What is the Draft Ruling about?
The Draft Ruling confirms that the prohibition on self managed superannuation funds (SMSFs) 'acquiring' an asset from a related party also applies to the SMSF passively receiving an asset from a related party.
Curiously, by extending the prohibition in this way, the ATO is taking a different approach to the one it took recently in relation to SMSFs borrowing through 'instalment warrant arrangements'.
The Draft Ruling also confirms the long-held view of practitioners that permissible related party assets can be 'contributed' to SMSFs — as well as purchased by SMSFs.
The prohibition, and exceptions: A quick summary
Generally, the Superannuation Industry (Supervision) Act 1993 (the Act) prohibits superannuation funds from acquiring assets from related parties. In this article we are considering only SMSFs.
The Act prohibits the SMSF trustee from intentionally acquiring an asset from a related party (s66(1)). The policy behind the prohibition is the need to prevent SMSF members from moving cash out of the fund (before they retire) by acquiring an asset, effectively, from themselves or a related party.
The relevant exceptions to the prohibition are that the SMSF trustee :
- may acquire listed securities at market value;
- may acquire business real property at market value;
- may acquire an asset at market value which is an in-house asset provided the 5% limit on in-house assets is not breached; and
- may accept a contribution of money.
The exceptions to the prohibition are in sections 66(2) and 66(2A) of the Act.
What issues does the Draft Ruling add or resolve?
The Draft Ruling raises three issues to consider:
- It extends the prohibition to include contributions of assets to a SMSF — whether by a member or related party of the SMSF.
- It confirms that the exceptions to the prohibition also apply to the contribution of asset
- It suggests there may be problems for instalment warrant arrangements: however, it appears the ATO will address these problems by adopting a pragmatic regulatory approach.
Each issue is considered below.
Issue 1 'Acquire', 'Contribute', 'asset' and when money isn't 'money'
The meaning of 'acquire'
The Draft Ruling confirms that the term acquire has a broad meaning which includes the acceptance of a contribution. The most interesting aspect of this interpretation is that while 'acquire' may often be considered as denoting some action on the trustee's part, the Draft Ruling extends the meaning to more passive behaviour such as receipt.
In Lock v FCT  FCA 309 Goldberg J gave the term a wide and ordinary meaning, which approach the ATO has supported:
...the expression 'acquire' means 'obtain' or 'gain' or 'receive' and 'acquisition has a corresponding meaning.
"acquire" means "obtain" or "gain" or "receive" .... The expression "acquire" is a work of common usage and does not have a technical meaning.1
This view conforms both to the Act's Supplementary Explanatory Memorandum and to the views expressed at the Select Senate Committee on Superannuation.2
The meaning of 'asset'
The Act defines an asset to be any form of property, including money (whether Australian or foreign currency).
The Draft Ruling outlines that any form of property refers to property that has economic value. The Draft Ruling clarifies the definition and says that it:
includes every type of right, interest or thing of value that is legally capable of ownership and can be alienated or transferred to an SMSF. The property may be personal or proprietary, legal, equitable or statutory, or tangible or intangible.3
Therefore, an asset may include an estate, interest in land, a car, machinery, shares, a mining lease and intellectual property rights. A trustee or investment manager will contravene section 66(1) if he or she accepts a contribution of property in any form.
The meaning of 'money' â?¦ when coins aren't 'money'
Although SISA generally says that 'money' is an asset4, the prohibition does not extend to acquisitions which are contributions of money.
However, the Draft Ruling draws a distinction between:
- money in the form of a medium of exchange - for example: cash, cheques, money orders; and
- certain objects of exchange - for example a valuable coin collection â?¦ which if 'acquired by' or 'contributed to' an SMSF will not be a contribution of 'money', and will instead be the acquisition of an asset.
Issue 2 Contributions as acquisitions at 'market value'
The fact that 'acquiring' includes 'receiving by contribution' means that the exceptions about the assets the SMSF trustee can 'acquire' (for consideration) also apply to 'contributions' (for no consideration).
Although this is how practitioners have generally interpreted the related party acquisition rules, it is good to have the ATO endorse this practice.
The ATO has also stated that if contributions are made in this way, then the amount of the contribution will be treated as being equal to the market value of the property contributed.
The Act defines 'market value' as being the amount that a willing buyer could reasonably be expected to pay to buy the asset from a willing seller if:
- the parties dealt with each other at arm's length;
- the sale occurred after proper marketing of the asset; and
- the buyer and seller acted prudently and knowledgeably in relation to the sale5.
The ATO confirmed that the SMSF trustee can acquire an asset from a related partly by:
- paying part of the market value; and
- treating the balance of the market value as a cash contribution from the member (the member's contribution cap must be observed).
Issue 3 The issue for instalment warrant arrangements
At first glance, the Draft Ruling suggests a problem for instalment warrant arrangements. Thankfully the ATO adds a solution that suggests all will be well.
The problem On the ATO's view, an 'acquisition' includes the passive receipt of any interest in property. The trouble is that exactly that sort of passive receipt would occur as part of the arrangements by which a SMSF trustee borrowing money to acquire an asset through an instalment warrant arrangement.
Here's how. An instalment warrant arrangement involves the asset the SMSF is acquiring being held by a custodian until the SMSF pays off the loan to the lender. When the SMSF trustee pays out the loan, the trustee takes legal title to the asset from the custodian. Taking legal title in this way is an acquisition of property from a related party (namely, from the custodian of a trust which the SMSF effectively controls).
Thankfully, the ATO seems to have adopted a pragmatic approach to this issue. In its recently released 'Instalment Warrants and super funds — questions and answers' publication, the ATO says:
The security trust which holds the asset underlying an instalment warrant arrangement will be a related party of an SMSF (and possibly also of other super funds). In these circumstances, the legal interest in the asset may be considered to be acquired from a security trust when the borrowing is repaid. The Tax Office considers the intent of the new laws is that this would not of itself contravene the existing prohibition on acquiring assets from related parties.
This paragraph of course sits at odds with the ATO's position in the Draft Ruling. However, it shows that the ATO will consider the underlying policy imperatives and adopt a sensible and pragmatic regulatory approach.
The ATO has invited submissions on the Draft Ruling to the ATO by 16 May 2008.
If you have any questions in relation to this article, or tax generally, please call Maddocks in Melbourne on (03) 9288 0555 or in Sydney on (02) 8223 4100 and ask for a member of the Maddocks Tax & Revenue Team.