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There are various types of unit trusts a SMSF can invest in, which in turn leads to confusion regarding in-house asset issues and whether it can be acquired from a related party.

To determine if a SMSF can invest in a trust, we suggest you follow the below guide.

Step 1 – Is the trust ‘Controlled’ or ‘Uncontrolled’?

If the answer is ‘YES’ to any of the below, the trust will be considered a ‘controlled trust’ under section 70E(2) (SISA):

1. The SMSF plus any related parties have a fixed entitlement to more than 50% of the capital or income of the trust
2. The SMSF or any related parties are able to remove or appoint the trustee, or a majority of the trustees, of the trust.
3. The trustee of the trust, or a majority of the trustees of the trust, is accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the SMSF or any related parties (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts).

To understand who is considered a related party, refer to our previous blog SuperAA Guide to Determine a Related Party 

If the answer was ‘NO’ to all of the above, the trust will be considered ‘uncontrolled’ and be regarded as one of the following trusts:

Unrelated Trust – (not Widely Held)

Where the SMSF invests in or loans to a trust which is not considered to be controlled by the SMSF and/or any related parties, the trust will be regarded as an unrelated trust.

The main advantage of the unrelated trust structure is that it does not fall within the in-house asset provisions. Accordingly, the trust is not restricted on the types of assets it can invest in.  The trust can also borrow, run a business etc.

One disadvantage that should be noted is that the SMSF cannot acquire any units held in an Unrelated Trust from a related party, as this type of trust is not a listed exemption classified under section 66 (SISA)

Summary:

Subject to in-house asset rules – NO

Can be acquired from related party – NO

Widely Held Trust

A widely held unit trust is one in which at least 20 unrelated entities between them have fixed entitlement to 75% or more of the income and capital of the trust.

The advantages and disadvantages of widely held unit trusts are the same as for unrelated trusts, however, unlike unrelated trusts, widely held unit trusts also offer the advantage of being exempt from section 66 (SISA), allowing units to be acquired from related parties.

Summary
Subject to in-house asset rules – NO

Can be acquired from related party – YES

Step 2 – What type of ‘Controlled’ trust do you want to invest in?

 If you made it down to this step, the trust you are looking for is not considered ‘unrelated’ or ‘widely held’.

The types of trusts that are considered a ‘controlled’ trust include:

Pre 1999 Unit Trust

Prior to August 1999, the definition of an in-house asset was limited to a loan to or an investment in, a standard employer-sponsor. This led to many SMSFs investing in related unit trusts to facilitate geared investments, without breaching the in-house asset rules.

To close this loop hole the ATO introduced new legislation on 11 August 1999 to extend the definition of an in-house asset to cover a range of transactions with a related party, including investments in controlled trusts.  Essentially, this stopped SMSFs from completing this strategy, as any investments made after 11 August 1999 into a trust controlled by related parties with borrowings would be considered an in-house asset.

However, to avoid the new in-house asset definition applying retrospectively to pre-existing arrangements, the ATO included a number of grandfathering provisions to exclude certain assets that were not an in-house asset previously from ever being an in-house asset. These included:

• A share in a company or unit in a unit trust, if the share or unit was acquired on or before 11 August 1999, or that was acquired after 11 August 1999 under a legally binding contract that was entered into before 11 August 1999, and
• Any additional investments into the company or trust acquired after 11 August 1999 and up to and including 30 June 2009 that represent a reinvestment of trust distributions from the pre 11 August 1999 investment plus any earnings on those reinvestments, or
• Additional investments in the company or trust acquired after 11 August 1999 and up to and including 30 June 2009 where the additional investment did not exceed the level of debt held by that company or trust as at 11 August 1999.

It is important to remember that the in-house asset rules will apply to any units acquired after 30 June 2009. Therefore, SMSF trustees will be restricted from reinvesting any trust distributions after that date.

Summary
Subject to in-house asset rules – NO (Providing units acquired prior to 30 June 2009)

Can be acquired from related party – NO

13.22C Trust

Under s71(1)(h) of the SIS Act, an investment by an SMSF in a related unit trust will be exempt from the in-house asset rules where the trust satisfies the requirements listed in the SIS Regulation:

• Regulation 13.22B (SISR) – where the investment was made prior to 28 June 2000
• Regulation 13.22C (SISR) – where the investment was made on or after 28 June 2000

Therefore, for an investment in a related party unit trust made on or after 28 June 2000 to be exempt from the in-house asset rules, the unit trust must satisfy the requirements of Regulation 13.22C (SISR):

• The trustee of the unit trust must not be party to a lease (or legally binding lease arrangement) with a related party of the fund, unless the lease relates to business real property
• The trustee of the unit trust must not have any outstanding borrowings
• The assets of the unit trust must not include:
  • an interest in another entity (including a shares in a company or a unit in another trust)
  • a loan to another entity unless the loan is a deposit with an authorised deposit-taking institution within the meaning of the Banking Act 1959
  • an asset over, or in relation to, which there is a charge
  • an asset (other than money) that was acquired from a related party of the fund after 11 August 1999, unless the asset was business real property acquired at market value
  • an asset (other than money) that had (at any time) been owned by a related party of the super in the previous three years, unless the asset was business real property acquired at market value.

Regulation 13.22D (SISR) also confirms that the exemptions in regulation 13.22B and SISR 13.22C (SISR) will cease to apply where either:

• The trustee of the unit trust fails any or the requirements in regulation SISR 13.22B or SISR 13.22C (whichever is relevant)
• The trustee of the unit trust conducts a business
• The trustee of the unit trust conducts a transaction otherwise than on an arm’s length basis
• The SMSF ends up with more than 4 members due to the admission of additional members.

Regulation 13.22D (SISR) also confirms, where a breach occurs and regulation 13.22C (SISR) ceases to apply, all units held by the SMSF will be considered an in-house asset, meaning the fund would be required to dispose of all units to a level that represents less than 5% of the fund’s assets.

Once a breach in 13.22D occurs, the trust can never be considered an exempt in-house asset again.

Summary
Subject to in-house asset rules – YES

Can be acquired from related party – YES

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