New ATO guidelines on SMSF’s and property development
Important message from the ATO: “Regularly check in with your SMSF professional advisor and your auditor to ensure that the investment stays on track”.
On the 1st May last the ATO issued a “Regulator’s Bulletin” SMSFRB 2020/1 outlining the ATO’s concerns and issues arising from property development arrangements involving SMSFs. The ATO’s new Bulletin is relevant to our SMSF clients who participate or invest in
“Property Development” whether directly, or commonly, indirectly, via a Unit Trust, Partnership or JV.
The ATO’s comments from the Bulletin are also relevant to SMSF’s which receive income from a “developed property” or who have recently disposed of an interest in such a property.
While raising concerns about the increased number of SMSFs entering into property development arrangements, the ATO stated that it can be a legitimate investment for SMSFs and “the Commissioner does not have any concerns with SMSFs investing in property development where it complies with the SIS Act and SIS Act regulations”
A “developed property” or ”property development” in this context has quite a broad meaning and includes to “improve” or “change the character” of an asset. Obvious examples would be a townhouse development undertaken by the SMSF or by a Unit Trust in which the SMSF hold units. Less obvious may an SMSF which fits out a factory or changes a property’s use to suits its tenant.
In our view, the Bulletin is largely positive and confirms Hill Legal’s views on a number of matters including:-
1. An SMSF can (in the right circumstances) be involved in Property Development, but trustees need to tread carefully;
2. SMSF trustees must obtain professional advice from their lawyers and accountants before purchasing a property or entering into any development type activities and, particularly, before entering into any type of arrangement which involves related parties or borrowing;
3. The ATO reminds SMSF trustees to “regularly check in with your SMSF professional advisor and your auditor” to ensure that the
investment stays on track and that adequate documentation is maintained;
4. Similarly, if you are worried about a previous development, get in touch with your advisers to consider the available options.
The Bad News?
There is nothing “new” in the Bulletin in terms of “bad news”, however the ATO do detail the numerous regulatory issues that can arise when an SMSF becomes involved with property development and also provide examples of situations which can create compliance issues. Here are
some examples to be aware of:
The ATO are looking more closely at how the developing entity such as the Unit Trust has obtained project funding and also at related party loans generally
– Taking what the ATO refer to as a “holistic” view, the ATO point out that where Members provide loan guarantees to enable a developing
entity to borrow money, the subsequent dividends received by the SMSF would not be consistent with an arm’s length dealings if “an
unrelated SMSF would not have been able to access these dividends” – that is, where the development was only possible because of the risk born by the SMSF members.
– Similarly the ATO will also look more closely at whether commercial or unrelated lenders would have been willing to lend on the development, and if not, where related parties have in fact loaned to enable the development to take place, the resulting dividends may
be NALI for the SMSF investor.
– The ATO reinforce that SMSF’s must be able to satisfactorily demonstrate that loans between related parties and the SMSF are on arms’ length terms. They also note the difficulties with this, in particular where the parties cannot point to a similar comparative commercial loan such as where the security offered are units in an unlisted trust.
Issues with property investments via Unit Trust
The ATO list some common sources of compliance issues where the SMSF holds units in a trust such as:
– Failing to maintain leases between the Unit Trust and its related party tenant creating in house asset issues for the SMSF
– SMSF’s borrowing to acquire units, but failing to recognise when separate LRBA’s are required
– Parties failing to recognise that a charging clause as contained in many building contracts is not permitted where a Regulation 13.22C Unit Trust is concerned
– The Unit Trust failing to deal with Related Parties of the SMSF (such as trades) on arms’ length terms
– Again, members providing guarantees to allow the developing entity to borrow
– Failing to understand the ongoing requirements when an SMSF invests in a Unit Trust such as the restriction on the trust carrying on a
– General poor management of Unit Trust’s documentation including valuations.
Joint Ventures via a partnership,company, trust or other arrangement.
ATO are asking:
– Can the SMSF demonstrate that the property development was pursued for the retirement purposes of the SMSF and is not influenced or motivated by other goals or purposes?
– Is the return to the SMSF excessive or conversely inadequate?
– Is it a genuine JV’s or does it disguise another arrangement such as an “investment in” or “loan to” to a related party?
– Has the SMSF become an investor in the property development principally to assist a related party which otherwise had insufficient funds to complete the property development?
– Is the arrangement intended to provide employment or income to a related party such as a member or child?
– Is the arrangement inappropriately diverting income into the superannuation environment or a scheme to illegally access superannuation ea?
Where the SMSF engages a Related Party to provide services in connection with the development
This has been on the ATO’s radar for some time, but they issue a few reminders:
– Seek advice to carefully document the arrangement and ensure it can be done on arms’ length terms
– Don’t inadvertently acquire building materials from the related party
– Ensure payments made by the SMSF to the related party are appropriately invoiced.
Record keeping issues
The ATO have warned that failing to comply with the Trust Deed or Investment Strategy or failing to maintain adequate records would in itself raise contravention concerns and the attention of the ATO. In particular the ATO has stated that the fund must keep the necessary records to establish its position and all transactions should be carefully documented to ensure that there is a proof of arms length dealings, the arrangement put in place reflect the legal status and the parties intend and they are permitted by the SMSF deed and investment strategy to undertake the property development transactions.
The bulletin is useful reading to advisers and clients who currently participate in property developments involving their SMSF and a full extract of the bulletin is and a full extract of the bulletin can be found at the following link: https://www.ato.gov.au/law/view/document?do
If clients or advisers have queries about whether their fund transactions are compliant, please do not hesitate to contact our SMSF lawyers, Chris Hill or Linda Shepherd of our office.