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Umesh Manek

Dec 13, 2023

Pre 99 Unit Trust and Charge Over Asset Within

in SMSF Technical Forum

I am auditing the fund that has invested in 70% of the units in the Pre-99 Unit Trust. The unit trust has invested 80% of the fund into properties. While conducting the title search of the property within the unit trust, it reveals a charge created by one of the big four banks. However, the unit trust is showing borrowing from members. Considering the charge over properties and adopting the look-through provision, do we need to report a breach of Regulation 13.14? What other breaches do we have to report?

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Comments (1)

The Auditors Institute Ltd

Dec 13, 2023

This is a very interesting question. In relation to Regulation 13.14 the issue here is whether a look-through approach is to be applied where an SMSF has invested in a unit trust (in this case a pre-August 1999 unit trust) and there is a potential breach of the SIS Act or the SIS Regulations, not strictly speaking by the trustee of the SMSF, but rather by trustee of the unit trust.

Where a look-through approach is applied, the actions of the trustee of the unit trust are imputed onto the trustee of the SMSF.

In Montgommery Wools Pty Ltd ATF for Montgommery Wools Pty Ltd Superannuation Fund v Commissioner of Taxation [2012] AATA 61 (Montgommery Wools) an SMSF owned 100% of the units in a unit trust, the unit trust owned real estate, and the real estate was the subject of a charge in relation to a loan for an entity that was controlled by the members of the SMSF. In this case the related party business defaulted on its loan, and the Commonwealth Bank (the lender which the charge over the unit trust's property) called in the asset that was the subject of the charge.

The following continuation of the discussion on Montgommery Wools is from DBA Butler:

https://www.dbalawyers.com.au/wp-content/uploads/2014/02/Bryce-Figot-University-of-Melbourne-Superannuation-Law-Handout-to-accompany-lecture-22014.pdf

In Montgomery Wools [2012] AATA 61, an SMSF bought all the units in a unit trust. The unit trust used the SMSF’s money to acquire real estate and then the unit trust allowed the real estate to be used as security in respect of a related business’ loans. The real estate was sold and the proceeds used to repay the related business’ debts. The unit trust, and therefore the SMSF indirectly, was left with a loan investment that existed on paper but realistically it had lost its money.

Naturally, in allowing its assets to be used as security, the unit trust was not acting at arm’s length. The ATO held that the SMSF failed the sole purpose test and the AAT agreed. On an interesting side note, the SMSF met the arm’s length rules in the SIS Act as the SMSF itself had not engaged in the non-arm’s length dealings. Rather, the unit trust had had the non-arm’s length dealings and the unit trust is not regulated by the SIS Act. That being said, the ATO in their decision impact statement said that they might dispute this point if it ever arises again.

Furthermore, from the decision in Montgommery Wools:

“The [superannuation fund] did not have the power under the Trust Deed to direct the investments of the [unit trust] but it did have the power to terminate and give reasonable directions in relation to the assets. As such, the breach of [the sole purpose test] arguably occurred as early as October 2000 when Montgomery Wools, as trustee of the [superannuation fund], acquiesced in the [unit trust] providing such security.

So, the potential risk in this situation is not so much a breach of Regulation 13.14 - as the trustee of the unit trust is strictly speaking, not breaching this Regulation as they are not the trustee of the SMSF.

It has not been definitively determined by the courts that there is a look-through approach that ought to be applied in relation to ther actions of the trustee of a unit trust, where the unit trust is 100% owned by the trustee of a SMSF.

Rather, the trustee of the SMSF has an obligation to act, in line with sole purpose test (section 62 of the SIS Act) to ensure that a trust of which it is a majority holder in, is not allowing the assets of the unit trust to be the subject of a charge for the benefit of other entities controlled by the members of the fund.

A distinguishing feature of your scenario, to that in Montgommery Wools, is that the client's SMSF holds 70% of the units in the unit trust, whereas the SMSF in Montgommery Wools held 100% of the units in the relevant unit trust. Nevertheless, this difference in facts does not remove the obligations the trustee of the SMSF has under the sole purpose test.

Would a prudent trustee adhering to the sole purpose test allow a substantial asset of a unit trust, which is itself a substantial asset of the SMSF, to be subject of a charge for a borrowing that benefits other related parties of the members of the SMSF?

Would be interested to hear the views of other fund auditors in relation to this question.