The following article on using an SMSF unit trust to buy property was written by Daniel Butler of DBA Lawyers and published in the Australian Financial Review on September 26; 2015. The original article can be found here: Beware when using a unit trust to buy property in your SMSF (AFR subscription may be required).
SMSF unit trusts are popular structures by which to hold property and other investments.
They are particularly popular for self-managed superannuation funds (‘SMSF’) that invest in real estate. Using such a structure, one or more SMSFs, as well as other investors, can join forces to acquire an investment property, potentially giving each investor access to a better property with more upside potential than they might otherwise have.
Working within the SMSF unit trust rules
However, an SMSF must be careful to ensure it complies with a raft of superannuation rules.
An SMSF is not permitted to invest more than 5 per cent in a related trust, including any other “in-house” asset. For example, an SMSF with $1 million of assets could not invest more than $50,000 in in-house assets, including any related trust.
A related trust includes a unit trust where an SMSF member and his or her associates hold more than 50 per cent equity, exercise significant influence in relation to the trust, or can hire or fire the trustee.
Under the in-house asset rules, if an SMSF held up to 5 per cent of its assets in units, that SMSF unit trust could invest in a real estate property where the other units are held by related parties, such as family members or a family discretionary trust.
The exception is with non-geared unit trusts (NGUTs). A NGUT allows an SMSF to invest up to 100 per cent of its assets in that related SMSF unit trust, provided the unit trust complies with the strict regulations. A failure to comply can result in the units becoming in-house assets – the potential problem here being that an SMSF cannot hold more than 5 per cent of the portfolio in-house assets, so the fund would be in breach of rules and would likely incur penalties.
Broadly, an NGUT is an ideal structure for holding real estate with no borrowings secured on the title to that property.
LEARN: In-house Asset Rules (from the ATO):
Tax considerations
There are also tax issues to consider. SMSF unit trusts are generally not subject to tax, provided the trustee of the relevant unit trust distributes all its net income (including any net capital gain) prior to June 30 each financial year.
Trusts are often referred to as “flow through” structures where the tax is structured differently.
If a unit trust is not investing in property primarily for rental purposes, then the unit trust can be taxed on a similar basis to a company.
Broadly, a company is taxed at 30 per cent and the tax paid by the company can be passed on to a shareholder by way of a franking credit offset.
Individual shareholders and SMSFs can offset these “franking credits” against their tax payable. In the case of an SMSF in pension mode, an SMSF trustee can also obtain a refund of franking credits. Thus, even though a unit trust may be taxed as a company, there may be no significant loss of tax efficiency, but the timing of the tax payable and the cash flow to an investor changes.
An example where a unit trust is typically taxed as a company is where a unit trust is conducting property development activity and more than 20 per cent of units in that trust are owned by SMSFs.
In the case of a unit trust conducting a property development to sell its apartments for profit, the unit trust is not investing in land primarily for rental. Thus, the unit trust will be taxed on a similar basis to a company.
Proposed changes
Proposed changes to this tax treatment, however, are under way.
Exposure draft Tax Laws Amendment (New Tax System for Managed Investment Trusts) Bill 2015 (“ED Bill”) will impact on the tax treatment of unit trusts that are currently taxed as companies under div 6C of the Income Tax Assessment Act 1936.
Currently, under div 6C, the 20 per cent tracing rule for public trading trusts broadly specifies that if exempt entities, such as SMSFs, hold more than a 20 per cent interest in a trust, the SMSF unit trust can be a public trading trust and taxed as a company unless the SMSF unit trust invests in real estate primarily for rental income or a range of passive investments such as financial instruments and securities.
SMSFs will no longer be included in the tracing rule once the ED Bill is passed as law. This should result in unit trusts with SMSF investors not invoking div 6C. Therefore, for example, a SMSF unit trust that is owned by an SMSF that owns real estate that is primarily used for development purposes, rather than only rental income, will not be taxed as a company when the proposed ED Bill is finalised as law.
The ED Bill will result in a number of ramifications, as some existing public trading trusts will exit the corporate tax environment shortly after the legislation is finalised and there may be limited transitional time to utilise available franking credits.
The changes, once enacted, will also reduce the need for SMSFs to claim a refund of franking offsets where public trading trust distributions are received by an SMSF in pension mode.
This will make unit trusts an even more attractive investment structure.
This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.
Daniel Butler is a director of DBA Lawyers and a leading SMSF lawyer.
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