With the ATO still closely monitoring personal services income in relation to SMSFs, SMSF trustees have been told to exercise extreme caution with any property developments they undertake.
DBA Lawyers senior associate David Oon says while there is no blanket ban on property development in SMSFs, “extreme caution should be exercised before and during, since it can be easy to contravene the law without realising [it]”.
Mr Oon said the ATO issued TA 2016/6 last year which warned against diverting personal services income to SMSFs.
While this did not specifically target property development, in subsequent speeches more recently, the ATO flagged that it is closely monitoring business ventures, including property development, through SMSFs.
“In particular, the ATO has warned that ‘involving SMSFs in related-business undertakings may be viewed as a mechanism for diverting members’ business-related income into a more tax concessionary environment,” Mr Oon said.
He said the tax office has stated that most of the problem cases have “commonly involved related-party joint ventures and trusts” that have raised the potential application of the non-arm’s length income provisions.
“Non-arm’s length income is taxed at the highest marginal tax rate, even where the fund is in pension phase,” Mr Oon explained.
“To help mitigate this risk, SMSFs and parties to property development must ensure that the SMSF is not deriving more income than would be arm’s length from the arrangement.”
Mr Oon said it is best practice for SMSF trustees to retain objective evidence such as arm’s length quotes from unrelated sources in order to demonstrate that what occurred was at arm’s length.
SMSF practitioners and clients should also keep in mind that SMSFs are generally only able to borrow to acquire a single piece of real estate.
“The SMSF cannot borrow to fund improvements to the land. Also, while the loan to the SMSF is in place, the real estate cannot be fundamentally changed. Some examples of a fundamental change would be a subdivision, the construction of a building on what was originally vacant land or a residential building being changed to a commercial building,” Mr Oon said.
“Accordingly, if an SMSF needs to borrow to acquire the real estate, this usually prevents any property development taking place before the loan is paid off.”
Mr Oon also warned SMSF members that in the March 2013 ATO National Tax Liaison Group Superannuation Committee meeting, the tax office 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.
“Accordingly, unless related party builders and service providers are remunerated, their services could give rise to a contribution. This can give rise to a tension with the prohibition on trustee remuneration,” he said.
“Also, typically, the trustees are involved in some way in managing these developments and may not charge for their time. However, where there is a substantial addition of value to the real estate investment as a result of the member or related party’s involvement, then a contribution risk exists.”
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