In-House Asset Rules: Regulation 13.22C Trusts
Certain trusts can qualify for an exemption from the in-house asset definition, as outlined in SIS Regulation 13.22C. These trusts, commonly referred to as non-geared unit trusts, must adhere to specific conditions, including:
- No outstanding borrowings.
- No leases to related parties (unless business real property).
- No investments in other entities or loans (except bank deposits).
- No assets acquired from related parties (unless business real property purchased at market value).
Failure to comply with these conditions at any point can permanently disqualify the trust from in-house asset exemption, requiring SMSFs to divest their holdings.
Practical Application: Co-Ownership and Creeping Acquisitions
Unit trusts structured under Regulation 13.22C allow for property co-ownership between an SMSF and its members. Over time, the SMSF can increase its ownership percentage by purchasing additional units from a related party, provided it adheres to market valuation principles and contribution cap limits.
Example:
The Bradley SMSF initially owns 70% of the BBC Unit Trust, with the remaining 30% held by its sole member, Bradley Barker. The trust owns a residential property leased to an unrelated tenant. Over time, Bradley transfers an additional 15% of his units to the SMSF, increasing its holdings to 85%. This strategy enables gradual SMSF investment growth while ensuring compliance.
Alternative Strategy: LRBAs and Unit Trusts
A key limitation of direct LRBAs is the restriction on property development while the loan remains active. However, an SMSF may use an LRBA to acquire units in a 13.22C unit trust, which subsequently purchases and develops property. This structure allows greater flexibility, though sourcing finance can be challenging due to commercial lending constraints.
Unrelated Unit Trusts: Risks and Considerations
Investing in an unrelated unit trust offers more flexibility, as it is not subject to the in-house asset restrictions of related trusts. However, risks arise if the trust later becomes related, such as:
- A unit holder forming a partnership with an SMSF member.
- A unit holder transferring their interest to a related party.
Changes in unit ownership can inadvertently breach in-house asset rules, necessitating the divestment of SMSF holdings.
Conclusion
While unit trust investments can be an effective strategy for SMSFs, compliance with superannuation regulations is critical. Trustees must carefully assess the nature of the trust, ensure adherence to regulatory requirements, and seek professional advice to mitigate risks. Whether investing in related or unrelated unit trusts, strategic planning is essential to maintaining SMSF compliance and achieving long-term financial objectives.