Speaking in a recent DBA webinar, DBA Lawyers senior associate Shaun Backhaus said sometimes situations will arise where a unit trust overestimates its distributions for the year and over pays, resulting in the SMSF unit holder receiving more income than its entitlement.
Determining whether this means the SMSF has borrowed from the unit trust and therefore contravened section 67 in this situation will depend on a range of factors, explained Mr Backhaus.
While there isn’t always a simple answer, Mr Backhaus said SMSF professionals looking at what the Commissioner’s interpretation of a loan is may help them to determine if it is in fact a borrowing.
“In SMSFR 2009/2, the Commissioner talks about what a loan is. It includes the provision of credit or any other form of financial accommodation whether or not enforceable, or intended to be enforceable, by legal proceedings,” he noted.
“It’s pretty broad and also goes through a fair bit of case law. It states that there are a few necessary features including a temporary transfer of an asset from a lender to a borrower and an obligation or intention to return the temporarily transferred asset to the lender.”
Mr Backhaus said practitioners and clients in this situation should look at what the unit holders agreement or unit trust deed says.
“Is the overpayment a CGT event and you’ve reduced your cost base? Is it something that has to be paid within a time limit that would probably make it a loan?” he said
“Could you make resolutions to show that there’s not an intention to repay it? What’s happened in the past? If there’s been unpaid present entitlements in the past and they’ve been repaid each time then that probably shows an intention to repay it and it is probably a loan.”
Mr Backhaus said where it is a related trust that’s involved it’s more likely to be considered a loan.
“That’s not necessarily the case, but where you’ve got a related trust that does bring issues to the forefront.”
If the overpayment is a result of tax deferred E4 gain, then a distribution statement to the SMSF should confirm this is not a loan, but a timing difference for taxation purposes. Documented, it should satisfy an auditor too.
When a Trust has a depreciating asset – it is quite common that there is more cash in the bank than the taxable income of the Trust which needs to be distributed to related parites including an SMSF. This distribution can be Tax Defferred – at times SMSF contributes to subscribe to more units – and then at a later stage plans change – these amounts can “return of capital”. The most usual case is that the Trust will owe money to the unit holder – these UPE are generally paid out at the time of preparing accounts
Clients often have this problem, when paying the available cash from the trust in June, and the GST liability creates an overpayment to the unit holders.
Do you feel that this is a “borrowing”. My view is its not more a borrowing as the GST liability is a loan.
especially when the July rental income usually creates enough profit to negate the minior overpayment in June
We have the same issue and the same resolution. The “borrowing” IMO is just a timing issue that is not really an issue and always rectified during the year even if there is a “borrowing” again at June the next year.