It is common knowledge amongst advisors to self-managed super funds that the in-house asset rules apply to investments in related trusts. It is also quite well known that a related trust is defined as an investment of over 50% in the trust. This is regularly treated as if is it a hard rule and we often see situations where advisors are quite comfortable in telling their clients that they can take up a 50% investment in a trust without the trust being at risk of the Regulator (who is the ATO for SMSFs) being able to treat the investment as an in-house asset.
Often such trusts hold geared investments and such situations should be subject to an increased level of review during their annual audit even before any possible ATO review.
We acknowledge that these rules apply to loans and other investments as well as investments in trusts, but for the purpose of illustrating the issue we will stick with using an investment in a unit trust as our example.
The 50% test is actually just one of three tests that the SIS Act contains to determine whether an entity controls the trust. These three tests are separately applied, and so if the conditions are met for any one of the three it means that the control exists. Once control is established the trust becomes a related trust under section 10(1) and a related trust is a trust that is an in-house asset via section 71(1).
So what are the three tests?
The three tests are set out in section 70E(2). The first one is the one referred to above – a ‘group’ has a fixed entitlement to more than 50% of the capital or income of the trust. The ‘group’ will include any member of the fund, their relatives and various other controlled entities. If you remember the Aussiegolfa cases from 2017 and 2018 that included Mr Benson (the member) and his mother – their combined investments totalled 75% of the issued units and thus the groups’ entitlement exceeded 50%.
The second test is any entity that the trustee of the trust (or a majority of its trustees) are accustomed, or under an obligation, or might reasonably be expected to act in some manner in accordance with that entity’s wishes (or that group of entities’ wishes). An example of this might be a unit trust in which an SMSF has a 40% interest. The member of the SMSF is a real estate agent and the unit trust invests in real property as chosen and directed mainly by that individual, as the individuals behind the other unitholders have no experience in property investing. If the individual is the sole influence as to what rental to charge, what repairs to undertake etc. then this test might be met for the SMSF’s investment in the trust such that the units held by the SMSF are an in-house asset for it. This could be uncovered a number of ways, including via the ATO asking for minutes or notes of meetings held by the trustee of the unit trust, or via interviewing trustees of that trust.
The third test looks to who has the ability to remove or appoint the trustee or a majority of trustees. This form of control would usually be contained in the trust deed and so any risks may be able to be identified via a review of it.
Even if all investors have a voice and all exercise their judgement independently of each other, the risks do not end there. The Commissioner (as Regulator) has the power to form his own view and make a determination that a loan, investment etc. is an in-house asset. He does this via a written notice to the SMSF trustee.
The most well-known use of this power by the Commissioner was in the Aussiegolfa case ( FCAFC 122). In that case the determination made by the Commissioner was set aside by the AAT. In the Full Federal Court appeal that outcome was upheld because the Court found that the investment in the relevant trust was an in-house asset under the normal rules and so the determination could not be made (because the Commissioner can only make a determination in respect of an investment that is not already an in-house asset).
The Commissioner has responded to this outcome in his Decision Impact Statement as follows:
“The ATO will continue to consider issuing a determination under subsection 71(4) of the SISA as appropriate in circumstances where the trustee of a SMSF enters into an arrangement to acquire an asset that would otherwise be an in-house asset under section 71 of the SISA if directly held by the SMSF.” (emphasis added)
Thus the Commissioner is saying it will look through structures, which (deliberately or otherwise) circumvent the in-house asset rules, to the ultimate investment and if that underlying investment would be an in-house asset if the SMSF held it directly then a determination may be issued.
Such an approach should be kept in mind when considering what advice to give. If the investment cannot be undertaken by an SMSF directly, then the ATO’s message flags that the SMSF will be exposed to compliance risks in structuring the acquisition via a unit trust.
However, the Aussiegolfa Full Federal Court decision also introduced a degree of doubt as to the validity of the Commissioner’s power to make such a determination. In the decision one of the three judges stated:
226. Section 71(4) is an unusual section because the criteria for its application are not expressed. The legislative scheme appears to be that there exists in s 71(1) positive criteria for determining what is an in-house asset, which is then juxtaposed against a power, in s 71(4), to undo the application of that criteria in particular cases. The power to undo the application of s 71(1) is seemingly unlimited.
227. A provision cast in such terms, raises the possibility that it is an unconstitutional delegation of legislative power: cf Giris Pty Ltd v Federal Commissioner of Taxation (1969) 119 CLR 365. I need not decide that issue because of the finding that the investment here is an in-house asset. As it happens, both parties accepted that one criteria for application which may be implied from the terms of the provision is that it permits the Commissioner to decide that an asset, which is not an in-house asset pursuant to s 71(1), should nonetheless be treated as an in-house asset if an application of the criteria in s 71(1), as a matter of substance, shows that it should be so treated. It is not desirable for me to determine whether the language, statutory context and statutory purpose support that construction of the provision. And as the matter was not argued before the Court, it is also not desirable for me to say anything further about this construction of s 71(4).
That judge is now a High Court judge, and so this view arguably has increased in importance since it was written. It appears that perhaps both the ATO and advisors should think about the hazards contained in the in-house asset rules before they act.
This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.