27/01/2016

If your SMSF is using a unit trust as an investment vehicle, it is necessary to consider the upcoming change to the law on when a trust is a trading trust for tax purposes.

If a super fund holds more than 20 per cent of the interests in a trust, the unit trust can be a public trading trust and taxed as a company unless the unit trust invests in real estate primarily for rental income.

Such a unit trust, called a public trading trust, is treated as if it were a company for tax purposes under Division 6C of the Income Tax Assessment Act (ITAA 1936). This means the trust’s income is taxed at the company rate.  Unitholders in the trust can then offset part of their tax liability by way of a franking credit.

In the context of SMSFs, if the following criteria is met, an SMSF’s investment in a unit trust is treated for the purposes of taxation to be an investment in a company:

•    the SMSF has to own 20% or more of units in the unit trust (which consequently meets the definition of a public unit trust); and
•    the trust is a ‘trading trust’.

Proposed legislation, if passed, will impact the way these arrangements are taxed.

The legislation proposes that from 1 July 2016 the interests of an exempt entity such as an SMSF will be disregarded for the purposes of working out whether the trust is a public trading trust or not.

So, for example, if the trust was wholly owned by the SMSF who was carrying out a property development using the trust vehicle, the trust is no longer a trading trust and no longer taxed as a company so the fund is no longer entitled to franked distributions and the ability to amass franking credits.

The proposed legislation provides for a transitional period if the following happens:

•    the trust makes a distribution on or after the time it ceases to be taxed as a corporate unit trust or public trading trust and before 1 July 2018; and
•    the trust’s franking account is in surplus just before it makes the distribution.

The explanatory memorandum for the Tax Laws Amendment (New Tax System for Managed Investment Trusts) Bill 2015 goes on to state, "A trust that ceases to be taxed as a corporate tax entity as a result of these amendments will have until 30 June 2018 to utilise any surplus in its franking account provided that the trust meets the requirements in Part 3-6 of the ITAA 1997 and any other imputation system integrity rules. For these purposes, a franking credit will arise in the trust’s franking account for any tax paid before 1 July 2018 in respect of an income year starting before 1 July 2016."

Whilst the legislation has not been passed yet, it is important to be aware of the changes so proper planning can take place so that franking credits are not lost.

If your fund is using a unit trust as an investment vehicle you should review the terms of the trust deed to ensure that the trust can efficiently make the transition from a trust taxed as a company to a trust taxed as a trust.  Particular attention should be paid to the super fund’s ability to access the franking credits before the 2018 deadline.

If your fund invests through a public managed investment trust perhaps you should seek guidance from the Manager of that trust as to the effect the changes will have on that vehicle also and again as to the fund’s ability to access the franking credits.

For further information, please contact Townsends Business & Corporate Lawyers on (02) 8296 6222.