Hello Howard
Thanks for the question.
Whilst the pre-August 1999 units are grandfathered from the operation of the in-house asset rules, any units issued in a debt for equity swap as being contemplated, assuming they would represent more than 5% of the fund’s total assets would give rise to an in-house asset problem.
Under sections 71D and 71E of the SIS Act there was a limited ability for an SMSF to subscribe for additional units post Augst-1999 without the additional units being in-house assets, but these provisions ceased to operate from 1 July 2009.
That aside the UPE owed the SMSF is problematic, as the ATO takes the view (not necessarily beyond all doubt, but nevertheless it is the ATO view – please refer to SMSFR 2009/3 | Legal database) that the UPE that remains unpaid more than 12 months after the year in which it was created, that the UPE is the provision of a loan from the SMSF back to the unit trust.  Although the unit trust, being a pre-August 1999 unit trust is allowed to have borrowing, this does not mean it is allowed to borrowing from the SMSF. Any such “borrowing” can be an in-house asset assuming it represents more than 5% of the fund’s total assets.
Hence Maria’s suggestion that perhaps the only way forward here, if the ATO view in relation to the status of a long standing UPE owed to the SMSF being a loan from the SMSF back to the unit trust is correct, might be to sell the underlying property.
This would ultimately be a matter on which the SMSF trustee may want to seek legal advice from a lawyer that is an SMSF specialist.
Best regards
The Auditors Institute