Following an easing of the superannuation borrowing prohibition, interest around how the provisions may allow self-managed superannuation fund (SMSF) trustees to acquire property assets (often from fund members) has gained momentum. To date, these types of arrangements appear to be of most interest to people who own business premises and run a business through these premises.
However, it is important for fund trustees to remember that while the borrowing prohibition has been eased, the usual investment restrictions continue to apply to any proposed asset purchase involving SMSF borrowings.
Therefore, it’s timely to revisit some key investment restrictions that should be considered before contemplating an acquisition involving a related party.
Acquiring an asset from a related party
In addition to estate planning and other potential applications, another benefit of acquiring an asset from a related party often involves a reduction in future income and capital gains tax for the individuals or entities concerned.
The earnings generated by an asset held within an SMSF are taxed at a maximum rate of 15 per cent (accumulation phase), and 0 per cent (pension phase). Long-term capital gains are taxed a maximum 10 per cent (accumulation phase), and 0 per cent (pension phase).
These concessional tax rates compare favourably to the company tax rate of 30 per cent and the marginal tax rate for most people up to 46.5 per cent.
However, acquiring an asset from a related party will trigger a capital gains tax (CGT) event and a possible CGT liability, with the market value of the asset being treated as the sale/disposal price. There may also be additional stamp duty implications.
Superannuation restrictions
The SIS legislation generally prohibits an SMSF from acquiring an asset from a related party of the fund.
However, there are a number of specific exceptions, including:
n business real property;
n listed securities;
n units in a widely held unit trust;
n certain insurance policies; and
n certain in-house assets.
Let’s consider business real property. Business real property is real property that is used wholly and exclusively in one or more businesses.
In practical terms, commercial properties, offices, warehouses and farms are likely to be considered business real property. A house or apartment that is being used for residential purposes is not likely to satisfy this definition.
Importantly, the business itself does not necessarily have to be conducted by a member or related party of the fund — that is, commercial premises leased to an arm’s length third party may be treated as being business real property as long as the third party is using the premises in conducting a business.
Who is a related party?
A related party includes any member, a relative of any member, a relative of the spouse of any member, and an entity (such as a company or trust) controlled by one or more of the above individuals.
The definition of relative includes a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of that individual or of his or her spouse.
Other acquisition issues
Any asset acquisitions undertaken by an SMSF must be conducted at market value. This means that in the case of an:
n SMSF purchasing an asset, the market value of the asset must be paid as consideration by the SMSF; and
n in specie contribution, the value of the asset transferred to the fund must be recognised as a contribution to the SMSF and subject to the relevant contribution cap(s).
Any acquisition of an asset from a related party must be in line with the requirements of the sole purpose test and with the fund’s stated investment strategy.
Leasing property to a related party
Once an SMSF acquires an asset from a related party, particularly property, it’s not uncommon for the fund to subsequently seek an avenue to lease that asset back to a related party.
When dealing with business premises, leasing it back to a related party may help to provide for the fund member’s retirement while allowing the asset to be used in the business of the member.
From a tax perspective, rent received by the SMSF is treated as income and taxed at a maximum of 15 per cent (accumulation phase), and 0 per cent (pension phase). The rent paid to the SMSF would generally be a tax-deductible expense to the business.
Further, as rent paid by the business to the SMSF is not counted as a contribution, this helps to boost a member’s retirement benefits without soaking up any of the member’s contribution caps.
Finally, a careful analysis of the business’ cash flow should always be undertaken before the transfer of business assets takes place. As any such lease arrangements need to be entered into at commercial rates and payment terms strictly enforced by the SMSF trustees, this has the potential to place additional strain on a business’ cash flow, particularly given current economic circumstances.
Where an SMSF has borrowed to acquire the property, rental income is often critical to the fund’s ability to service its loan obligations.
Superannuation restrictions
While the above is true for assets that meet the business real property definition, the same flexibility may not be available in regards to other types of assets.
An asset that is subject to a lease or lease arrangement between the fund trustee and a related party of the fund is regarded as an in-house asset of the fund.
Further, the value of a fund’s in-house assets is restricted to 5 per cent of the fund’s total market value.
This would appear to make it very difficult for SMSF trustees to ever enter into such lease arrangements.
However, business real property leased to a related party is excluded from the definition of an in-house asset.
But care needs to be exercised when dealing with houses, apartments, or other property that are being used for residential purposes.
Finally, an SMSF leasing property to a related party must ensure that this is appropriate for the fund given the fund’s investment strategy, and ensure that the fund continues to comply with other superannuation investment restrictions.
Fabian Bussoletti is a technical analyst at AMP TapIn.
