Law firm offers strategies for combating in-house asset hurdles

Whether it is a property development project or other types of investment, the main compliance hurdle for SMSFs when related parties are involved is the in-house asset rules, he explained.

“In simple terms, the in-house asset rules require trustees to ensure that the fund does not have more than 5 per cent of its investment in in-house assets,” Mr Song said.

“[There] is a prohibition of new in-house assets if the level of in-house assets is over 5 per cent prior to acquisition or will be over 5 per cent after the acquisition and a requirement to dispose of in-house assets if the level is exceeded.”

In keeping the level of in-house assets under the 5 per cent limit, it is important to consider whether the proposed structure will give rise to in-house assets.

Mr Song explained that a joint venture has no uniform legal meaning under the superannuation law and generally refers to a commercial arrangement between two or more individuals or entities for the purpose of undertaking a particular business.

“On the other hand, the Superannuation Industry (Supervision) Act 1993 has adopted the tax law definition of partnership for IHA purposes which is broader than the general law definition of a partnership. This broader definition includes arrangements whereby two or more individuals or entities are simply in receipt of income jointly,” he said.

He gave an example of an SMSF and a building company that is a related party.

“The property owned by the SMSF with its related party as tenants in common is not an IHA due to s71(1)(i) of the SIS Act which excludes such property from the definition of that term,” he said.

“Further, the joint venture is a commercial arrangement between parties and is not by itself a related party of the fund if it is properly set up with necessary features of a joint venture. With this structure, the SMSF would not have an investment ‘in’ a related party and accordingly does not acquire any IHAs by the project.”

If, however, the arrangement is not properly set up as a joint venture and the SMSF and the building company receive income jointly, Mr Song warned that the arrangement will be deemed as a partnership under the superannuation law for in-house asset purposes.

“Being properly set up means that the agreement between the parties and all the documents they issue to, or enter with, third parties make clear that neither party is liable for any defaults or wrongful acts of the other and each is only entitled to a half share of any profit from the enterprise,” he clarified.

In contrast to a joint venture, Mr Song said a partnership would itself be a related party of the fund and the SMSF’s investment in the partnership would be an in-house asset of the fund, being an investment “in” a related party.

“The issues surrounding whether an investment structure is a joint venture or a partnership for IHA purposes are not only complex but are also the subject of some legal uncertainty,” Mr Song added.

It is important the advisers and their clients consider the potential in-house asset implications of different investments structures and that trustees considering a joint investment with related parties obtain appropriate advice in order to remain compliant.