Hello SP
Thanks for the question.
The pre-11 August 1999 units in the related party unit trust are effectively outside of the in-house asset rules, even where the pre-11 August 1999 unit trust enters into a new borrowing after this date.
There are also rules that give the same grandfathered treatment to investments from 11 August 1999 to 30 June 2009 that meet the requirements of either sections 71D or 71E of the Superannuation Industry (Supervision) Act 1993.
However, any further investments in the unit trust from 1 July 2009 can potentially be in-house assets.
Can a pre-11 August 1999 unit trust have borrowings?
A pre-11 August 1999 unit trust can have borrowings, whether from a related party or an arm’s length party. This can be the case even where the borrowings were obtained after 10 August 1999.
Can a pre-11 August 1999 unit trust have interest-free borrowings?
Whilst a pre-11 August 1999 unit trust as an investment of a self managed super fund, could be an investment in related party that is not required to satisfy Regulations 13.22C and 13.22D, this does necessarily mean that an interest free loan is without consequences.
This is because the non-arm’s length income (NALI) rules have the potential to apply to treat as NALI, and therefore taxable at 45%, distributions from a unit trust where there is a scheme that has been entered into between parties that are not dealing with each other on an arm’s length basis (as suggested by the balance of the loan remaining the same for an entire income year – that is, no interest charged) such that the income of the trust is greater than it otherwise would have been if the parties were acting on an arm’s length basis.
Refer to section 295-550(5) of the Income Tax Assessment Act 1997.
Summary
Unless there are units acquired by the SMSF in the unit trust:
- from 11 August 1999 to 30 June 2009 that do not have the protection of either sections 71D or 71E of the SIS Act;
- from 1 July 2009 onwards
that are worth more than 5% of the fund’s total assets, I do not see there being an in-house asset issue, as a unit trust that is a pre-11 August 1999 investment of an SMSF is allowed to have a borrowing, even if the borrowing was entered into after 10 August 1999.
However, where the lender to the unit trust has not structured the borrowing on an arm’s length basis, this may suggest that the income from the investment in the unit trust is to be taxed at 45% as NALI, on the basis that the income is higher than it what it would otherwise be if the parties to the loan had transacted on an arm’s length basis.
Triggering the NALI rules is not necessarily of itself a reportable breach, as it does not attract any of the SIS Act sections referred to in Table 1A or any of the SIS Regulations referred to in Table 1B of the ACR instructions as issued by the ATO.
However, to the extent that it causes a material misstatement of the fund’s income tax expense (that is not corrected by the trustee in the accounts for the year in question) then this could give rise to a qualification of Part A of the Auditor’s Report.
Happy to hear the thoughts of other auditors on this matter.
Best regards
The Auditors Institute