In-house assets: is your SMSF ready — or preparing — for June 2009? (Yes, that's 2009)

The 10-year transition period for the (generally) 5%, limit on "in-house assets" for SMSFs ends in less than 3 years. Some trustees may not be prepared for — or indeed, aware of — the transitional period. But unless they act, their fund could breach the in-house assets test. Bernie O'Sullivan and Julian Smith

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What are "in-house assets"?

From 30 June 2009, an "in-house asset" is any of:

• a loan to, or an investment in, a related party of the fund — including: members, standard employer-sponsors, and "Part 8 associates" of members and standard employer-sponsors. Part 8 associates are widely defined, to include related companies, partnerships and family members, and — for an SMSF — other members of the fund.
• an investment in a related trust — that is, a trust controlled by a member, or by a standard employer-sponsor of the fund. But the following trusts are not included: trusts arising under instalment warrant arrangements; widely held unit trusts; unit trusts which meet the requirements of regulation 13.22C of SIS (where the trust has no leases in place with related parties, no borrowings etc); and pooled superannuation trusts if the investment is made at arm's length. You can ignore these excluded trusts when considering the impact of an SMSF's investments in related trusts.
• an asset leased by the fund to, or from, related parties. However, the definition does not include a lease of business real property.

Before 1999, only investments in and loans to standard employer-sponsors and their associates were included. However, the new definition (above) is much broader.

What is the limit on "in-house assets"?

All superannuation funds are subject to limits on in-house assets. Generally, the limit is 5% of the market value of the fund's assets.

What does the relevant law provide?

New legislation in December 1999, restricted related party investments for SMSFs. It applied from 11 August 1999.

A transitional period to 30 June 2009 applied to some of the changes. A summary is below.

Impact of the changes — is your, or your client's, fund engaged in these activities?

Investing in related trusts? Including related trusts in the definition had a potentially major impact on self-managed funds. This is because investment through a unit trust had previously been a common way to invest in geared investments. Before the changes, it was generally accepted that the unit trust could borrow to finance the acquisition of an asset — even if all the units on issue were held by the superannuation fund's trustee (as long as a geared trust was an acceptable risk under the fund's investment strategy). The process worked liked this: SMSF trustees would aim to purchase an increasing number of units, or would make additional payments on partly paid units, and the loan in the unit trust would gradually be repaid from contributions to the fund and earnings of the unit trust.

Lease arrangements with related parties? These were also a common way of enabling the employer-sponsor (and other related parties of the fund) to use fund assets (such as property, but also including art work and other assets) under arm's length leasing arrangements. Again, the arrangements would always need to have been assessed in the context of the fund's investment strategy. The 1999 legislative changes significantly restricted this option. However, they continue to allow leases of business real property to related parties.

Transitional measures and concessions: background

In 1999, the government recognised the changes were likely to have a severe impact on existing arrangements, so it allowed certain "grandfathering" rules and transitional provisions.

Pre 1999 arrangements OK: One of the grandfathering rules is that assets which were held before, or which were subject to contracts, loan agreements or leases which existed before, the 11 August 1999 changes can continue unaffected by the change.

June 2001 transition: A transitional measure delayed the new definition for arrangements entered into between the introduction and passing of the legislation, until after 30 June 2001. This concession is not discussed further as it is no longer current.

Concessions which will end in 2009 — possibly needing action now

Other transitional measures apply until 2009. These are the measures on which trustees of SMSFs need to focus now.

Arrangements need to be made to ensure that the funds remain complying. The removal of the concessions will have a major impact on financing and other arrangements. The penalties for failure to comply are considerable and can include fines for the trustee and loss of complying status for the fund. Loss of complying status is a serious event resulting in a tax at 47% on the fund's assets (other than those representing undeducted contributions) and ongoing income tax at 47%.

Three concessions which will end in 2009 are:

Additional payments on partly paid shares and units

Additional capital payments on partly paid shares or units owned by the fund at 11 August 1999 and made up to 30 June 2009 are not in house assets. Any paid after 30 June 2009 are in house assets.

Additional units to replace debt

Additional acquisitions of units or shares in certain related geared trusts or companies up to 30 June 2009 are not in-house assets if the trustee chooses to adopt this concession (and that choice is recorded in writing). The exemption applies to new units acquired to replace borrowings of the trust or company (limited to the amount). This transitional arrangement is subject to restrictions, and cannot be used with the re-investment concession (see below) or the grandfathering rules relating to assets subject to a pre 11 August 1999 agreement.

Re-investment of income

Until 30 June 2009, income from a related trust can be re-invested in that trust — and will not be treated as an in-house asset. The same treatment applies to dividend re-investment in a company whose shares would otherwise be treated as in-house assets under the new definition and which would not have been in-house asset before the 1999 changes.

Industry and ATO concerns

There are concerns that the long, 10-year period of transition may mean trustees will have forgotten, or will be unaware of, the need to address the 30 June 2009 deadline.

Some fund trustees:

• may not be taking steps to prepare for the loss of ability to re-invest income or to invest in additional units or make additional capital payments under the transitional rules; and
• may even be entering into new investments in trusts which were established before 12 August 1999, in the belief that the ability to re-invest or re-finance trust borrowings as outlined above will continue indefinitely. Unfortunately, this is not the case.

What trustees need to do

Trustees who have investments in related unit trusts or companies which have outstanding borrowings need to review their position. If they are relying on re-investment or other additional capital injections under the transitional rules outlined above, then they need to consider whether the borrowings will be repaid by 30 June 2009.

If these financial arrangements are not on track, then the trusts or companies may need to consider alternative methods of funding repayments, or refinancing. In some cases, property may even need to be sold. Best use should be made of the available time to plan any exit strategy.

More information?

For more information, contact Julian Smith at Maddocks on 03 9288 0555.