SMSFs and property development – why is the ATO concerned?

The ATO has issued a bulletin highlighting its concerns surrounding SMSFs being used to invest in property developments. While there is no blanket ban on SMSFs investing in property developments, there are areas which concern the ATO. This article outlines the rules that SMSF trustees must consider when investing in real property and those that most concern the ATO.

Why is the ATO concerned?

Property developments can be a legitimate investment for SMSFs provided they comply with superannuation law.

However, such investments raise concerns for the ATO where:

• they are used to inappropriately divert income into the superannuation environment;
• SMSF assets are used to fund property development ventures in a manner that is inappropriate for, and sometimes detrimental to, retirement purposes; or
• they involve complex structures that can lead to inadvertent yet serious contraventions of the superannuation law.

What are the ATO's concerns?

The ATO's main regulatory concerns in this area as follows:

• Collateral purposes

  Where the arrangement amounts to the SMSF being maintained for a purpose outside those permitted by the sole purpose test (referred to as a collateral purpose). The sole purpose test broadly requires trustees of a SMSF to ensure that the SMSF is maintained for the sole purpose of providing retirement benefits for its members.

  For example, if an SMSF trustee decided to stop paying its members a pension so that the SMSF could use its cash reserves to make an additional capital contribution to a struggling property development venture, this decision may demonstrate that the SMSF is being maintained for the purpose of ensuring the property developments success above the retirement requirements of the SMSFs members and may, therefore, contravene the sole purpose test.

• Operating standards

  Whether the SMSF continues to meet the relevant operating standards, including record-keeping requirements, ensuring assets are appropriately valued and recorded at market value and keeping SMSF assets separate from members assets. In this regard, all transactions should be carefully documented

• Related party loans

  Whether the arrangement includes the provision of a loan or financial assistance (directly or indirectly) to a member or their relative. For example, the ATO would be concerned if the SMSF is motivated to become an investor in a property development carried out by a related entity in circumstances where there would otherwise be insufficient funds to complete the development.

• LRBA

  Whether the arrangement features the SMSF borrowing money, and whether that borrowing fails to meet the requirements to be exempted from the prohibition on borrowing under a limited recourse borrowing arrangement (LRBA).

  LRBAs involve the purchase of a "single acquirable asset" that is held in a separate holding trust (for so long as the loan amount remains unpaid). The SMSF holds a beneficial interest in the acquirable asset and a right to acquire legal title from the trustee of the holding trust once the SMSF has repaid the loan. Some points worth noting in the context of property developments include:

  • amounts borrowed under a LRBA cannot be used to develop or improve the acquirable asset; and
  • if money from other sources is used to develop a property and the development fundamentally changes the character of the property, it may fail to the LRBA requirements by ceasing to be the same acquirable asset.
• In-house assets

  Whether the SMSF has contravened the in-house assets rules by "investing" in the property development, and thereby exceeding the level of in-house assets allowed (that being more than 5% of the market value of the fund's assets in any financial year).

• Early release payments

  Whether payments out of the SMSF under the arrangement are, in fact, "early release" payments of benefits contravening the relevant payment standards (commonly known as illegal early release of superannuation).

• Arm's length dealings

  Property developments generally involve many different contracts and arrangements to bring them to completion. This brings into focus the question of whether the SMSF's investments are made and maintained on an arm's length basis and, if they are not, whether the terms and conditions of the transaction are not more favourable to the other party than would be expected in an arm's length dealing. Where a transaction is more favourable to the SMSF, there will be no breach of the SISA but there may be adverse income tax consequences.

• Taxation

Whether the SMSF's taxation obligations have been taken into account including income tax matters, such as the non-arm's length income provisions. and goods and services matters, such as GST registration requirements.

What do you need to do?

The ATO has said it will continue to monitor property development arrangements involving SMSFs for compliance with the provisions set out in the Bulletin. Accordingly, and in light of the detailed and complex regulation that governs this area, it is strongly recommended that you seek independent professional advice:

• before entering into such arrangements; and
• during the course of such arrangements to ensure continued compliance.

You are also encouraged to disclose contraventions or concerns to the ATO early so that a rectification plan can be implemented where possible.

More information

For more information, please read SMSFRB 2020/1 or contact Maddocks on (03) 9258 3555 and ask to speak to a member of the Commercial team.

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