Related unit trusts that meet the requirements of Superannuation Industry (Supervision) (SIS) Regulation 13.22C occupy a unique place in the SMSF landscape. The reason is that the core rules impose an unforgiving compliance framework on trustees and advisers, leaving little room for error.
But there is one SIS Regulation 13.22C rule everyone forgets, which sets up an often-overlooked compliance trap for the unwary.
Why do we have Reg 13.22C?
Regulation 13.22C introduced the in-house asset rules in August 1999. At that time, pre-1999 unit trusts were grandfathered because many of these trusts would otherwise have been classified as in-house assets.
As a result, they were allowed to continue operating, largely unrestricted, provided all transactions were conducted at arm’s length and at market value. However, a practical problem emerged.
Many SMSFs lacked sufficient capital to invest directly in property. Treasury recognised this and sought to provide a specific exclusion from the in-house asset rules to allow SMSFs to invest in a company or trust that owned property for business purposes and leased it to a related party.
As a result, the SIS Amendment Regulations 2000 (No 2) introduced Division 13.3A into the SIS Regulations. The intent was to provide SMSFs with flexibility to hold business real property through a related entity without breaching the in-house asset rules while still complying with the sole purpose test.
The basic rules of Reg 13.22C
Firstly, a related-party lease is permitted only for business real property and the lease must be legally binding at all times. A break in lease continuity, even briefly, can bust the trust and expose the SMSF to serious compliance consequences.
Secondly, trust assets cannot be sub‑leased to a related party unless the asset is business real property. For example, even if a residential property is leased to an unrelated party, which is otherwise permissible, that tenant cannot sub‑lease the property to a related party. Doing so would immediately breach the rules.
The trust must also have no borrowings of any kind, including overdrafts and other short-term facilities. Similarly, the trust cannot hold interests in other entities: no shares in companies and no units in other trusts.
Loans are entirely prohibited. The trust cannot lend money or provide any form of financial assistance. There must also be no charges over trust assets, meaning no mortgages or other security interests over property titles.
Finally, the only asset that can be acquired from a related party is business real property at market value. Valuations under these circumstances are always subject to scrutiny at audit time.
The Reg 13.22D catch‑22
Meeting Regulation 13.22C alone is not enough. Once a trust qualifies under the regulation, it must also continuously satisfy Regulation 13.22D, creating a Regulation 13.22D catch‑22 situation.
Where the trust fails to meet either Regulation 13.22C or Regulation 13.22D at any point, the in‑house asset exemption ceases to apply and can never be restored. The trust becomes an in‑house asset forever.
Regulation 13.22D effectively restates the Regulation 13.22C requirements and adds several more:
- The trust cannot operate a business, which can become a grey area in the context of property development.
- All transactions must be conducted on an arm’s-length basis, placing every decision under scrutiny.
- The SMSF cannot have more than six members.
Fail Reg 13.22C once means fail forever
There are two unwritten rules when dealing with Regulation 13.22C trusts: don’t bust the trust and don’t forget rule number one.
These rules apply not just when the SMSF first acquires an interest in the trust, but continuously throughout the year. Once the trust is busted, it is permanently treated as an in‑house asset and the SMSF must then comply with the in‑house asset rules.
But there is another rule that is frequently overlooked.
The three‑year asset look‑back rule
Regulation 13.22C(2)(f)(v) contains a critical compliance requirement that is often glossed over.
In simple terms, a trust will fail the Regulation 13.22C conditions if it holds any asset, other than business real property, that was owned by a related party at any time during the three years before the SMSF first acquired an interest in the trust.
It is an asset‑washing rule designed to prevent related parties from transferring personal assets into a trust and then having the SMSF invest in that trust shortly afterwards.
Crucially, the rule applies regardless of whether the trust is new or long established. It requires advisers and auditors to look backwards and not just at the trust’s current holdings. A historical breach can exist even if the trust appears fully compliant today.
Case study: an ‘accidental’ compliance breach
Consider Calvin, who owns a residential property in his personal name. In March 2024, he transfers the property into a trust unrelated to him. In January 2025, the Calvin SMSF acquires 100 per cent of the units in that trust, representing 40 per cent of the fund’s total assets.
The problem arises because the three‑year look‑back period extends to 2022. During that period, the property was owned by Calvin, a related party. As a result, the trust breaches Regulation 13.22C(2)(f)(v) and the SMSF’s investment becomes an in-house asset forever.
The breach is not the result of aggressive planning or misconduct on Calvin’s part; it occurs simply because the rules were overlooked.
The key lesson is clear: always review the asset history of a related trust before the fund invests.
When SIS Act section 82 is triggered
Once the trust becomes an in‑house asset, the consequences flow automatically. As of 30 June 2025, the trust represents 40 per cent of the SMSF’s assets, exceeding the 5 per cent in‑house asset limit and triggering Section 82 of the SIS Act.
As such, the trustee must prepare a written plan to dispose of the excess in‑house asset by the end of the following income year, which is 30 June 2026. While there is no reportable breach of Section 82 in the first year, the obligation to act is immediate.
If the asset is not disposed of by the deadline, the auditor has no discretion. The fund must be reported for breaches of SIS Act Sections 82 and 84 in the subsequent audit year, and an auditor contravention report must be lodged with the ATO.
Is there any way out?
Realistically, no. Section 82 leaves trustees with no discretion to retain the asset and reducing the in‑house asset level to 5 per cent or less is rarely practical where related trusts are involved.
The only viable option is to use the ATO’s voluntary disclosure service. While outcomes will depend on the specific facts and circumstances, trustees have nothing to lose and everything to gain by engaging with the ATO early.
Conclusion
Regulation 13.22C unit trusts offer valuable flexibility for SMSFs, particularly in relation to business real property. However, that flexibility comes with absolute compliance requirements and once breached, the consequences are permanent.
Where SMSFs invest in previously unrelated trusts that are subsequently reclassified as related trusts, the forgotten three-year asset look-back rule in Regulation 13.22C(2)(f)(v) applies.
The most important takeaway is this: compliance is not just about what the trust holds today, it is also about what it held in the past. Ignoring that history can turn an otherwise compliant structure into an in‑house asset forever.
Shelley Banton is director of Super Clarity.
