M10 Property investments & development Dan Butler FCA Director DBA Lawyers
SMSF development facts Brownstone Super Fund ( BSF ) Will & Monica with $1.5m Brownstone P/L ( Build Co ) is a building company and Will and his brother Tim own this company 50/50 via their respective family trusts. The company has $600k cash Will proposing the following development: May 2016 the SMSF paid $10k for an option to purchase $1m land (W.Syd) Will proposes to build apartments with a friend Marty; dev costs $1m BSF will do a joint venture ( J.V. ) with Marty s SMSF ( MSF )
SMSF development facts BSF will provide land of $1m and MSF provide cash of $1m Build Co will do the building under a standard building contract The output of the J.V. development will be split between the 2 x SMSFs 50/50 Will & Marty own business real property ( BRP ) together but do not carry on a business together Legislative references will be to the Superannuation Industry (Supervision) Act 1993 (Cth) ( SISA ) and Superannuation Industry (Supervision) Regulations 1994 (Cth) ( SISR ) unless specified otherwise
SMSF development queries You are asked to prepare a preliminary report to meet with Will & Marty to discuss the SMSF and related aspects of their proposal Also, Will & Monica need advice on: BSF is looking at overseas property They want insurance inside the BSF and Will wants buy-sell insurance Sept 2009 an ACR in relation to in-house assets ( IHA ) was made
Applying the law JVs must be carefully & properly structured Can the 2 x SMSFs enter into a J.V.? Will a J.V. be an entity that will give rise to IHA issues? An IHA includes an investment in a related party of fund Related party includes a partnership in which a member (regardless of whether acting as trustee) is a partner Partnership includes joint receipt of income What is the difference between a J.V. v P/S?
Applying the law J.V. to produce output and each venturer sells independently Note that a J.V. can easily become a partnership giving rise to joint and several liability: see Yacoub v FCT [2012] FCA 678 If a Partnership exists it can be an entity which could give rise to IHA risks Note that Will and Marty are in partnership as they own a BRP together s70b(c) includes a partner of the [member] as a Part 8 associate Thus, if the J.V. = a Partnership; which = an entity; an IHA risk arises On balance, there are risks with a J.V. 6
LAND $ BSF MSF
Applying the law Lets consider a unit trust ( UT )? Would a 50/50 UT overcome the IHA issue? s70e(2) an entity controls a trust if: a group fixed entitlements to more than 50% of the trust; [significant influence]; or a group remove or appoint the trustee. s70e(3) group, in relation to an entity, means: the entity acting alone; a Part 8 associate of the entity acting alone; Recall, Will and Marty own a BRP together = partners Thus, a 50/50 UT would be treated to both the BSF and MSF as a related trust Being a related trust, would the non-geared UT exception under div 13.3A SISR apply? 8
Applying the law Reg 13.22C requires, among other things: there are no charges, interests in other entities, a loan to another entity; there is no use of the UT s assets by a related party unless it is at arm s length; Reg 13.22D sets out when 13.22C cease to apply: (1)(d) trustee of the unit trust, conducts a business; Thus, given the development is a business and as there are other hurdles with satisfying reg 13.22C, this is not available A private company would suffer the same issues: related company fail div 13.3A SISR 9
Applying the law Thus, what other options exist: Seek to de-group Will & Marty- sell or transfer the BRP to SMSFs or Family trusts Note, if Will & Marty held the BRP via 50/50 their respective family trusts (with corporate trustees), this would not result in grouping. Individuals in partnership can easily result in grouping Bring in a 3 rd party with > 50% (if Will & Marty remain grouped) Persist with J.V. and seek to overcome any partnership risks Let s assume that Will & Marty de-group and use a 50/50 UT In ATO NTLG Superannuation Committee Minutes 5 March 2013 at [7.10]: The fact that an entity has a 50 per cent interest in the capital or income of a trust does not, of itself, determine whether an entity controls a trust by reason of paragraph 70E(2) The constitution of the UT trustee and UT deed must be carefully checked to ensure there is no casting vote, etc. Otherwise control to one or both sides may exist 10
Applying the law Now, examine the application of the law to this proposal SMSF deed, investment strategy & constitution S 62 sole purpose test s 65 providing a loan or financial assistance to members: If services are provided to an SMSF on arm s length terms, this should not contravene s 65: SMSFR 2008/1 at [105] [107] where the ATO confirms that services provided by a related party to an SMSF at greater than an arm s length charge would contravene s 65 s 66 prohibition against acquisitions from related parties SMSFR 2010/1: the acquisition of the performance of a service does not contravene s 66 However, at [19] if materials are provided by a related party s 66 applies unless those materials are insignificant in value, eg, a member of an SMSF buys and installs ducted air-conditioning in a rental property owned by the SMSF Thus, SMSF should acquire material directly from trade suppliers 11
Applying the law ATO NTLG Superannuation Committee Minutes (8 Dec 2011) suggests the ATO is comfortable with this SMSF trustee delegates purchasing to the related party pursuant to deed of agency SMSF trustee opens new bank account in name of related party (held on bare trust by related party for SMSF trustee) SMSF Trustee transfers money to the bare trust a/c as needed under the contract to make progress payments If a 50/50 UT is used, consider looking through the UT to test whether there would any contravention of s 66 the UT not to acquire any materials from Build Co s 67 prohibit borrowings unless an LRBA under s 67A Investing in a 50/50 UT should not result in a borrowing The 50/50 UT itself may borrow and this should not contravene SISA A 50/50 UT can use its assets as security for UT borrowings 12
Applying the law Part 8 IHA rules A 50/50 UT relies on no control by either BSF or MSF interests ATO has discretionary powers to deem assets to be IHAs, eg, s70a, 71(2) & (4) s 109 arm s length rule Every investment to be dealt with on arm s length terms Reg 13.14 charges Most building contracts have a charge provision Build Co will do the building under a standard building contract s 295-85 ITAA 1997 CGT is the primary code that applies to SMSFs and any gain (even from development), is on revenue account 13
Applying the law Further, s 295-85(4) ITAA 1997 the apartments would not constitute trading stock to an SMSF if held directly by the UT On 10 May 2011 an amendment as made to broadly exclude real property, shares, units and stapled securities from the trading stock provisions of super funds due to the fear that losses would be claimed as a result of the GFC Thus, SMSFs even if operating a property development business would not have trading stock and the proceeds would be on capital account The 1/3 rd CGT discount could be accessed by a complying SMSF under s 115-100(b) However, a development via a UT could readily be on revenue a/c and the ATO has been closely examining arrangements that claim revenue gains are a capital gain subject to the 50% CGT discount 14
Applying the law Thus, if the UT developed and held the apartments, any gain would be on revenue a/c: ATO TA 2014/1 extracts: This TA describes an arrangement whereby a trust undertakes property development activities as part of its normal business. The developed property is subsequently sold and the proceeds are returned on capital account, resulting in access to the general 50% capital gains discount. The proceeds are not returned as ordinary income under s6-5..., either on a gross basis (as part of a business of property development, where the underlying property constitutes trading stock for the purposes of s70-10) or on a net basis (as part of a profit making undertaking). 15
Applying the law ATO will closely examine developments involving related parties for a contribution risk any excess CC taxed as income to member(s) as income with a 15% offset (and interest) Given reduced concessional contribution ( CC ) cap of $25k from mid-2017 TR 2010/1 a contribution increases the capital of the fund and is for providing retirement benefits to members Provision of services, eg, non-significant accounting, may not result in a contribution see example with Jasmine in TR 2010/1 However, where a development adds value, ATO argues it is a contribution 16
Applying the law March 2013 NTLG Superannuation Committee minutes, where the ATO stated that, where a related party improves an SMSF asset at no cost to the SMSF, for the purpose of benefiting the SMSF, this will constitute a contribution reflective of the increase in market value of the SMSF s assets Thus, if Build Co is doing the work, everything needs to be documented and transparent that it is at arm s length SISA s17a and 17B also need to be considered regarding remunerating a director of a corporate trustee. Build Co overcomes these sections that would apply if Will was personally providing building services 17
Applying the law ATO is targeting arrangements where the return from SMSF investments are increased due to services provided Example, an SMSF invests in a private company or UT and the SMSF members undertake work in respect of the company or UT and as a result the dividends or distributions are bolstered ATO may raise the following concerns: NALI Contributions Other, eg, Part IVA TA 2016/6 is a recent example 18
Extract from TA 2016/6 diversion of personal income 19
Applying the law Sec 295-550(1) of ITAA 1997: an amount of... statutory income is [NALI]... if: it is derived from a *scheme the parties to which were not dealing with each other at *arm s length in relation to the scheme; and that amount is more than the amount that the entity might have been expected to derive if those parties had been dealing with each other at arm s length in relation to the scheme. Sec 295-550(5) other income derived by the entity as a beneficiary of a trust through holding a fixed entitlement to the income of the trust is non-arm's length income of the entity if: See 1 st point above See 2 nd point above
Applying the law A UT is not a fixed trust unless 100% unitholder consent is required to vary the trust in respect of income and capital entitlements: Colonial First State Investments Limited v Commissioner of Taxation [2011] FCA 16 However, TR 2006/7 ATO distinguished between a unit versus discretionary trust Best to have a fixed trust for various reasons including land tax and changes to law and benefits of carry forward of losses and passing on franking credits Many UT deeds are deficient in other respects of limited liability and having appropriate provisions regulating voting, change of trustees, etc 21
Applying the law s 295-550 non-arm s length income ( NALI ) taxed at 47% to an SMSF SMSFs need to ensure they have sound evidence to prove dealings are at arm s length Typical exposure exists: asset purchased at an undervalue income/gain generated higher than arm s length Free services or lower value service including loans and other resources ATO more aggressive in its application of NALI and see related party LRBAs as a focus moving forward especially after Jan 2017 following its PCG 2016/5 warning these LRBAs be brought on arm s length terms (from 1 July 2015) to avoid NALI ATO assessment is a debt due and payable. Onus is on the SMSF trustee to prove the assessment is excessive or incorrect 22
Overseas property The interplay of Australian and the overseas country s laws can prove interesting including any double tax agreement, etc Many O S countries require a resident to purchase real estate Invariably, an O S company is required The SMSF invests in share (not real estate) The company must satisfy div 13.3A However, an O S bank a/c is a disqualifying event Thus, an IHA issue arises Refer to my article at: http://www.dbalawyers.com.au/investments/smsfsbuying-overseas-property-tips-traps/ 23
Overseas property Some O S countries the purchase is via a local resident individual ( LRI ), eg, Asia In one case the LRI was paid an annual fee for doing this SMSF client believed they were getting freehold estate in the Asian country Auditor queried and requested legal opinion Translator interpreted the O S legal documents as a loan Thus, the SMSF s only recovery against the LRI was via enforcement of a loan What if the LRI rattled on the deal or died and a family provision type claim was lodged? Also, the O S law imposed 3 years jail for contravening their foreign investor review laws Care is needed! 24
Insurance Insurance can use up valuable CC space at $25k from FY2018 Consider whether insurance should now be outside super The untaxed element can result in a 30% death tax to adult children Inside the BSF and Will wants buy-sell insurance and Will has a buysell agreement ( BSA ) with his brother Tim and their respective family trusts with respect to Build Co 25
Insurance Types of insurance after 30 June 2014 SISR reg 4.07D: Death Terminal medical condition Permanent incapacity (TPD any occupation) Temporary incapacity Grandfathered insurance pre-july 2014: TPD own occupation (but deduction only for any occupation) Trauma Cross-insurance Thus, should more people be taking insurance outside super? 26
Insurance Accountants may provide generic risk management advice. The exemption in Corporations Regulations 2001 (Cth) reg 7.1.29(3)(b) clarifies that an accountant may advise on the risk that a business or individual has and identify a FP that could mitigate that risk An appropriate disclaimer would need to be issued: We are not licensed to provide financial product advice under the Corporations Act 2001 (Cth) and you should consider taking advice from the holder of an Australian financial services licence before making a decision on a financial product. Refer: http://www.dbalawyers.com.au/strategy-compliance-kits/non-licensed-afsl-smsf-advisers-kit/ 27
Buy-sell insurance ATO ID 2015/10 confirms that: an SMSF trustee contravenes the sole purpose test s62 and the financial assistance test s65(1) (b) of the SISA by purchasing a life insurance policy over the life of an SMSF member where the purchase of the policy is a condition and consequence of a BSA the member has entered into with his brother as co-owners of their business the SMSF is not a party in an arrangement the SMSF is directed under the BSA to expend contributions on insurance premiums Any issues with ATO view? The sole purpose is an objective purpose insurance for providing benefits What happens after a death/tpd benefit is made, its generally irrelevant what the member does with a benefit paid to them by the fund 28
Buy-sell insurance The ATO Life insurance and buy-sell agreements web info provides: John & Kate (siblings) run a business via a company and have a BSA that covers: the company contributes to John s SMSF John s insurance is aligned to the value of his shares the BSA requires the company contributions to fund the premium Broadly, on John s death, the insurance goes via his SMSF to his wife Robin The ATO also notes that the arrangement allows his sister Kate to obtain ownership and control of the company on John s death, without consideration. The ATO says this results in a contravention of John s SMSF providing financial assistance to a relative 29
Buy-sell insurance Let s contrast the ATO web info on 19 August 2015 to 6 April 2016 (ref: QC 46541). Underlined wording at 19-8 and the new words now What you should do If you have entered into an agreement of this type you should seek independent professional advice. All insurance held by an SMSF trustee should be consistent with the purposes of super, and therefore correspond with one of the requirements of the core or ancillary purposes set out in the sole purpose test in s62 of SISA. Deciding if the trustee has complied with the sole purpose test requires an examination of all the facts and circumstances associated with the maintenance of the SMSF. Generally, the presence of a buy-sell agreement on its own will not result in a breach of the sole purpose test. 30
Insurance Summary BSA cross-insurance pre-30 June 2014 may be grandfathered BSA self-insurance from 1 July 2014 problematic unless the BSA is carefully worded BSA might provide that the individuals must have insurance However, the BSA should not insist on insurance being in an SMSF 31
Conclusions There are many factors at play SISA and SISR Tax Stamp duty Structuring Legal agreements Careful planning required Get advice where needed 32
Questions?
Abbreviations AFSL: Australian financial services licence AR: authorised representative of an AFSL holder BRP: business real property BSA: buy-sell agreement CC: concessional contribution ECPI: exempt current pension income FP: financial product FSS Bill: Treasury Laws Amendment (Fair and Sustainable Superannuation) Bill No., 2016 FY: Financial Year ITAA 1936: Income Tax Assessment Act 1936 (Cth) ITAA 1997: Income Tax Assessment Act 1997 (Cth) LRBA: limited recourse borrowing arrangement LRI: local resident individual NALI: non-arm s length income PCG: Practical Compliance Guideline 2016/5 SG: superannuation guarantee SGAA Superannuation Guarantee (Administration) Act 1992 SISA: Superannuation Industry (Supervision) Act 1993 (Cth) SISR: Superannuation Industry (Supervision) Regulations 1994 (Cth) TRIS: Transition to Retirement Income Stream UT: unit trust 34