Alarms bells ringing with ATO around property investing in SMSFs


After only just discussing the regulatory focus by ASIC on SMSFs and property investments, we have seen further regulatory “alarm bells” ringing through the ATO’s release of taxpayer alert, TA 2012/7.  A Taxpayer Alert is an “early warning” of significant new and emerging higher risk tax and superannuation planning issues or arrangements that the ATO has under risk assessment, or where there are recurrences of arrangements that have previously been risk assessed.  With the growing amount of ‘hype’ in the use of these type of strategies, the alert is a timely reminder to ensure such arrangements comply with the strict nature of superannuation law.

It is often lost in the conversation, that borrowing is ordinarily prohibited in superannuation.  Limited exceptions apply, with the ability to enter into a limited recourse borrowing arrangement for prescribed purposes.  The specific purpose of the borrowing must be for the acquisition of a ‘single acquirable asset’.  To say ‘near enough is good enough’ simply won’t cut it when it comes to compliance with these requirements.  Failure to comply with sections 67A & 67B of the SIS Act, will mean that any maintenance of the loan will be in breach of the borrowing provisions.  With an inability to sell a brick-at-a-time, the unwinding of these arrangements can be difficult, and potentially expose the fund to a significant loss on a forced sale.

What problems are the ATO seeing with property investments using LRBAs?

  • The borrowing and title of the property is held in the individual’s name and not in the name of the trustee of the holding trust.  The SMSF has paid the deposit and ongoing repayments;
  • The title of the property is held by the trustees of the SMSF, not the trustee of the holding trust;
  • The trustee of the holding trust is not in existence and the holding trust is not established at the time the contract to acquire the asset signed;
  • The SMSF acquires residential property from a member;
  • The acquisition comprises two or more titles and there is no physical or legal impediment to the two titles being dealt with, assigned or transferred separately; or
  • The asset is a vacant block of land, with the intention to construct a house on the land.  The land is transferred to the holding trust prior to the house being built.

These problems throw up a whole range of compliance concerns, including:

  • potential breach of the sole purpose test in section 62 of SISA;
  • failure to comply with section 67 which prohibits a SMSF from borrowing money or maintaining a borrowing;
  • the acquired asset not meeting the single acquirable asset definition under section 67A(2) as it comprises two or more proprietary rights;
  • the acquirable asset is subject to a charge which would prohibit the fund from borrowing money or maintaining a borrowing of money under section 67A(1)(f); and
  • where the title is incorrectly held in the name of the individual and not the trustee of the holding trust, the deposit and/or loan repayments may breach the payment standards, effectively drawing on preserved benefits prior to meeting a cashing condition.

As highlighted by the Commissioner, there is a lot of talk about the benefits of limited recourse borrowing in super, but not a lot about the risks.  It is important to remember, responsibility ultimately rests with the trustees to comply with superannuation law.  Ensuring that the fund’s governing rules allow for borrowing (and assets to be held in a custodian arrangement), and that the decision is consistent with the fund’s investment strategy are all critical elements to ensure compliance.  Failure to do so, can render the fund non-complying, effectively meaning the fund is subject to a 45% tax rate which is applied to its income and market value of fund assets (other than undeducted contributions).  Furthermore, civil and criminal penalties could also apply.

Related trust arrangements

The taxpayer alert also highlights a range of concerns around the use of related unit trust structures to acquire property.  Once the ‘darling’ of the SMSF sector, the use of unit trusts has somewhat diminished with the inability to typically leverage inside these trusts, nor put a charge over the assets of the trust.  These strict requirements are outlined within SIS Regulation 13.22C.

The ATO concerns with these arrangements appear to stem from investments that are failing to adhere to the requirements of SISR 13.22C and subsequently become in-house assets under section 71 of SISA, thereby counting towards the allowable 5% limit.

It is not to say these strategies don’t provide some fantastic outcomes for individuals, but the decision process to establish a SMSF and consider acquiring property is not something to be taken lightly.  These alerts and investigations by the Regulators highlight the need for “buyer-beware” when it comes to property in SMSFs.

 

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