Tag Archives: SMSF

Changing the trustee of a trust – some elements for success

It is sometimes wrongly assumed that a minute of the current trustee is sufficient to change the trustee of:

  • a family discretionary trust (FDT); or
  • a self managed superannuation fund (SMSF) (which must be a trust with a trustee too – see sub-section 19(2) of the Superannuation Industry (Superannuation) Act (C’th) 1993 (SIS Act));

and that a change of trustee will have no serious tax consequences. The second proposition is more likely to be true, but not always.

FDTs and SMSFs invariably commence with a deed which contains the terms (the trust terms or governing rules – TTOGRs) on which the trust commences. That, in itself, is a reason why I contended in 2009 in Redoing the deed that an instrument or resolution less than a deed to change the trustee is prone to be ineffective even where change by less than or other than a deed is stated to be permitted by the TTOGRs in the trust deed.

Changing trustee relying on ability to change in the trust deed

It is thus to the trust deed that one needs to look to find:

  1. whether there is a power in the TTOGRs to appoint a new trustee or to otherwise change the trustee; and
  2. if, so, what the procedure or formalities are for doing so.

Changing trustee relying on the Trustee Acts

If ability to change trustee is not present, or is derelict, in the TTOGRs then the Trustee Acts in states (and territories) provide options for appointing a new or additional trustee which vary state to state.

Trustee Act – New South Wales

In New South Wales: section 6 of the Trustee Act (NSW) 1925 allows a person nominated for the purpose of appointing trustees in the TTOGRs, a surviving trustee or a continuing trustee to appoint a new trustee in certain specified situations such as where a trustee:

  • has died;
  • is incapable of acting as trustee; or
  • is absent for a specified period out of the state.

However an appointment of a new trustee in these situations must be effected by registered deed: sub-section 6(1) That is the deed of appointment must be registered with the general registry kept by the NSW Registrar-General, which is publicly searchable, and the applicable fee to so register the deed must be paid to NSW Land Registry Services for the appointment to take effect.

It is apparent from sub-section 6(13) that registration of a deed of appointment is not required where ability to appoint a new trustee is in the TTOGRs where the TTOGRs express a contrary intention; that is: where the TTOGRs expressly and effectively allow an appointment to be effected without a registered deed.

Trustee Act – Victoria

In Victoria there is a comparable capability for a person nominated for the purpose of appointing trustees in the TTOGRs, a surviving trustee or a continuing trustee to appoint a new trustee in writing in certain specified situations such as where a trustee:

  • has died;
  • is incapable of acting as trustee; or
  • is absent for a specified period out of the state;

under section 41 of the Trustee Act (Vic.) 1958. However this Victorian law does not impose any requirement that the required instrument of appointment in writing must be registered.

Changing trustee by obtaining a court order

The supreme courts of the states and territories are also given a residual statutory capability to appoint trustees under the respective Trustee Acts. However applying to a supreme court for an order to change a trustee of a FDT or a SMSF with sufficient supporting grounds is an option of last resort given likely significant costs and uncertainties of obtaining the order.

Changing trustee by deed

The TTOGRs in a trust deed of a FDT or a SMSF will frequently require that an appointment of a new trustee may or must be effected by a deed. It is desirable that it should do so to ensure the appointment of a new trustee does not become of a matter of uncertainty and difficulty for the reasons I have described in Redoing the deed.

Tax consequences of a change of trustee

As a change of trustee without more generally does not change beneficial entitlements under a trust, the tax consequences are usually benign:

For capital gains tax (CGT), assurance that changing trustee does not give rise to a CGT event for all of the CGT assets held in a trust is diffuse under the Income Tax Assessment Act (C’th) (ITAA) 1997:

Sub-section 104-10(2) concerning CGT event A1 states:

(2) You dispose of a * CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

Note: A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event A1 will not happen merely because of a change in the trustee.

Sub-section 960-100(2) with the Notes below it in fact say:

(2) The trustee of a trust, of a superannuation fund or of an approved deposit fund is taken to be an entity consisting of the person who is the trustee, or the persons who are the trustees, at any given time.

Note 1: This is because a right or obligation cannot be conferred or imposed on an entity that is not a legal person.

Note 2: The entity that is the trustee of a trust or fund does not change merely because of a change in the person who is the trustee of the trust or fund, or persons who are the trustees of the trust or fund.

Similarly sections 104-55 and 104-60 of the ITAA 1997 which concern:

• Creating a trust over a CGT asset: CGT event E1

• Transferring a CGT asset to a trust: CGT event E2

each restate the above Note: viz.

Note: A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event E… will not happen merely because of a change in the trustee.

Stamp duty

A change of trustee can have stamp duty consequences where the trust holds dutiable property such as real estate.

Duty – NSW

Concessional stamp duty on the transfer of the dutiable property of the trust to the new trustee can be denied in NSW to a FDT unless the trust deed of the trust limits who can be a beneficiary, for anti-avoidance reasons: see sub-section 54(3) of the Duties Act (NSW) 1997.

Indeed Revenue NSW withholds the requisite satisfaction in sub-section 54(3) unless the TTOGRs provide or have been varied in such a way so that an appointed new trustee or a continuing trustee irrevocably cannot participate as a beneficiary of the trust. Contentiously satisfaction is withheld by Revenue NSW unless a variation to a FDT to so limit the beneficiaries is “irrevocable“ : see paragraph 6 of Revenue Ruling DUT 037, even though that variation may not be plausible or permissible under the TTOGRs of the FDT.

This hard line is taken by Revenue NSW to defeat schemes where someone, who might otherwise be a purchaser of dutiable property who would pay full duty on purchase of the property from the trust, becomes both a trustee and beneficiary able to control and beneficially own the property who is thus able to contrive liability only for concessional duty and avoid full duty,

Duty – Victoria

Although the Duties Act (Vic.) 2000 contains anti-avoidance provisions addressed at this kind of anti-avoidance arrangement, there is no comparable hard line to that in NSW in sub-section 33(3) of the Duties Act (Vic.) 2000 so that the transfer of dutiable property, including real estate, on changing trustee is more readily exempt from stamp duty.

Other requirements

A prominent requirement on changing trustee of a SMSF is notification to the Australian Taxation Office, as the regulator of SMSFs, within twenty-eight days of the change: see Changes to your SMSF at the ATO website.

Where changing trustee involves a corporate trustee then there may also be an obligation to inform the Australian Securities and Investments Commission of changes to details of directors of the corporate trustee, if any. There may be further matters to be addressed if any new or continuing directors are or will become non-residents of Australia and, with SMSFs, the general requirement in section 17A of the SIS Act that the parity between members of the fund on the one hand and trustees, or directors of the corporate trustee on the other, needs to borne in mind and, if need be, addressed.

Taking out tax when superannuation death benefits are paid to deceased estates and testamentary trusts

Confusion-Blue

Who pays tax and how much when a superannuation fund pays out death benefits to a deceased estate or to a testamentary trust is not intuitive. The two technical concepts of “dependant” and “taxable component” in particular are a source of confusion.

Dependant

There are two relevant kinds of dependant. The SIS Act kind of dependant (a spouse of the person, any child of the person and any person with whom the person has an interdependency relationship – section 10 of the Superannuation Industry (Supervision) Act 1993) notably differs from a death benefits dependant under section 302-195 of the Income Tax Assessment 1997 , a subset of (SIS Act) dependant, as a death benefits dependant excludes adult children who are not disabled or in an interdependency relationship. Such an independent adult child can be a (SIS Act) dependant in receipt of a death benefit from a superannuation fund but is not a (section 302-195 of the ITAA 1997) death benefits dependant.

Taxable component

For tax purposes a death benefit is split into a taxable component and a tax fee component. The tax free component is tax free to any dependant but the taxable component is a misnomer when paid to a death benefits dependant (DBD): it’s tax free too! So of the four permutations (tax free to DBD, tax free to Non-DBD, taxable to DBD, taxable to Non-DBD) it is when a death benefits dependant receives a death benefit comprising taxable component that the benefit becomes taxable.

Re-contribution

Superannuation benefits can be paid prior to death if a member has satisfied a condition of release such as reaching the age of 65 years. This can be a way of reducing the taxable component of a death benefit that might be taxable to a dependant when paid after the member’s death. Member benefits, viz. benefits withdrawn by a member during his or her lifetime, are generally not taxable to the member where the member has reached aged 60.  It is permissible to re-contribute withdrawn benefits as non-concessional contributions back into superannuation, which become tax free component, when later paid out by the superannuation fund as death benefits.

Non-concessional limits and caps on re-contribution

However the member must be within non-concessional contribution limits to re-contribute back into superannuation in this way. At over age 65 that involves meeting the work test and being within the non-concessional caps. That is being under:

  • annual non-concessional contributions of $100,000 p.a. (no bring forward allowed for over age 65s); and
  • a total superannuation balance of $1.6m.
A look at how a taxable death benefit is taxed

A payment of death benefit that flows to a beneficiary of a deceased estate is something of a three stage event. The tax system looks through to the ultimate dependant in receipt of the death benefit (the third stage) even though the trustee of the superannuation fund may simply be paying death benefits to the legal personal representative of the deceased member who is an allowable (SIS Act) dependant (the first stage).

Non-death benefits dependants only get lump sum death benefits

Only lump sum death benefits can be paid to a dependant who is not a death benefits dependant, such as an independent adult child, so ordinarily we are looking at tax at 15% on a “taxed element” (the usual source [element] of benefits from a SMSF) but other rates can apply: see this table of rates at the ATO website https://www.ato.gov.au/rates/key-superannuation-rates-and-thresholds/?page=12

A curiosity is that taxable lump sum death benefits received by the trustee of a deceased estate are not subject to the medicare levy. Taxable lump sum death benefits viz. taxable component received directly by a non-death benefits dependant from the trustee of a superannuation fund, that is, not indirectly from the fund via a legal personal representative deceased estate dependant, is subject to medicare levy and PAYG withholding.

No PAYG withholding on lump sum death benefit paid by the trustee of the superannuation fund

The ATO also confirms that a lump sum death benefit is not subject to PAYG withholding where it is paid to:

  • a death benefit dependant (tax free); or
  • the trustee of a deceased estate – this amount is taxed within the deceased estate broadly in the same way it would be taxed if it was paid directly to the beneficiary.

https://www.ato.gov.au/super/apra-regulated-funds/paying-benefits/taxation-of-super-benefits/?default

The trustee of the superannuation fund is obliged to provide a PAYG payment summary – superannuation lump sum form (NAT 70947) to the trustee of the deceased estate within fourteen days of the payment though.

Obligations of the trustee of the deceased estate

According to the 2018 trust tax return instructions at the ATO website https://www.ato.gov.au/forms/trust-tax-return-instructions-2018/?page=43

A superannuation death benefit paid to a trustee is taxed in the hands of the trustee in the same way that it would be taxed if paid directly to a beneficiary, that is, the portions of the payment are subject to tax to the extent the beneficiary is a dependant or a non-dependant of the deceased. There is no tax payable to the extent that the payment is made to dependants or eligible non-dependants of the deceased.

At stage two, the trustee returns the taxable portions applicable to the non death benefits dependants in the trust return so that the ATO can assess the tax payable by the trustee as if the estate beneficiary/non-death benefits dependant was being directly taxed (with the taxed element generally capped to 15%).

This tax is a final tax paid at the trustee of the deceased estate level so no tax at stage three! A trustee of deceased estate should not include taxable elements of a superannuation death benefit lump sum, otherwise returned and directly and finally taxed, in income in its tax return. Then these amounts will not be further taxed at stage three as income say of a resident adult beneficiary.

Bringing trusts to a timely ending

MovingOnEnding a trust is straight forward, isn’t it? Vest all interests in the trust in beneficiaries and make the right accounting entries and the trust is terminated? Not quite.

That word “vest”. What does it mean? Vest is a technical legal term. Broadly it means to imbue with ownership of property. So, when a trust ends and the property of the trust vests, the beneficiaries of the trust succeed the trustee of the trust as entitled to the property in the trust.

But not all trusts end that way. For instance a unit trust or an unpaid present entitlement may already be vested in a beneficiary or beneficiaries. Clearly something other than vesting is needed to bring trusts of that type to an end. In those cases property that has already vested in beneficiaries may need to be paid to or put in the possession of the beneficiaries too for the trust to end.

Ending is all in the timing

In most states and territories of Australia trusts must vest within a statutory perpetuity period, typically 80 years. From this point this post relates to jurisdictions where a statutory perpetuity period applies.

Trusts that are fully vested, such as bare trusts, fixed trusts, some sorts of unit trusts and “indefinitely continuing” superannuation funds may continue for longer than the perpetuity period. A discretionary trust must vest no later than the perpetuity period, that is, discretions to distribute all income and capital of the trust must be taken and sunset once the time for vesting has been reached otherwise it will be too late and the formula for distribution for “takers-in-default” set out in the trust deed will apply to the property then left in the trust. The divesting of those interests, which are then held by the trustee outright for those beneficiaries, by payment over to, or at the direction of, the beneficiaries, can happen later after the expiry of the perpetuity period.

Bringing forward the ending of a trust

The trust deed should also set out how the time for vesting can be brought forward from the expiry of the perpetuity period. That time of expiry will usually be the “default” time for vesting, or a time just before it, (the last vesting time) in a well-crafted discretionary trust deed.

An objective of winding up a trust is to satisfy all parties with interests, in the wider sense,  in the trust, including creditors, trustees, beneficiaries and the Commissioner of Taxation.

Failure to address these interests of the parties interested, or the trust deed requirements and formalities for the bring forward of the time of vesting, can mean that the trust, or its aftermath, will remain a matter in contention or dispute which is diametrically not what a trustee will want to occur following their effort to bring the trust to an end. A trustee can face difficulty in the converse case too where a trust is inadvertently brought to an end prematurely. In other words trustees can face problems where a trust has a mistimed ending either way. A trust may go on longer than planned or it may be inadvertently brought to an end before the trust should end. An example of the latter is to be found in trust deeds which set an inexplicably early time for vesting many years prior to the expiry of the perpetuity period.

Ending by depletion and merger

Depletion and merger are two other ways a trust may be brought to an end even where the intent of the trustee and beneficiaries is, and the trust deed may suggest that, the trust is to go on for longer.

Depletion is where the trustee no longer holds property on trust. If trust property is depleted and the trustee acquires more property on trust, the arrangement is treated as a new and separate trust. A “resettlement” occurs as well as likely confusion about which trust is which. Hence the device of a “settled sum” for a discretionary trust, which remains as trust property, to ensure continuity of the (original) trust even where the trust is in deficiency and has no other identifiable property.

Merger also brings a trust to an end in an untimely and premature way. Merger occurs where the trustee and the beneficiary are or become the same person. In the case of a merger the trust obligation of the trustee under the terms of the trust is no longer owed to the beneficiary so the trust does not continue.

Merger and SMSFs with individual trustees

Merger can be an interesting issue in the case of a self managed superannuation fund with individual trustees. There is no merger while the fund has two trustees: Trustee A has trust obligations to member B and trustee B has trust obligations to member A. However if a trustee/member dies and the surviving sole trustee is also the sole member of the fund with a fully vested beneficiary account of the entirety of the fund, the fund likely merges. It follows that the fund is no longer a trust. The Commissioner of Taxation has not addressed how the doctrine of merger may apply in these cases, and, as I understand it, the Commissioner treats a fund in this situation as continuing on as a matter of administrative convenience. If the Commissioner’s approach, which may be tantamount to a recognition of a self managed superannuation fund that is not a trust, came before the courts, it is unclear how it might be explained or permitted.

Some starting points

Trusts that require winding up usually commence by and are governed by a trust deed. I am not writing here of testamentary trusts. A trust deed will usually state the requirements to wind up the trust including how the time of vesting must be brought forward. A trust deed may also provide for other things which complicate vesting or winding up, or both. The trust deed may require that a party’s consent is required before either can happen. There may be other forerunner steps which haven’t been taken which must be taken before the trust can vest under the deed. A grasp of the design or method of the trust provisions in the trust deed will build confidence that all requirements for a winding up raised in a trust deed have been identified and addressed.

If the accounts of the trust have been correctly prepared then the current balance sheet, in particular, gives a list of activity to be addressed before the trust can be wound up. For a company liquidation, liabilities need to be satisfied with the balance of assets (property) distributed to owners. Trusts are no different. The more assets have been converted to cash and liabilities have been met the simpler the contemporary balance sheet and the winding up will be.

Tax planning

The conversion of assets to cash can give rise to taxable capital gains and assessable balancing charges but the alternative, their distribution to beneficiaries on a winding up inevitably does so too. It is generally simpler or more tax effective, or both, if these CGT events are contemporaneous with the trust coming to an end.  In the cases of a fixed trust or a unit trust CGT event E4 can occur where a non-assessable part of a capital gain is distributed to a beneficiary when the interest of the beneficiary in the capital of the trust persists.

Errors frustrate the ending

Correct accounting in the trust will follow correct treatment of interests, assets or liabilities in the trust by the trustee. But correct treatment of interests, assets or liabilities doesn’t always happen. Notable examples where correct treatment doesn’t happen include:

  • the elimination of entitlements of family beneficiaries in the course of a winding up. Trustees of discretionary trusts distribute trust income to family members on lower tax rates (A) which remains unpaid and which is treated in the accounts of the trust as an unpaid present entitlement under terms in the trust deed. On winding up the distribution may revert to or may be paid to the principals of the family (B) instead without explanation. That suggests that the present entitlement of beneficiaries to former income of the trust was a sham or misunderstood with potential tax liability for the trustee;
  • distribution in the course of a winding up to individuals where the trust holds money or property sourced from a private company to which Division 7A of the Income Tax Assessment Act 1936 applies. This may be inconsistent with repayment of the money or property to the relevant company and could trigger a “deemed dividend” tax liability; and
  • backdating and forgiveness of loans – it can be tempting for a trustee to purge debts to related parties in the accounts of a trust but the purge is unlikely to be legally effective. A more nuanced treatment, which actually addresses the nature of the original transaction, is more likely to be accepted.

The Commissioner of Taxation investigates, audits and challenges trusts and the parties involved in these kinds of errors including after a winding up.

Conclusion

The affairs of trusts vary greatly and some have deeply intransigent issues. Getting a trust ready to wind up, and executing that wind up at a custom desired point in time may pose a number of challenges which should be considered and addressed in the process. The legal, accounting, business and practical attributes of the trust and possible errors should be considered through the due diligence process so that a non-contentious consignment of the trust to history can be effectively documented.

Minority SMSF investors and related unit trusts

AssociatesA popular pro-active SMSF strategy is to skirt the boundaries of the associate rules in Part 8 of the Superannuation Industry (Supervision) Act 1993 (SISA) with minority SMSF investors taking units in a unit trust with no apparent majority controller with other unrelated SMSF or non-SMSF investors. The object of the minority strategy is that the minority SMSF investor and associates have a less than 50% entitlement to income and capital of the unit trust and so the unit trust will not be a related trust of the SMSF automatically. This is an alternative strategy to investing in a non-geared unit trust which complies with Regulation 13.22C of the Superannuation Industry (Supervision) Regulations.

If the minority strategy doesn’t work

If the unit trust is, or becomes, a related trust of the SMSF the consequences can be severe. The investment in the related trust by the SMSF is taken to be an in-house asset. A SMSF that fails to remedy an investment of more than 5% of its assets in in-house assets faces loss of complying status potentially causing:

  • tax at 47% on its current income; and
  • loss of almost half of the assets of the SMSF in a one-off additional tax bill in the year in which the SMSF becomes non-complying; or
  • prosecution for civil or criminal breach of a civil penalty provision under the SISA.

An investment in a non-geared unit trust which complies with Regulation 13.22C is specifically excluded from being an in-house asset. The minority strategy does not give the same assurance to a SMSF investor in units in a unit trust which is not Regulation 13.22C compliant.

Control of a trust

The more  than 50% entitlement to income and capital test is one of the tests of control of a trust in sub-section 70E(2) of the SISA which determine whether or not a trust is controlled and is thus an associate and, by that, a related trust. An alternate test in paragraph 70E(2)(b), sometimes overlooked by users of the minority strategy, is the directions, instructions or wishes test which is an alternative test of control of a trust. Its formulation:

an entity controls a trust if:
…               (b)  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 a group in relation to the entity (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts);

is based on a similar formulation in sub-section 318(6) of the Income Tax Assessment Act 1936 which deals with associates under the income tax controlled foreign corporations (CFC) rules.

MWYS v. Commissioner of Taxation

The directions, instructions or wishes test in paragraph 318(6)(b) in the CFC rules was recently considered by the Administrative Appeals Tribunal in MWYS v. Commissioner of Taxation [2017] AATA 3037 (22 December 2017) and the companies in dispute with the Commissioner in that case were found not to be associated even though the companies concerned had the same directors.

Deputy President Logan found that, despite the unanimity of the directors of the companies involved, the companies were not associates as it could not be concluded, on the evidence, that the directors of one company, acting in that capacity, would influence themselves acting in their capacity as directors of the other company. Deputy President Logan observed that the arrangements between the companies involved: an Australian listed company and a UK publicly listed company which enabled them to dual list on the ASX and the London Stock Exchange, were for the purpose of compliance with dual listing requirements but, within that framework, the companies were structured with similarity to unrelated joint venturers. No inference could be drawn about one company acting on the directions of the other.

Moreover the strict governance which applied to both of the listed companies actually helped the companies to establish that the directors were acting independently and at arms length from the other company even where the directors were directors of the other company too. Short of a sham, or a cipher, as arose in Bywater Investments Ltd v Federal Commissioner of Taxation [2016] HCA 45 (see our blog -Why setting up offshore companies for Australians is a tricky business), the AAT was prepared to rely on the meticulous corporate documents which set out the distinct responsibilities of the directors of the companies they separately served.

Directors in common

It is certainly clear from MWYS that commonality of directors of a company, or in the case of paragraph 70E(2)(b) of the SISA, commonality of directors of a corporate trustee is not enough, in itself, to amount to a reasonable expectation that one company will act in accordance with the directions, instructions or wishes of the other company or of a group including it.

Is MWYS good news for SMSFs using the minority strategy?

Is the decision in MWYS a relief to minority SMSF investors in unit trusts concerned about paragraph 70E(2)(b) of the SISA? Maybe not. Documents of SMSF trustees and of unit trusts, in which they invest, are far less likely to be as meticulous at keeping the affairs of entities being examined for control apart. A unit trust deed is more likely than, say, a joint venture arrangement to show that the trustee of a unit trust might act in accordance with the directions, instructions or wishes of a unitholder, albeit a minority unitholder.

Frequently, under unit trust deeds, minority unitholders have the right to vote on resolutions which bind the trustee of the unit trust to act. A minority unitholder may not have the votes, alone, to so bind the trustee; but the question posed by the test is whether the trustee is accustomed to act, or whether there is a reasonable expectation that the trustee of the unit trust will act, in accordance with the directions, instructions or wishes of a minority unitholder. The answer in fact is equivocal – yes, if the minority unitholder votes are in the majority and no, if not. So yes, a part of the time or on some occasions. So the minority SMSF investor and the trustee of the unit trust are associated?

What will facts show under scrutiny?

The concern for SMSF users of the minority strategy is: will their position, that the unit trust they invest in is not a related trust, become less defensible under scrutiny from the Commissioner? From the activities of the SMSF investor, its associates and the trustee of the unit trust the Commissioner can gauge how the trustee of the unit trust has reached decisions, which may not have been in accord with documents, whether sound or not, and form a view as to how likely the trustee of the unit trust is likely to have acted on directions, instructions or wishes of the SMSF investor and its associates.

Until the circumstances of a SMSF using a minority strategy, including the relevant documents, are considered it can be uncertain whether a SMSF minority unitholder may “control” a unit trust and cause it to be a related trust.

SMSFs getting practical to invest in land with others

The force of the superannuation law is that investment in land by a SMSF needs to be prudent. An investment needs to be considered in a business-like way.

Limited recourse borrowing is one way to fund investment in real estate. SMSF principals may prefer to arrange equity investment from private connections outside of the SMSF.

Investment as a tenant-in-common?

I am frequently asked about SMSFs participating in land investments as a tenant-in-common with related and unrelated entities of the principals of the SMSF. It is apparent from the NTLG Superannuation sub-committee technical minutes of June 2011, released by the Australian Taxation Office, that tenants in common arrangements for SMSFs are not going to be prudent for the SMSF without careful and restrictive implementation. Wherever other tenants in common could borrow, or use or risk their interest as security, the SMSF tenant-in-common is exposed to uncontrolled risks which would bring into question, for instance, whether the SMSF:

1.    has acted prudently pursuing the investment for members for whom it is bound to provide;

2.    has breached regulations which prevent charges, or the potential for them, being taken over SMSF property; or

3.    has satisfied the sole purpose test.

Investment through a trust?

The tenant-in-common option is frequently turned to because of the restrictive regime that has applied in relation to the investment by SMSFs in related trusts since 1999. Shortly stated, a post 1999 investment by a SMSF in a trust, which is related to the principals of the SMSF, a “related trust”, is treated as an “in-house asset” and more than 5% of the assets of a SMSF in in-house assets can leave the SMSF non-complying.

Non-geared unit trust – expressly relieved from being a related trust

The SIS Regulations provide an express exception. A superannuation fund can invest in a non-geared unit trust (NGUT) to which Regulation 13.22C applies without the NGUT being taken to be a “related trust” and thus the investment isn’t taken to be an investment in an “in-house asset”.

This express exception is especially limited and, aside from relief from “related trust” treatment causing in-house asset difficulty, offers no expansion in the kind of investment that can be pursued with superannuation money. In other words, the investment still needs to address 1 to 3 above, for instance.

The Regulation 13.22C and 13.22D requirements and restrictions on NGUTs essentially mirror the restrictions on regulated superannuation funds. NGUTs cannot borrow and they can only “lend” to operate a bank account. They cannot secure or charge their assets. (A non-SMSF unit holder in a NGUT could give a security over his, her or its units but security could not be given over the assets of the NGUT.) A NGUT cannot run a business – unlike with superannuation funds, this is a direct requirement. Loss of NGUT status, so that the NGUT becomes a related trust triggering in-house asset difficulties follows the merest breach under Regulation 13.22D which can put complying status of a SMSF investor at the mercy of the ATO.

Practicalities

1.    Nevertheless a carefully implemented NGUT can be the most practical way to pursue unitised investment in land by related parties and unrelated parties of a SMSF with the SMSF.

2.    Compliance with the regulations needs to be closely monitored as stated. Any debtor or creditor, aside from a bank for the (credit only) trust bank account, potentially causes loss of protection from related trust status. Funding of, and money flow to and from, the NGUT without breaching the rules is thus practically challenging. The trustee needs to raise equity (unit) funding whenever any extra funding is required. From a practical and paperwork burden perspective, using partly-paid units is a strategy that might be considered wherever the trust needs a flexible equity facility.

3.    The activity of the NGUT that invests in land also needs to be monitored and carefully planned and structured. It is possible for real estate activity by trustees to be considered the carrying on of a business under tax rules. As stated a NGUT cannot carry on a business under the NGUT regulations nor, if it has a trust deed to suit, under its trust deed.

4.    Under the special trust rules in NSW, a special trust pays land tax at the highest land tax rate without a threshold. A SMSF can attract a better land tax rate. A NGUT will not automatically qualify for the rate for a SMSF to the extent a SMSF invests in it. However if the NGUT is a “fixed trust” under the land tax rules then a better rate than the special trust rate can be achieved. Hence there can be advantage to structuring a NGUT with a trust deed so that the NGUT can be treated as a fixed trust under the land tax rules.

5.    A carefully crafted trust deed can be very useful to assist the trustees of a SMSF and a NGUT to keep within the express requirements and restrictions on NGUTs.

Can I have the real estate in my SMSF?

Real estate can be provided in kind to a member as a superannuation benefit. Prohibitions can apply to acquisitions of real estate from members but this prohibition does not apply going the other way. That is: from a fund to a member on a payment out of the fund as a superannuation benefit.

Still a condition of release needs to be met before a superannuation benefit is provided by a SMSF. Let us say that the fund is in pension mode and the member is over the age of sixty-five so a condition of release is met for a benefit to come from the member’s superannuation balance in the fund to the member.

Difficulties providing a real estate benefit from a SMSF in an income stream

A SMSF in pension mode must face these difficulties before releasing a benefit in the form of real estate:

  • the Australian Taxation Office (ATO), if not the superannuation laws unequivocally, require that a pension (a superannuation income stream) benefit must be paid in money and not in kind;
  • the benefit can take the SMSF out of pension mode, where the income of the SMSF is tax exempt on its earnings; and in to accumulation mode, where the fund is taxable at 15% on its earnings; depending on how the commutation of pension is done. This could inadvertently cause the capital gain, the SMSF makes on the disposal of the real estate as a benefit, to be taxable to the SMSF; and
  • the SMSF may not have paid a minimum annual pension payment for the year as required by the superannuation income stream regulations.

Partial commutation solution

A partial commutation of a pension is a work around for these difficulties. A partial commutation of a pension is a commutation of less than the member’s pension balance in the fund as a lump sum. That is the member needs to have remaining member pension balance after the commutation. The ATO has indicated that a partial commutation:

Doing it

There are a number of traps to implementing this solution:

  • The governing rules of the SMSF must allow for partial commutations of pensions, the trustee must have a power under the governing rules to pay benefits in kind and the pension arrangements or agreement with the member must reflect this.
  • The member needs to trigger the partial commutation and the benefit in kind in accordance with the pension arrangements or agreement.
  • The trustee of the SMSF must value the real estate to ascertain the amount of the lump sum benefit being paid to debit to the member’s account.
  • The member getting the real estate benefit must have a sufficient member account balance remaining after the debit to treat the satisfaction of the benefit in kind as a partial commutation of the pension.
  • The fund and conveyancing documentation needs to be prepared on an arms length basis as required under superannuation law.

Although there is no capital gains tax if the fund remains exempt from tax in pension mode, other taxes and duties on a transfer of real estate can still apply.

For instance:

  • GST can apply to the transfer of commercial premises or new residential premises from a SMSF where the fund is registered or is required to be registered for GST.
  • Stamp duty liabilities vary significantly from state to state. Victoria has concessions on the transfer of dutiable property to a beneficiary of a trust. In New South Wales there is generally no relief from full ad valorem duty. A concession which applies in New South Wales on the transfer of dutiable property to a superannuation fund as a contribution does not apply to a transfer out the other way as a benefit.

Thus, to recap our disclaimer, partial commutation of a pension to provide real estate from a SMSF should be considered case by case and specific advice should be taken in relation to the above general comments.

Is a transfer to a SMSF by a related holding trust, after repayment of a LRBA to purchase residential property, prohibited by s66 of SISA?

Is a transfer to a SMSF by the trustee of a holding trust, who happens to be a related party of the SMSF, after repayment of the borrowing under a limited recourse borrowing arrangement – LRBA, to purchase residential property, prohibited by section 66 of the Superannuation Industry (Supervision) Act 1993 (“SISA”)?

Section 66 of the SISA prohibits a SMSF from acquiring residential property, which is not business real property, from a related party of the fund.

Returning an asset that is already in the SMSF

A similar question arises when a SMSF receives a return of an asset of the fund from a custodian or an investment manager, which incidentally happens to be a related party, which is similarly not covered by any exemption in section 66. Technically the SMSF has acquired the asset from a related party; the legislation could be clearer providing exceptions in section 66 for these cases especially as the scope of acquisition prohibited by section 66 is expressed in very wide terms: see paragraphs 88 to 109 of SMSFR 2010/1.

But an acquisition, being the return or resumption of the asset, not for consideration (value) from a related party, does not really explain the actual transaction happening. In these cases, the SMSF is acquiring or resuming title or legal ownership of an asset it already owns beneficially. So, in the case of a LRBA of residential premises, section 66 would be concerned with who the residential property was originally acquired from, not with the” acquisition” of the asset from the related holding trust once the borrowing is paid out.

As with a custodian or investment manager, the power of the related bare trustee of a holding trust to hold the asset, and the power to transfer the asset back to the trustee of the SMSF, is stated or is implicit in the SISA itself – see sections 67A and 123.  As a matter of statutory interpretation those powers should prevail over the prohibition in sub-section 66(1): generalia specialibus non derogant   Nevertheless a clearer description of the scope of the acquiring prohibited, and of exceptions, would be preferable to relying on that maxim though SMSFR 2010/1 issued by the Commissioner of Taxation does helpfully state at paragraph 113:

It is therefore necessary to take a holistic approach to the transaction to determine objectively what it is that the trustee or investment manager is actually acquiring. If, for example, something is being purchased by a trustee or investment manager, a relevant question is what is the trustee or investment manager paying money to acquire. While many transactions involve rights, an acquisition is of rights only if the substance of the transaction is rights.

What is the whole LRBA really about?

From a holistic viewpoint the SMSF, which already holds beneficial ownership of the residential property, is, in substance, concluding the acquisition from the original vendor by taking legal title to the residential property by the transfer from the holding trust. It follows that the acquisition of legal title from the related holding trustee is the exercise of a right to acquire legal title which is not the “substance of the transaction”.

The Australian Taxation Office may not necessarily take the same view.