The 3 most common SMSF audit issues for related unit trusts
A unit trust structure allows multiple investors, including a Self-Managed Super Fund (SMSF), to share ownership with other investors of one or more investments. Unit trust investments are commonly used by SMSF’s to acquire property with other parties. The units represent the proportionate ownership of each investor of the trust.
The most common audit issues when SMSF’s invest in related unit trust are:
Insufficient evidence to support the 30 June market value of the units.
Insufficient evidence to support existence of the assets and liabilities of the unit trust.
Underpaid or overpaid trust distributions.
When is a unit trust a related trust?
A unit trust will be considered a related trust where the member either alone or with other related parties controls the trust, either by being:
Entitled to more than 50% of the capital of the trust; or
In a position to either formally or informally direct the trustee of the unit trust to act in accordance with their directions; or
Able to appoint or remove trustees.
Broadly a related party of a member includes other members and trustees of the SMSF, their relatives, spouses of relatives, partners in a partnership and their child or spouse, controlled trusts and controlled companies.
A partner in a partnership also includes a ‘tax law partner’, for example someone who the member co-owns a rental property with.
What are the key compliance considerations for related unit trust?
When an SMSF invests in a related unit trust or a related company, this investment will be considered an “in-house” asset unless an exemption applies. An SMSF can only invest up to 5% of the market value of its assets in “in-house assets”. The main exception to this is where the related unit trust or company complies with all restrictions outlined in section 13.22C of the SIS Regulations. These include that the entity:
Does not borrow;
Does not own any assets over which there is a charge;
Does not invest in or lend money to individuals or other entities (other than deposits with authorised deposit taking institutions within the meaning of the Banking Act 1959);
Does not lease assets to related parties, other than business real property;
Has not acquired any assets from a related party of the fund other than business real property;
Has not acquired any assets owned by a related party of the fund in the previous three years (apart from business real property);
Does not conduct a business; and
Conducts all transactions on an arm’s length basis.
The above applies to investments made in related unit trust and related companies on or after 28 June 2000. Where the entity fails one of the criteria, regulation 13.22C ceases to apply and the investment held by the SMSF will be considered an in-house asset. In addition, the unit trust can never be considered an exempt in-house asset again. This will likely mean that the SMSF would need to sell units to reduce the value of the investment to 5% of fund assets. This means it is very important for trustees to be aware of the restrictions as breaching them can have major consequences.
How to support the market value of the investment?
Private unit trusts are generally not required to value their assets at market value each year. This means, simply dividing the net asset value of the trust by the number of units issued is unlikely to represent the market value of the units.
Evidence to support the market value will be a copy of the financial statements of the trust or company, including evidence that the underlying assets & liabilities exist and are valued at market value.
Since 13.22C entities cannot invest in other entities, their main asset is often property for which the 30 June value can be supported by:
Formal valuation from a qualified and independent valuer.
Real estate agent valuation - with comparable sales included.
Online valuation – these will normally indicate whether the reliability is high, medium or low. The valuation needs to have a high reliability and include comparable sales.
Valuation from trustees - with evidence of market valuation such as recent comparable sales.
Existence of assets & market value go hand in hand
The market value of the units or shares held by the SMSF depends on the market value of the assets & liabilities of that entity, which means the auditor first needs to confirm they actually exist!
For example, if the entity holds a property, the auditor will require a title search to confirm the trust owns it. There is no difference to the things the auditor needs to verify compared to where the property would be owned by the SMSF directly.
Unpaid or overpaid trust distributions / dividends
Related entities that rely on the 13.22C provisions exclusion from the in-house asset will not be able to borrow or lend monies.
This means income distributed must be paid in a timely manner as unpaid trust distributions or dividends could be considered a loan from the SMSF to the entity. There is normally a timing difference but continually carrying forward unpaid income will likely result in a breach being reported.
As 13.22C trusts are not allowed to borrow, unpaid trust distributions could result in the trust being considered an in-house asset. Another consideration is that income not being paid when due is likely a breach of the arm’s length rules.
It is also important for the accountant of the entity to use the correct terminology. Some unit trust financial statements refer to “loan to beneficiary” rather than “distribution payable”. This generally means the financials need to be reproduced with the correct reference of what the amount payable actually represents.
Similar considerations apply where too much income is paid to the fund, as this could be considered a loan provided by the entity to the SMSF.
Checklist of documents to be provided for audit
A complete set of the financial statements of the unit trust or company. These must be signed to support they represent the final approved copy. The tax return must also be provided to confirm the taxable distribution. Where the entity holds property, the tax return will also confirm the details of the property owned by the entity.
Unit / share certificate, unit / share register confirming SMSF ownership of the investment.
Supporting evidence for the 30 June market value and existence of all material assets and liabilities of the entity.
Where the unit trust or company owns a property:
Property title search or title number details.
Lease agreement or income statements issued by real estate agent.
Rental appraisal for property leased to a related party.
How can Red Willow Super help you?
We would love to help you, whether it is with completing SMSF audits, providing compliance support or delivering technical SMSF training.
Our team has extensive experience which means we can assist with a range of SMSF issues. We have assisted many accountants, advisors and trustees deal with compliance issues.
We provide cost effective audits and offer support to solve potential problems, let us be your competitive advantage.
Want to find out more? Check out our website, call us on 1300 920 2230 or email Support@RedWillowSuper.com.au
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