Non-compliant SMSF property investments, and complying fund status
The Alert describes certain features of SMSF property investments which concern the ATO. The ATO highlights these as putting an SMSF at risk of becoming a non-complying superannuation fund, and therefore at risk of incurring the onerous taxation penalties which may flow from its non-complying status.
A number of the ATO's concerns relate to investments that are not authorised investments under superannuation law. The ATO has previously provided extensive commentary on some of these issues, including in relation to 'acquirable assets' (see our ClearLaw article of June 2012 here).
Investments through LRBAs: features which concern the ATO
The Alert identifies the following features of an SMSF's property investment, each of which separately or in combination, concern the ATO:
- the borrowing and the title to the property is held in the individual's name (not in the SMSF trustee's name) and the SMSF pays part of the initial deposit and ongoing loan repayments;
- title to the property is held by the SMSF trustee and not the custodian;
- the custodian does not exist, and the custody trust is not established, when the contract to buy the asset is signed;
- the SMSF acquires a residential property from the SMSF member;
- the SMSF buys an asset comprised of 2 or more separate titles which may be dealt with separately: this is, there is no physical or legal impediment to the 2 titles being dealt with separately; or
- the SMSF buys a vacant block, and intends to use the borrowing to construct a house on the land and the land is transferred to the custodian before the house is built.
The ATO considers that an LRBA with one or more of these features may result in the SMSF breaching the Superannuation Industry (Supervision) Act 1993 (SIS Act), including:
- the sole purpose test; or
- the general prohibition against borrowing money, by not investing in an authorised asset.
The feature that causes the most concern to the ATO is the timing of the establishment of the custodian and the custody trust - we discuss this in greater detail below.
The balance of the compliance issues are relatively straightforward - for instance, the SIS Act plainly states that the custodian must hold the title to the property. Likewise:
- the loan and security documents must properly reflect the commercial transaction, which must comply with the clear requirements of the SIS Act;
- the investment must be comprised of a single acquirable asset;
- the investment must have as its sole purpose providing permissible benefits (retirement, death, incapacity) to the SMSF's members; and
- if the SMSF is to acquire assets from members, it must be within the permissible categories such as business real property or listed securities, or certain in-house assets.
Custodian and custody trust to exist when contract is signed - the ATO must clarify its position
There has been significant discussion in the sector about the ATO's concern with a contract being signed to acquire an asset before the custodian and the custody trust exist. However, the ATO does not provide much in the way of reasoning and clearly needs to.
There are differing practices across the SMSF sector when establishing a custody trust, often due to concerns about differing stamp duty regimes applying in different states. These practices can involve the SMSF trustee entering the contract of sale to acquire an asset and, at some time before completion, establishing the custody trust and nominating the custodian as the purchaser of the asset.
When should SMSF trustees establish the custody trust?
Generally, best practice is to execute a declaration of custody trust at the same time as the contract of sale to acquire the asset. In that situation, the custodian must exist prior to signing the contract of sale.
It may be that the ATO is concerned whether the property was acquired with the intention that it would be purchased by the SMSF - if so, it would be important for the SMSF trustee(s) to be able to evidence its intention to buy the asset when the contract was signed rather than the relevant parties deciding after the fact that the SMSF would purchase the asset.
If that is the nature of the ATO's concern, then the best way to evidence that intention is certainly to ensure:
- the custodian exists when the contract is signed and signs the contract in its capacity as custodian for the fund; and
- the custody trust is created at that time.
Otherwise, it may be possible to provide other evidence of the parties' intentions such as correspondence, source of deposit moneys or instructions to advisors.
Given that the ATO has not spelled out why it is concerned with a transaction occurring in this order, until it does so, it would be prudent for SMSF trustees to:
- obtain specific advice on the proper timing for signing the contract, and nominating the custodian, under each state and territory's duty laws; and
- ensure that, at a minimum, the custodian exists before signing the contract to acquire the asset.
Property investments using related unit trusts
The ATO is also concerned that some characteristics of certain unit trust arrangements may:
- give rise to breaches of either the sole purpose test or the restriction on allowable investments under the Superannuation Industry (Supervision) Regulations 1994; or
- otherwise contribute to the SMSFs in-house assets which are limited of 5%.
Which unit trusts do the ATO concerns relate to?
The ATO is concerned with related unit trusts in which both the SMSF members and the SMSF subscribe for units in the trust, including where the SMSF members may borrow money from a commercial bank to fund the subscription. The trustee of the unit trust then purchases a property which is rented out.
Related unit trusts: features which concern the ATO
The ATO is concerned about unit trust arrangements having the following features that do not comply with superannuation law:
- the asset acquired by the unit trust is used as security for the money the SMSF members have borrowed to subscribe for units (or is used as security for any other purpose);
- an asset of the unit trust, which is not business real property, was acquired from a related party of the SMSF; or
- an asset of the unit trust, which is not business real property, is leased to a related party of the SMSF.
As with LRBAs, it is important that SMSF trustees take care to ensure that both the structure of the arrangement, and the investments made pursuant to the arrangement, comply with superannuation law.
If the arrangement does not comply, then the SMSF's investment in the unit trust will be subject to the in-house asset rules - meaning primarily that the SMSF's investment in that unit trust (together with other related party investments) may total no more than 5% of the value of all the SMSF's investments.
Where can I read the full Alert
You can access the full Alert here.
More information from Maddocks
For more information, contact Maddocks on (03) 9288 0555 and ask to speak to a member of the Superannuation team.
More Cleardocs information on related topics
You can read articles on a wide range of SMSF topics here.
Order SMSF related document packages
- Set up an SMSF
- Update an SMSF deed
- Set up an SMSF pension
- Arrange SMSF borrowing documents:
- Set up an SMSF corporate trustee
- SMSF Death Benefit Nomination - binding or non binding
- SMSF Death Benefit Agreement - binding and permanent