How to combine a unit trust with your SMSF

The investment markets are down, you need capital to expand your business and you’re after a better return on your SMSF. How can you benefit?

Once your total super balance, measured as at 30 June in the previous financial year, is greater than $1.6 million you won’t be able to make non-concessional contributions to the fund. This may limit you to concessional contributions, downsizer contributions or accessing the capital gains tax (CGT) small business concessions. Access to some of these concessions may be a long way off if you ever qualify.

It is possible for the fund to invest in related partnerships, trusts, companies or joint ventures as a strategy to increase income, but it’s important all income paid to the fund reflects a true market rate of return. If income received by the fund is more than if all parties are dealing at an arm’s length basis, trustees could be up for penalties and the income may be taxed at penalty rates.

SMSFs and trusts

But let’s just look at the combination of trusts and an SMSF to see how you could use both structures effectively. The main trust structures are a unit trust or discretionary (family) trust. A discretionary trust does present some problems for an SMSF as any income the fund receives from the trust will always be taxed at penalty rates as non-arm’s length income. A unit trust is a better choice for an SMSF to make an investment as income the fund receives from the trust can continue to be taxed concessionally if it’s done correctly.

By investing in the unit trust it is possible for an SMSF to own certain assets that can be leased or rented to ‘related parties’ such as members, trustees, their relatives or related entities. This, for example, may involve the unit trust owning business property which is rented to a related party on an arm’s length basis. The benefit of this is that the unit trust receives rent from the related party which is then distributed to the superannuation fund. The related party may be eligible for a tax deduction for any rent paid on the business premises and the members can increase their superannuation balance irrespective of how much they have in their fund.

Combining the SMSF and a unit trust requires the purchase of units in the trust at their market value. Market value can be determined in many ways, but it is usually the net realisable value of the underlying assets of the unit trust or a nominal value when the trust has been established. The benefit of the unit trust is that it may have other unitholders who can purchase units or make loans to the unit trust.

Once the superannuation fund is a unit holder the trustees of the fund need to be aware of the impact of the Superannuation Industry (Supervision) (SIS) Act and regulations so there is no breach of the rules. As a rule, units owned by a superannuation fund in a unit trust that is ‘controlled’ by related parties, including the fund, is treated as an ‘in-house asset’ which has restrictions applying. A unit trust is controlled, including when related parties hold more than 50 per cent of the units in the unit trust or the trust deed of the unit trust authorises the related parties to appoint or dismiss the trustees. Careful drafting of the unit trust’s deed is essential to make sure there is no slip up.

If the units owned by the superannuation fund are ‘in-house’ assets there is a five per cent restriction on the proportion of the fund that can be invested in all in-house assets. This is measured just before the fund purchases an in-house asset to make sure the fund will not exceed the five per cent limit and at the end of each financial year. If a breach occurs at the end of the financial year, the fund must put in place a plan to reduce its holdings of in-house assets to no more than five per cent of the market value of the fund.

There is an exception that excludes the fund’s investment in a related unit trust from the ‘in-house asset’ rules. This may apply if the trust has not borrowed, invests in other entities and it does not carry on a business. This exception means the fund can purchase more than 50 per cent of the units in the unit trust without being treated as an in-house asset. However, you need to careful as a minor breach of the exception can end up with the investment in the unit trust being treated as an in-house asset.

The use of a unit trust as an investment of a superannuation fund can certainly come in handy to assist by increasing the value of the fund where members have ‘maxed out’ their superannuation balances. However, anyone wishing to take advantage of this strategy needs to make sure there is no breach of the SIS Act rules, otherwise the fund could be penalised and in the worst case, be treated as a non-complying fund. Advice from a superannuation expert will prove invaluable.