David Court outlines some common queries that arise out of the new rules for SMSF investment in personal use assets.
The investment by a self-managed superannuation fund (SMSF) in an asset that has potential for personal use by a member of the fund creates tension with the overriding requirement that the sole purpose of the fund must be for providing a retirement benefit to members.
It has been generally accepted by the regulators that the sole purpose test allowed for the personal use of assets if that use was ‘incidental’ or ‘ancillary’ to the purpose of providing for retirement benefits.
Accordingly, many SMSFs have invested in assets such as artwork or sporting club memberships that provided ‘incidental’ benefits to members such as interior decoration for a member’s private residence or the ability of the member to play a round of golf.
The Cooper Review expressed concerns in relation to the use of such assets, and recommended that investment in them be banned.
In response, the Government introduced new rules for investment in personal use assets which took effect from 1 July 2011.
While the new rules do not impose an outright ban on the acquisition of personal use assets, they impose requirements that raise significant practical and cost issues for any SMSF trustee proposing to invest in such assets.
Here are some common queries that arise out of the new rules.
Which funds do the rules apply to?
The new rules apply only to SMSFs. Accordingly, they do not apply to those superannuation funds regulated by the Australian Prudential Regulation Authority rather than the Australian Taxation Office.
The rules apply regardless of whether the SMSF has full or partial ownership of the relevant asset.
What assets are covered?
The type of assets covered is set out at length in the legislation.
In general terms, it includes artwork and similar artefacts, currency and medallions, postage stamps, rare books, memorabilia, wine or spirits, motor vehicles, recreational boats and membership of sporting or social clubs.
While there are no specific exclusions, there are asset types which are amenable to personal use that are not mentioned.
Horses, bicycles, industrial machinery, commercial fishing vessels and specialised off-road commercial plant and equipment could also be of personal use, but seem to fall outside of the listed asset types.
Can an SMSF still buy a personal use asset?
The new rules do not prevent the purchase of personal use assets by the trustee of an SMSF.
However, any purchase (and subsequent leasing of the asset) would need to comply with the general investment rules, including:
- Meeting the sole purpose test;
- Acting in the best interests of members;
- Complying with the fund’s investment strategy;
- Purchasing the asset on arm’s length terms;
- Not acquiring the asset from a related party.
A personal use asset could also be the subject of a limited recourse borrowing arrangement if the trustee wanted to fund the purchase through borrowing.
Before purchasing a personal use asset, the trustee will also need to consider the effect of the specific restrictions and obligations which are discussed below as they will impact materially on the purchase decision.
What can’t a trustee do?
A personal use asset cannot be:
- Leased to a related party;
- Stored in the private residence of a related party (but it could be stored at the business premises of a related party or offsite storage facilities owned by a related party);
- Used by a related party (and note that use includes ‘displaying’ the object).
Somewhat strangely, therefore, an artwork can be stored at the business premises of a related party, but only as long as it is not ‘displayed’.
However, a wine collection could not be kept at the private residence of a related party – even if that person had state-of-the-art cellarage facilities.
The new rules also prevent any incidental or ancillary use of the asset, which may make it difficult to provide the asset with ongoing care.
For example, keeping a motor vehicle ‘run in’ can now only be performed by a non-related party to the SMSF.
What must a trustee do?
The new rules impose a number of obligations on the trustee of an SMSF that holds a personal use asset:
- Any decision made by the trustee relating to the storage of the asset must be in writing and kept for 10 years;
- The asset must be insured in the name of the SMSF within seven days of acquisition (unless the asset is a sporting or social club membership);
- If the asset is to be sold to a related party, then the price must be the market price determined by an independent valuation.
It seems, theoretically at least, that the trustee is not forced to make an active decision relating to the storage of the asset.
However, a physical object must be located somewhere, and presumably, failure to store the asset properly could be attacked by the regulator as a breach of the trustee’s statutory covenants to act prudently and in the best interests of members.
Who is a related party?
A related party is, essentially, a member of the SMSF, a wide range of their relatives and various legal entities that the members of the fund control.
What if an SMSF already holds personal use assets?
Transitional arrangements apply to the new rules so that personal use assets held at 30 June 2011 do not come within the new arrangements until 30 June 2016.
However, trustees are cautioned to give early consideration to the revised usage, storage and insurance requirements that they will need to meet in 2016.
Not only may it take some time to put these arrangements in place, but it also may take some time to dispose of personal use assets if the trustee no longer wishes to hold such assets after 1 July 2016.
Practical problems
The new rules, while not prohibitive of the holding of personal use assets, create strong disincentives to SMSF trustees wishing to hold such assets.
Practical problems will arise from the need to make storage, usage and insurance arrangements that accord with the new rules.
Those services might be difficult to obtain – either at all, or at an affordable price – and are likely to make the holding of low value personal use assets unattractive to SMSF trustees.
However, where a high value personal use asset that is a genuine investment proposition is involved, then the storage, usage and insurance requirements of the new rules would seem largely to be the type of actions that a prudent trustee would be expected to take, in any event.
David Court is a lawyer with Holley Nethercote Commercial Lawyers.
