Self Managed Super Fund (SMSF) Article
Howard era ruling pays off for small funds
By Tony Negline.
This article may be out of date.
11th March 2009
On 30 June 2009 an important deadline passes for some lucky small super funds.
These super funds are fortunate because they have always been able, and with good planning and advice always should be able, to invest with much greater freedom than all other small super funds.
The reason for this additional freedom comes from a government policy decision in the 1998 Federal Budget. Back then the Howard Government announced that from the '98 Budget day, super funds would invest a small amount of their total assets in related companies or trusts. They would also be banned from making new loans to super fund members, their relatives and related companies and trusts. Similar rules were introduced for super fund assets leased to fund members, their relatives and related companies and trusts.
Investments, leases or loans which were completed before the announcement were permanently exempted from these new prohibitions if they satisfied certain rules.
When the change was announced the government faced down intense furor. Ultimately the new rules started on 11 August 1999, some 15 months after their original commencement date. The government also gave small super fund investors until 30 June 2009 to fix any problems they might have with the new rules.
Since 1998 it seems that the main beneficiaries of the permanent exemption from these new restrictions are super funds which invest in closely held unit trusts.
These exempt unit trusts are free to engage in many transactions which super funds are not normally allowed to do. For example:
- These exempt unit trusts can borrow money and security can be placed over the unit trust's assets to secure the borrowings
- They might be able to purchase assets from super fund members, their relatives or other related trusts or companies which a super fund might not be ordinarily permitted to purchase. For example, suppose a member owns an investment residential property and after considering all the costs of transfer (such as CGT, stamp duty and legal fees) thinks it would be better if the asset were held in the unit trust and therefore indirectly in their super fund
- The unit trust can operate a business which means that if the super fund owns all of the units in the unit trust then the ultimate tax rate on business income should be lower than normal business tax rates
- Similarly the unit trust could purchase a business
- The unit trust can lease assets to fund members, their relatives and related companies or other trusts
- The unit trust can loan money to super fund members, their relatives and related companies or other trusts.
It needs to be remembered that these unit trusts can only become involved in a transaction if it's by its trust deed.
There are many misconceptions about the post June 2009 rules and how they apply to super fund investments in closely held unit trusts. For example it is commonly assumed that:
- Pre 11 August 1999 small fund investments in closely held unit trusts have to be unwound by 30 June 2009
- A pre 11 August 1999 unit trust cannot undertake additional borrowings after 11 August 1999A pre 11 August 1999 unit trust cannot enter into borrowing arrangements after 30 June 2009
- A pre 11 August 1999 unit trust with outstanding borrowings must fully re-pay those borrowings by 30 June 2009
None of these views are correct.
Depending upon how the unit trust has been structured it is possible for super funds to continue to invest new monies into a pre 11/8/1999 unit trust until 30 June 2009. This cut-off date is quite close and some investors will need to take action this financial year because after this date no further investments are allowed.
Overall this unit trust structure is much more flexible than the so called 'instalment warrant' borrowing provisions which require the establishment of a security trust which is a special kind of trust that is neither a unit trust nor a discretionary trust.
Despite the obvious flexibility that these structures provide, investors who decide to use them need to be aware of a number of common pitfalls. For example:
- If the unit trust loans money to a member or their relatives then the ATO may be deem that the super fund is providing financial assistance not allowed under the super laws
- The super laws give the ATO tremendous power to deem any asset to be an 'in house asset'. If this is done to one of these unit trusts then it would cease to have the above structural advantages
- If a unit trust has outstanding borrowings and the super fund can no longer make new investments then how is the unit trust going to repay those borrowings?
- Deemed distributions – the super fund must be careful to ensure that it actually receives unit trust distributions in a timely fashion
- All dealings that the super fund has with the unit trust must be conducted on a genuine arm's length basis
Many people who recognize the benefits of these unit trust arrangements are willing to 'purchase' the super fund and unit trust from those lucky enough to still have them. An informal market is known to operate.
Frequently those who currently have these structures don't realize the economic potential of what they have and therefore 'sell' their current arrangement for less than it's really worth to the purchaser. Any willing 'buyer' however needs to be careful that they are not taking over a structure that has been badly run.
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