In this guide
One of the outcomes from the rapid rise in Australian property prices in recent years has been the significant increase in property development activity by self-managed superannuation funds (SMSFs).
The ATO, as the regulator of SMSFs, responded by releasing an information bulletin setting out the potential risks of property development activity through an SMSF and highlighting areas that can create compliance concerns.
This Regulator’s Bulletin SMSFRB 2020/1 was released in March 2020 and provides an insight for SMSF trustees on the potential issues that need to be considered. It also sets out common scenarios that will often give rise to a breach of the super rules.
Background
There is a common misconception that property development activities carried out through an SMSF would automatically result in a breach of the superannuation rules. This is not the case. Where these activities are carried out correctly, they are absolutely allowed and the ATO clearly states:
“Property development can be a legitimate investment for SMSFs, and the Commissioner does not have any concern with SMSFs investing in property development where it complies with the Superannuation Industry (Supervision) Act 1993 (SISA) and Superannuation Industry (Supervision) Regulations 1994 (SISR).”
SMSF trustees contemplating development activity involving their SMSF would therefore need to work through the relevant rules and requirements.
Compliance considerations
There are specific areas of both the superannuation and tax laws that SMSF trustees need to be familiar with before entering into any form of property development.
The sole purpose test
Any SMSF involvement in the development must be for the sole purpose of providing the fund members with retirement benefits. There can be no form of current day benefit given to the members by including the SMSF in the project.
This will require a clear reasoning as to why the SMSF is involved in the development and what the trustees expect to achieve at the conclusion.
Where a related party is also involved in the development, it is important that the SMSF trustees act only in the best interests of the fund members.
SMSF investment strategy
SMSF trustees need to consider their fund’s investment strategy and what it allows. In most cases, updating the fund’s strategy documentation would need to be carried out before any action is taken.
Clearly defining why the SMSF is involved in the property development and what outcomes are likely to be achieved should also be included in the fund’s investment strategy.
Trustees will need to refer to the fund’s trust deed and ensure that all activities are in accordance with the rules contained in their deed.
Arm’s-length requirements
All transactions entered into and carried out need to be at arm’s length. Neither party to the transaction should be treated more favourably than the other.
If the terms of the arrangement or transaction are seen to favour the other party (the non-SMSF participant), then there would be a breach of the SIS arm’s-length rules (Section 109). This will often lead to a contravention that needs to be reported by the fund’s auditor.
Conversely, if the terms of the arrangement or transaction are seen to favour the SMSF, then it would create a non-arm’s length income issue under the tax rules. When this occurs, all SMSF income (and capital gains) from the development are taxed at the top marginal tax rate instead of the concessional rate given to super funds. This is set out in the Income Tax Assessment Act Section 295.550 and will be the result regardless of whether the other party to the transaction is related or not.
Of course, where there are related parties involved in the development then this becomes even more relevant.
Learn more about the arm’s-length rule for SMSFs.
Related party involvement
It is possible for an SMSF to carry out a property development together with, or involving, related parties. But it will require the fund trustees to consider the relevant compliance issues, including:
- The arm's-length rules that were covered above
- The trustee remuneration rules (read more about the trustee remuneration rules)
- The need to maintain clear and concise paperwork for all decisions and transactions that take place.
