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Seemed like a good idea at the time

Many people consider undertaking a joint property development via their SMSFs. Michael Hallinan examines the intricacies of these ventures.

It’s a common story: after a Sunday barbeque a group of four families agree to join forces and pool resources to develop real estate.

They set up a company to act as trustee of a unit trust with one member of each family as a director of that company. Each family is to hold their shares in the company and units in the trust either directly or through an associated entity.

One of the friends says they understand that doing it through an SMSF is a good idea. They all decide to set up SMSFs as the entities to hold the units in the trust. They appoint one of the married couples who are retired to look after the operation of the trust.

They find a property and run the numbers, but find to conduct the development properly they need more capital. Not keen on borrowing, they talk to other friends and another four families agree to become unitholders and subscribe for extra units in agreed proportions.

There are now eight family unitholders holding a total of 800 units, with no single unitholder holding more than about 20 per cent of the total.
One issue that is regularly overlooked in this scenario is the potential for the arrangement to be caught by the fundraising restrictions imposed by the Corporations Act 2001.

In particular the following questions need to be considered:

  • Is the unit trust a managed investment scheme under the act?
  • If so, does it need to be registered with the Australian Securities and Investments Commission (ASIC)?
  • What documents would need to be given to a potential investor in the trust?
  • Does the trustee of the unit trust need an Australian financial services licence (AFSL) to operate the scheme?
  • Is there a promoter of the scheme and if so, does that person need to hold an AFSL?
  • Can the four families (or any one of them) conduct another development without breaching the act?
  • Is the unit trust a managed investment scheme?

A managed investment scheme is defined in section 9 of the Corporations Act. There are 15 different sorts of arrangements. Among them is a scheme where people contribute money to acquire rights to benefits from the scheme, the contributions are pooled or used in a common enterprise and the members do not have day-to-day control over the scheme.

A unit trust is a very typical type of managed investment scheme. The unit trust in the case study has brought together a group of investors who have pooled their money with the common enterprise of investing in a particular piece of real estate. Most of the unitholders do not have day-to-day control over the operation of the trust. The unit trust in the case study meets all the criteria and is a managed investment scheme.Some managed investment schemes need to be registered with ASIC. The trustee of a registered managed investment scheme must hold an AFSL issued by ASIC. The interests in the scheme (for example, units in a unit trust) can only be sold via a product disclosure statement (PDS) – effectively a prospectus for managed investment schemes.

Must the trust be registered with ASIC as a managed investment scheme?

A managed investment scheme has to be registered (see section 601ED(1) of the act) if:

  • it has more than 20 members,
  • it was promoted by a person in the business of promoting managed investment schemes, or
  • ASIC believes it is related to another such scheme and the total number of members in all the related schemes is more than 20.

Our unit trust was established by agreement among the original four families and was not created as the result of any promotion by anyone. Also, as it was the first of such trusts to be established, there are no related schemes.

This leaves the 20-member maximum as the only remaining basis on which the trust could be a registrable managed investment scheme.

Although it would be convenient to say there are only eight unitholders in the trust, and therefore there are not more than 20 members, in fact section 601ED(4) of the act sets out how to calculate the number of members and requires that, where units are held on trust for beneficiaries, each beneficiary is a member if all the beneficiaries can control the trustee of their trust.

Therefore, to work out how many members there are in our unit trust you count the members of the SMSFs, not just the SMSFs themselves.
Based on all this, our unit trust exceeds the 20-member maximum and prima facie must be registered with ASIC.

However, section 601ED(2) says a managed investment scheme does not have to be registered if the trustee of the unit trust would not have had to issue a PDS in relation to the issue of units in the trust if the trust had been registered.

This means it is necessary to consider when the law allows a scheme to get away with not issuing a PDS.

Section 1012D(9A) of the act says it is not necessary to give a PDS to a person who is associated with the trustee of the trust. The original four unitholders are directors and shareholders and they are therefore associated with the trustee.

Section 1012E(2) of the act says a PDS is not necessary if the issuer makes personal offers and as a result of the acceptance of those personal offers:

  • all of the financial products (that is, units) are issued by the same issuer,
  • the number of people to whom the issuer has issued financial products (that is, units) does not exceed 20 in any 12-month period, and
  • the amount raised by the issuer from issuing financial products (that is, units) does not exceed $2 million in any 12-month period.

Section 1012E(5) defines a personal offer as one that may only be accepted by the person to whom it is made and is made to a person who is likely to be interested in the offer, having regard to previous contact between the offeror and the person or some other connection or any statement or action by the person indicating they’d be interested in receiving an offer.

In our case, the offers to the additional four families would appear to fit the description of personal offers.

Now consider each of the requirements in the context of our trust.

Same issuer test : All the units were issued by the same issuer, namely the trustee of our unit trust.

20-person maximum test: Unlike the definition of member in the decision of whether a scheme needs to be registered, there is no requirement the issue of units made to a trustee is deemed to have been made to all the trust’s beneficiaries. Accordingly, provided that ultimately not more than 20 SMSFs accept the offer annually, then this test has been met.

$2 million maximum test: There is some uncertainty as to whether it is still necessary to count the four original SMSF unitholders in this test even though the trustees of each of the four original SMSF unitholders are associated with the trustee of the unit trust. There is no ASIC guideline or case decision on that point. However, even though the associated persons are exempt because of their association, the so-called 12 months/20 members/$2 million test relates to the making of personal offers to all investors (including the associated ones) via the trustee. The prudent course would therefore be to count the associated members in the calculation of the $2 million limit. Accordingly, to pass this test, you should be able to prove the total amount raised from all families did not exceed $2 million in any 12-month period.

If our trust can pass these tests, had the managed investment scheme (the trust) been registered, it would not have had to issue a PDS to any of the unitholders and as a result it is not necessary to register the unit trust as a managed investment scheme.

What documents need to be given to a potential investor in the trust?

As our trust is not a registrable managed investment scheme, it does not have to issue a PDS to potential investors in the trust. An unregistered information memorandum should be issued to the additional families to properly protect the original four families from claims by the additional four families they were misled about the investment’s potential.

Does the trustee of the unit trust need an AFSL to operate the trust?

Because the trust is not a registrable managed investment scheme, the trustee does not need to have an AFSL in order to operate the trust. Compare this to the trustee’s obligation to hold an AFSL to issue units in the unit trust discussed below.

Does anyone promoting the trust need to hold an AFSL?

Units in the trust constitute a financial product regardless of whether the trust is a registrable managed investment scheme. If a person recommends a financial product, they are said to be providing a financial service (see the definition of recommendation in section 766B(1) of the act.In addition, if a person deals in a financial product, then they are also providing a financial service.

The meaning of deal includes issuing a financial product or arranging for the issue of a financial product. The trustee of our unit trust is therefore dealing when issuing the units and anyone arranging for the trustee to issue a unit is also dealing.

Section 911A(1) says anyone carrying on a financial services business must hold an AFSL. As noted above, the trustee and anyone promoting the units in our unit trust is providing a financial service, but are they carrying on a financial services business?

There is no strict definition of the phrase “carrying on a financial services business” in the act. Sections 18 to 21 set out some criteria.

It seems more likely than not the trustee of our trust is not carrying on a financial services business. As a result, even if it is providing a financial service, it does not need an AFSL.

Turning to the individuals who may have recommended our trust to their friends and acquaintances again, as this is a one-off occasion and they were not remunerated for their role, it seems more likely than not none of those people were carrying on a financial services business and therefore no AFSL was needed.

Can the four friends do the same thing again on the same basis without breaching the act?

Repeating this process of setting up a unit trust and then selling units in it to friends and acquaintances increases the chances the scheme will be a registrable scheme.The repetition of the process with the establishment of another scheme could result in:

  • ASIC determining the two schemes are related and applying the tests to both schemes instead of just one,
  • ASIC determining the people involved in the establishment of both schemes were in fact now carrying on a financial services business and as such must be licensed, or
  • the parties being considered partners under the common law and or tax law definitions of that term for the purposes of the Superannuation Industry (Supervision) Act so that
  • those parties become part 8 associates of one another, thereby making the second scheme a related trust of the SMSF members and an in-house asset.

Great care should be taken if a second trust and or joint property development is contemplated so that breaches of the act are avoided.

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