The Commissioner of Taxation has recently released a Taxpayer Alert addressing issues he is concerned with regarding self-managed superannuation funds acquiring property using limited recourse borrowing arrangements or using related unit trusts, which may not comply with superannuation law.

Below is an summary of this Taxpayer Alert.

Types of Arrangements

Property Investments using LRBA

Subject to a limited number of exceptions, self-managed superannuation funds (SMSFs) are prohibited from borrowing money, unless it is done through a limited recourse borrowing arrangement (LRBA).

These arrangements may include at least one of the following features:

1. The borrowing and the title of the property is held in the individuals’ name and not in the name of the trustee of the holding trust. The SMSF funds part of the initial deposit and the ongoing loan repayments;
2. The title of the property is held by the SMSF trustee not the trustee of the holding trust;
3. 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 is signed;
4. The SMSF trustee acquires a residential property from the SMSF member;
5. The acquisition comprises two or more separate titles and there is no physical or legal impediment to the two titles being dealt with, assigned or transferred separately; or
6. The asset is a vacant block of land. The SMSF intends to use the same borrowing to construct a house on the land. The land is transferred to the holding trust prior to the house being built.

Property Investments using Related Unit Trusts

Subject to certain exceptions, the trustee or investment manager of an SMSF is prohibited from intentionally acquiring assets from a related party. An exception to this is where the asset is an investment in or loan to a related party, commonly referred to as an ‘in-house asset’. However the total market value of the SMSF’s in-house assets must not at any time exceed 5% of the total market value of the fund’s assets.

SMSFs are able to exclude themselves from the calculation of the 5% limit by investing in a related trust unit. These investments are excluded from the definition of an in-house asset when the unit trust complies with Div 13.3A of the Superannuation Industry (Supervision) Regulations 1994 (SISR). Furthermore, the general prohibition on SMSFs acquiring assets from a related party does not apply where the SMSF’s investment is in a unit trust which complies with those requirements.

These arrangements are likely to include at least one of the following characteristics:

1. The asset acquired by the unit trust is used as a security for the money borrowed by the members to subscribe units in the unit trust;
2. The assets of the unit trust include an asset that was acquired from a related party of the superannuation fund which is not business real property; and/or
3. The assets of the unit trust include real property which is leased to a related party of the superannuation fund, and the real property subject to the lease is not a business real property.

 

Concerning issues associated with property investments using LRBA (after 7 July 2010)

Superannuation Issues (re: SIS Act and SISR)

1. The investment arrangements may be in breach of the sole purpose test in section 62 of the SISA;
2. Section 67 of the SISA which prohibits the SMSF trustee from borrowing money or maintaining an existing borrowing may have been breached;
3. The asset acquired is not a single acquirable asset as required under section 67A(2) of the SISA as it is comprised of two or more proprietary rights;
4. The acquirable asset is subject to a charge which would prohibit an SMSF trustee from borrowing money, or maintaining a borrowing of money under subparagraph 67A(1)(f); and
5. The deposit paid by the SMSF and/or loan repayment by the SMSF may be considered as a payment of superannuation benefits which contravenes Part 6 of the SISR where the title of the property is not held by the trustee of the holding trust.

Taxation issues

1. The member(s) may be required to include the SMSF loan repayments in their assessable income under Division 304 of the Income Tax Assessment Act 1997 (ITAA 1997); and
2. The income and its associated deductions from the investment should be declared by the individual member(s) rather than by the SMSF where the investment is not held for the beneficial interest of the SMSF.

 

Concerning issues associated with property investments using related unit trusts

Superannuation Issues (re: SIS Act and SISR)

1. The investment arrangements may be in breach of the sole purpose test in section 62 of the SISA;
2. The SMSF’s investment in the unit trust fails to meet the requirements of Regulation 13.22C of the SISR; and
3. The SMSF’s investment in the unit trust is an in-house asset under section 71 SISA, therefore counting towards the 5% limit under section 83 SISA.

Taxation Issues

1. SMSF may become a non-complying superannuation fund for tax purposes and must include amounts of income from previous years in its assessable income under section 295-325 of the ITAA 1997;
2. The unit trust may incur a capital gains tax liability in relation to the disposal of the property;
3. The members and the SMSF may be required to include a capital gain in their assessable income an amount on redemption of their units in the unit trust.