The ATO has flagged their concern about an increase in the number of SMSFs entering into related-party property development arrangements for subsequent disposal or leasing.
These arrangements include participating in joint ventures, entering into a partnership or investing through ungeared related unit trusts or companies.
Where property development activities comply with the superannuation legislation, then legitimate property developers should not be worried.
But care needs to be taken to ensure there are no breaches of SIS.
The slippery slope to having to deal with the ATO quickly arises from not understanding how the SIS legislation operates, especially where some arrangements may contribute to questionable dealings that fail to meet the relevant operating standards.
As a result, a fund breaching the in-house asset rules or not meeting their record-keeping requirements can result in costly rectification action to help bring the SMSF back into compliance.
In-house asset definition
The in-house asset rules, along with all SIS rules, are in place to stop SMSF trustees from receiving a benefit from their SMSFs before they retire. And although the definition of an in-house asset appears to be straightforward, the legislation surrounding in-house assets is anything but simple.
SMSFs involved in property development ventures need to have an understanding of the in-house asset rules as well as who is a related party of the fund.
An asset becomes an IHA (under s71 SIS) when SMSF trustees either loan, invest or lease the assets of their SMSF to a related entity. A related party is any member of the fund, a standard employer-sponsor or Part 8 associate of either of these.
In broad terms, an asset of an SMSF that is used and enjoyed by a related party of the fund is generally an in-house asset.
Regardless of whether the use of that asset also contravenes the sole purpose test or not, the trustees must still ensure that the total market value of the SMSF’s in-house assets does not exceed 5 per cent of the market value of the SMSF’s total assets.
Conditions for ungeared entities
An SMSF may invest in a related company or unit trust without it becoming an in-house asset if it meets the conditions of r13.22C SIS at the time the investment is acquired and at all times while the fund holds the investment.
The conditions relevant for property development inside these entities include:
SISR Conditions Ungeared Unit Trusts & Companies Must Meet
SMSF has less than 5 members
Only assets in the unit trust are cash and property
The unit trust cannot borrow or give a charge over the assets of the fund
Where the fund fails to meet any of the conditions in r13.22C, a catch-22 situation arises, triggering r13.22D which states the related entity is required to meet the conditions of r13.22C at all times to be exempt from the in-house asset rules.
Not meeting the conditions of r13.22C means that all investments held by the SMSF in that related company or unit trust, including all future investments, will become in-house assets.
The asset can never be returned to its former exempted status, even if the trustee fixes the issue/s that caused the assets to cease meeting the relevant conditions.
It can be difficult, therefore, for SMSFs to meet and maintain these conditions while undertaking property development investments.
Decisions that cause the exception to cease will require the fund to divest itself of the shares or units it holds over the 5 per cent limit within 12 months.
Where the fund holds 100 per cent of the shares and the only asset in the ungeared entity is property, this may result in a fire sale of the property and winding up the unit trust or company.
Property development v carrying on a business
There is nothing in SIS which prohibits an SMSF from running a business, but the business must be:
Where the trustee of an SMSF carries on a business, the activities of the business should not breach the sole purpose test, and any business operated through an SMSF must comply with the investment rules and restrictions applying to SMSFs.
One of the most critical implications for classifying property development as a business is where the fund has invested in an ungeared unit trust or company.
By definition, these types of trusts are not allowed to carry on a business and r13.22D will cease to apply, with the investment losing its exemption from being an in-house asset.
How poor record keeping can bust the trust
Overlooking a legal technicality within a lease arrangement can trigger an r13.22C event that may cause the in-house asset exemption to cease to apply. In other words, failure to have a legally binding lease agreement in place with a related party can bust the trust.
Where a previous lease contract does not provide for a continuing legal relationship after the lease expires, and the trustee has not renewed the lease, the lease arrangement ceases to be legally binding.
Can it be fixed?
Under these circumstances, the fund becomes subject to the 5 per cent in-house asset rules requiring the disposal of some units.
As it is unlikely that the fund will be able to sell units to an unrelated party to reduce their investment to below the 5 per cent in-house asset threshold, selling the property to redeem the units becomes the only option.
The complex SMSF path to property development is paved with legislation, resulting in more onerous obligations and responsibilities for SMSF trustees.
While property continues to remain a sought-after investment within SMSFs, it is critical to keep on top of the rules to ensure that funds with property development investments continue to operate in a compliant manner.
Head of technical, ASF Audits
BEc (Acc), MBA, CPA, FFin
David has been in the Financial Services Industry for nearly 30 years. He was one of the founding Directors of the successful Financial Planning and Stockbroking Practice, Henderson Gregory Forrest, for a decade. Prior to that, he held senior roles in companies such as ING, KPMG Accountants and AMP. David was previously Chairman of OAMPS Superannuation Trustee Board and currently serves as an independent Board Director for several companies.
David’s extensive experience in all forms of superannuation, including Self Managed Super Funds (SMSF), Defined Benefit Funds, retirement funding through Account Based Pensions, stockbroking with a focus on Direct Share Investment, Taxation/Remuneration Planning, Centrelink, Aged Care and business management, equip him to advise expertly on all aspects of Financial Advice.
Those with a particular interest in superannuation/SMSFs, direct share investment, salary packaging or applying for the Centrelink Pension will find his knowledge and ability in formulating and implementing creative, logical and simple wealth creation strategies a valuable asset.
David maintains a strong personalised client service focus, providing tailored solutions for clients.
David Forrest is an Authorised Representative of Integrity Financial (SA) Pty Ltd ABN 16 133 921 187 — AFSL No 334846
Business Finance Manager
B Bus (Acc), CPA
Michelle’s career has spanned across the Financial Services, Retirement Living and Aged Care industries working in the private sector, not for profit and more recently with the state government for over 20 years. Her experience extends to many facets of the financial services industry, having worked in superannuation administration, technical support and financial planning practice administration.
Commencing with AMP and subsequently working in commerce and accounting roles with companies such as Brambles, Adelaide Bank Retirement Services, ECH Inc and SA Health and Wellbeing, Michelle returns to financial services after working in practice financial management at Henderson Gregory Forrest. This wide range of experience from senior accounting and management roles has provided Michelle with a strong background in business administration.
With an astute financial acumen and keen interest in business improvement strategies, Michelle ensures the smooth running of the Integrity Financial Advisory practice providing valued management support to our personalised client service focus.
B Com, Dip FP
Darren joins the Integrity team as a strong technical specialist with almost 20 years’ in the Financial Services industry. He has extensive experience advising clients on how to build and protect wealth, prepare for retirement and retire comfortably.
Commencing with advising clients on direct equities for over 10 years at Baker Young, Tolhurst Noall, and ABN AMRO Morgans, his career expanded to providing holistic client advice, having operated his own financial services licence and company. Most recently having worked for a 'Big 4' bank, he has welcomed the more personalised ‘client first’ approach that is evident at Integrity Financial Advisory.
With a deep understanding of investment markets, he is appropriately qualified and authorised to provide direct share advice, as well as superannuation/SMSF advice, encompassing both investments and insurance.
Meticulous in his approach, he aims to deliver quality outcomes for clients by understanding their financial situation and needs before providing advice which is central to our advice process. Darren supports David in tailoring solutions for all client financial advice needs.
Darren Chalk is an Authorised Representative of Integrity Financial (SA) Pty Ltd ABN 16 133 921 187 — AFSL No 334846
Client Service Manager
Natasha commenced working in the financial services industry in June 2008 and is a new addition to the Integrity team. During the past 11 years, she worked closely with advisers providing administration support in a share broking and financial advice business.
Having successfully completed her RG146 accreditation in securities and managed investments and continued her studies to complete her competency in Superannuation, Natasha can ably assist with all aspects of fixed interest, cash management, portfolio administration, direct shares and client advice implementation.
Natasha takes time to ensure she understands our client’s financial goals and needs and believes in creating, preserving and utilising wealth through effective financial management as a key objective in helping clients.
Client Service Manager
Kelly has worked in the Financial Services Industry for over 10 years and has supported David since 2013. Kelly’s primary background is in customer service and administration.
On starting in the industry, Kelly initially focused on direct shares, stockbroking administration and client liaison. Since moving to the Client Service Manager role, Kelly has developed skills encompassing all aspects of financial planning including client advice implementation and term deposit management.
Kelly’s experience in the direct share environment, especially management of estates, provides a key part of the direct equity expertise in Integrity’s Client Service Team.
Returning from Parental Leave following the arrival of her second child, Kelly has developed further honed multi-tasking skills after juggling the demands of a growing family.
Client Service Manager
Jasmine has worked in the financial services industry for over 12 years in all areas of client administration, working with David since 2013.
Jasmine has extensive knowledge and experience in client service including implementation of advice, portfolio reporting, assisting with the establishment of Self Managed Super Funds (SMSFs), term deposit management and a long history of helping clients with their enquiries.
Jasmine’s attention to detail, yet gentle approach, means she is able to solve the trickiest of questions for our client community.
Jasmine has gained her Certificate III in Financial Services qualification.
Client Service Manager
Merrilyn has worked in the financial services industry for over 11 years in all areas of client administration, and is a new addition to our client services team, returning from Melbourne to join the team in June 2019.
Merrilyn has extensive knowledge and experience in client service including implementation of advice, managed fund administration, assisting with the establishment of Self Managed Super Funds (SMSFs) and process improvement for the previous practices she has worked with. Merrilyn’s experience with direct shares constitutes the other part of our administrative support for direct equity investments.
Merrilyn’s warm and caring nature continues to endear her to our clients and she has already established herself as a valued member of our team.