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I am auditing the pre-99 unit trust. The SMSF owns 100% of units. There is a loan from a related company. There is no interest on the loan paid because the loan agreement did not have an interest in it. There was no principal repayment either. My concern is that the loan should be at arm's length and include the interest. Any thoughts about it?
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Thanks NN for an interesting question.
Whilst a pre-12 August 1999 unit trust 100% owned by an SMSF, is certainly able to borrow money (and borrow from a related party), you are right to be concerned about the fact that in this scenario the borrowing is apparently interest free and no principal repayments have been made.
For the 2019 income year (and subsequent income years) as a result of the operation of section 290-550(5) of the Income Tax Assessment Act 1997, the Non-Arm’s Length Income (NALI) rules have to contemplated.
That a related company has lent to the unit trust 100% owned by the SMSF on an interest-free at call basis, at first glance suggests that the income generated by unit trust will be taxed at 45% as NALI in the hands of the SMSF. So too would any resultant capital gain when the SMSF sells the units. This is because the income generated by the unit trust is more than it would have been had it obtained its finance on arm’s length terms.
Deriving NALI is not itself a reportable contravention.
However, where a fund has derived NALI this should direct the auditor to ensure that the Income Tax Expense has been correctly calculated and that sole purpose test has been complied with.