AMP’s Philip LaGreca explores the key considerations for SMSF trustees investing in overseas property.
Sharemarket volatility and subsequent investor concern, along with falling interest rates, has seen self-managed super fund (SMSF) trustees focus more and more on the direct property asset class.
Further, the high Australian dollar has sparked interest in investing in overseas property.
In this article we will explore the key considerations for SMSF trustees investing in overseas property.
Australian superannuation law
The SIS legislation does not prevent trustees from buying property overseas.
As with any SMSF investment, the trustee needs to ensure overseas property is a good fit with the overall investment strategy and that it complies with a number of rules.
The property cannot be acquired from a related party (ie, the trustees can not buy from themselves, a family member or family entity) and there is a limit on how much can be invested in related party assets, known as the “in-house assets rule”.
Trustees also need to have commercial pricing for in-house transactions.
Investing in overseas property does not have many implications in terms of Australian super legislation unless the property is acquired from a related party, or has a related party as a tenant.
This does mean, however, that under superannuation laws trustees can’t purchase an overseas holiday home or buy a coastal weekender within an SMSF.
The big issue surrounding investing in overseas property is generally around the practical aspects of satisfying the relevant laws of the country in which the asset exists and how these relate to Australian superannuation law. Here are some of the major considerations:
1. No charge over the property
It can sometimes be difficult to obtain documents confirming no charge is in place over a property in countries where there is no Australian-style register of titles.
If someone has a legal charge over a property as security for a loan, they have the right to recover any losses from the property should there be a default on the repayments. Most modern mortgages over registered land take the form of a legal charge.
If documents in relation to the property are not provided in English, they would have to be translated to prove ownership.
In addition, differences in language and customs may sometimes result in miscommunication between the parties involved in the transaction or management of the property.
2. Entity that holds the property
In several countries, a foreign entity such as an SMSF cannot hold property directly. A possible option may be to establish a local entity that purchases the property with the SMSF owning all the interests in the entity.
This structure would generally need to fall under the SISR 13.22C rules.
If structured this way, the assets of the owning entity would generally be restricted by the super law to the property and a bank account.
Even this simple requirement might be an issue as the bank account needs to be with an entity that is classified as an ADI by the Australian Prudential Regulation Authority.
Of course, not all foreign banks would meet this criterion. Failing this aspect would mean the entity is in an ‘in-house’ asset and the SMSF would only be able to invest 5 per cent of its market value in the entity.
Breaching this limit would then require the SMSF to dispose of its interest in the entity.
3. Different laws and customs
The laws and customs of the country where the property is located also need to be carefully considered.
Applicable tax and landlord/tenant laws can raise issues: for example, in some US states, authorities have the power to sell property where there are outstanding fees.
4. Payment of taxes
The investment entity itself may need to be a taxpayer in the foreign country, so who will ensure that the appropriate returns are lodged and taxes are paid?
This will mean that additional specialist assistance will be required by the SMSF, probably based in the country where the asset is located.
5. Local real estate agent
It is expected that the property would receive rent and the SMSF would pay for all expenses in relation to the property.
However, doing this from Australia would be impractical, particularly if an overseas bank account is established. A locally-based real estate agent could run an account for the SMSF, with rent and expenses going via this account.
In this scenario the trustees will need to ensure regular statements are received, and that an agreement is in place covering how frequently net proceeds will be transferred into the SMSF.
6. Foreign currency
The trustees of the SMSF need to consider the risks associated with fluctuations in the value of foreign currency and exchange rates.
All superannuation assets need to be converted into Australian dollars for financial statements, so movement in the exchange rate may result in variation.
These variations could in turn have impacts on other superannuation calculations such as member balances and minimum pension levels.
Additionally, care would need to be taken when considering the tax treatment on profits that may result from currency movement.
7. Sovereign risk
The final consideration is the question of sovereign risk. Just as can happen in Australia, a foreign government can change the rules in relation to taxation or foreign investment.
The implication of these changes may mean that the ownership of the foreign property is no longer tenable.
In fact there is even the possibility of the foreign regime resuming ownership of their domestic assets from foreigners without compensation.
As you can see, there are many things trustees must consider before purchasing an overseas property within their SMSF.
And we have not even touched on the additional complications surrounding acquisition of overseas property using a Limited Recourse Borrowing Arrangement.
While the law does not prohibit this, ensuring the structure meets the foreign jurisdiction’s requirements, as well as the lender requirements, requires many further considerations.
In summary, it is possible for an SMSF to purchase overseas property, but the trustees will need to consider and address the risks and practical issues that result from the transaction.
Philip LaGreca is the administration head of technical services at AMP SMSF.
