There is a lot of speculation and fear mongering going on about closing pre-1999 unit trusts (attached to self-managed superannuation funds (SMSFs)) before the trusts’ tenth anniversary.
However, pre-1999 unit trusts are an extremely valuable animal as they have been granted significant exceptions from the in-house asset rules, which will extend beyond July 1, 2009. Here is a review of some common questions and misconceptions:
1. MUST THE UNIT TRUST BE WOUND UP BEFORE JULY 1, 2009?
No. There is no SIS or Tax Act requirement that the unit trust be wound up before July 1, 2009. They can continue past July 1, 2009.
2. MUST THE SUPER FUND’S HOLDING IN THE UNIT TRUST BE REPAID BEFORE JULY 1, 2009?
No. Units acquired by the super fund before August 12, 1999 won’t have to be redeemed before July 1, 2009.
Units acquired after August 12, 1999 and before July 1, 2009 under the transitional rules (that is, units acquired by reinvesting distributions sourced directly or indirectly from units acquired before August 12, 1999) do not have to be redeemed before July 1, 2009.
In both cases these units can continue to be held by the fund after June 30, 2009.
3. MUST ALL GEARING IN THE UNIT TRUST CEASE AFTER JUNE 30, 2009?
No. The gearing can continue after June 30, 2009. In fact, the unit trust may undertake new gearing after June 30, 2009.
However, the gearing will generally have to be positive. This follows, as the ability of the unit trust to negatively gear after June 30, 2009 will be constrained by the fact that any fresh capital, introduced into the unit trust by the super fund after June 30, 2009 (whether as new subscriptions or reinvestment of distributions) will be counted as in-house assets.
4. WILL PRE-1999 UNIT TRUSTS HAVE REACHED THEIR “USE BY” DATE ON JUNE 30, 2009?
No. In fact, pre-1999 unit trusts will have significant value as they are permanently grandfathered from the in-house asset rules (so long as any units acquired between August 12, 1999 and June 30, 2009 have been acquired in accordance with the transitional rules).
Given the value, after June 30, 2009, of pre-1999 unit trusts, advisers should:
- Identify all clients who have pre-1999 unit trusts attached to their super funds.
- Identify any pre-1999 unit trust that has partly paid units that were originally issued before August 12, 1999 and ensure that the super fund pays the remaining balance on the partly paid units before July 1, 2009. The amount paid on these partly paid units will not be treated as an in-house asset. However, amounts paid on these partly paid units, if paid after June 30, 2009, will be counted as in-house assets.
- Identify any pre-1999 unit trust which has unpaid distributions. It may be necessary to prepare interim accounts for the unit trust well before June 30, 2009 to estimate the likely distributable income for 2008/09 and for the trustee to pay out the distributable income in sufficient time to allow any reinvestment. Determination of the distributable income after balance date will preclude the super fund from taking advantage of the “reinvestment” exception, as the distribution and reinvestment will occur after June 30, 2009.
- Calculate for each pre-1999 unit trust the total dollar amount of all distributions made by the unit trust to the super fund in the period from August 11, 1999 to June 30, 2009, which have arisen from investments held in the unit trust before August 12, 1999 (and any earnings on the reinvestment of such distributions) – this amount is the maximum amount of reinvestment which, if made before June 30, 2009, is an exception to the in-house asset rules.
- Distribute the unpaid distributions and reinvest those contributions up to the maximum amount.
- Ensure that any reinvestment is “actually done” and “done before” July 1, 2009. Journal entries will generally be insufficient. Actual distribution and reinvestment will be sufficient. Also, reinvestment
in accordance with a specific request by the SMSF will be effective if such a request is implemented before July 1, 2009 by the unit trust, even though the distribution is not paid to the SMSF.
Also, the terms of the unit trust must be reviewed to ensure that the trustee of the unit trust is permitted to prepare interim accounts and to make distributions before balance date. If not, the trust deed of the unit trust may need to be amended.
Reinvestments in excess of the maximum amount will be counted as in-house assets and subject to the 5 per cent holding limit. Also, reinvestments made after June 30, 2009 – even if within the maximum amount – will be counted as in-house assets and subject to the 5 per cent holding rule. (Note: the maximum amount has to be reduced for any reinvestments previously made under this grandfathering provision.)
The point to remember is that pre-1999 unit trusts are potentially extremely valuable because they enjoy significant exemptions from the in-house asset rules and, as mentioned, these exemptions will extend beyond July 1, 2009.
WHAT’S AN IHA?
A super fund asset will have in-house assets (IHAs) if it has any of the following with a related party:
- A loan;
- An investment in the related party, including in a related trust;
- A fund asset subject to a lease or lease arrangement;
- An asset that the regulator decides should be an IHA.
However, there are some important exemptions including:
- Business real property, but only for funds with fewer than five members (that is, including SMSFs). This is a very popular exemption and only applies if property (for example, land) is used wholly and exclusively in a business or businesses. With this exemption, great care must be taken to ensure that the preconditions for the exemption to apply are satisfied.
- – Investments in related companies and unit trusts where certain conditions are satisfied (including the conditions that the company or trust is not carrying on a business, is not geared and does not own interests in other companies or trusts). The exemption is provided by SIS Regulations 13.22B and 13.22C.
- – Property held by a custodian/security trustee, where the arrangements satisfy the requirements of the “instalment warrant/limited recourse” borrowing exception.
As discussed above, the world does not end for all pre-1999 unit trusts at midnight on June 30, 2009. Before any action is taken in respect of a pre-1999 unit trust, specific professional advice should be obtained relating to the particular circumstances of the superannuation fund and the unit trust.