Trustees warned on property co-ownership through SMSF

According to the principal of Townsends Business & Corporate Lawyers, Peter Townsend, the ATO has greatly emphasised the need for SMSFs to formulate and incorporate a clear and transparent “investment strategy” when acquiring real property.

“Generally, this involves the trustee proving that they have developed a methodology for the purpose of accumulating the fund’s superannuation benefits,” he said.

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Mr Townsend used an example of Carter Holdings Pty Ltd, which is the corporate trustee of the J. C. Superannuation Fund.

Ms Carter, the sole member of the fund and the sole company secretary/director of the corporate trustee, is looking to buy a two-bedroom apartment as part of her superannuation investment strategy which will be jointly owned by Ms Carter’s life-time friend, Mr Lee.

Under their proposed co-ownership agreement, both Ms Carter and Mr Lee will each own a 50 per cent share in the property as tenants in common.

Based on this example, Mr Townsend said that Carter Holdings Pty Ltd and Mr Lee have entered into a valid transaction and, as a result, where Carter Holdings Pty Ltd is concerned, co-ownership of real property doesn’t violate the provisions of the SIS Act and is allowed provided that both entities deal “at arm’s length”.

He said that the term “at arm’s length” primarily refers to:

1. the relationship between the two parties (section 70B to 70E of the SIS Act), and
2. any requirement under the SIS Act relating to limited recourse borrowing arrangements and the giving of security over the property.

Under this example, Mr Townsend said Ms Carter, as the SMSF member, and Mr Lee are not related parties for the purposes of section 70B to 70E, noting that while the term “related party” is a relatively broad term, it is generally understood as:

• relatives of each member of the fund (spouse, children, siblings, etc.);
• business partners of each member of the fund;
• any spouse or children of those business partners;
• any company controlled by the member or any of the above associates; or
• any trust controlled by the member or any of the above associates.

Further, Mr Townsend said the proposed co-ownership agreement will also have a substantial influence on the transaction and may affect the fund’s investment strategy in the future.

“Generally, a co-ownership agreement will state the rights and obligations of each co-owner with regard to the administration of the property. Important provisions may refer to, but are not limited to, the right to sell or force a sale of the property and the right to refuse proposals of sale,” he said.

“As Ms Carter’s fund trustee is purchasing the property as part of that fund’s investment strategy, the right to sell (and refusal to sell) are important prerogatives which ought to be formalised in a co-ownership agreement.

“Should the fund need to sell the property in order to make payments to its member, the right to sell and/or the right to refuse sale will be of paramount importance.

“In the absence of a co-ownership agreement, the matter is likely to end up in court, causing excessive financial and emotional distress, not to mention the huge amount of time usually required from the court system.”