NALI barriers outlined with property development and related unit trusts
SMSFs planning to utilise a related party loan to buy units in a related unit trust, which undertakes a property development, have been warned this is very likely to raise non-arm’s length income issues due to the difficulty in obtaining arm’s length evidence.
DBA Lawyers special counsel Bryce Figot explained that one of the red flags raised by the ATO in SMSF Regulator’s Bulletin 2020/1 related to situations where an SMSF borrows money from a related party to buy units in a related unit trust and that unit trust undertakes a property development.
Mr Figot noted that while the ATO doesn’t explicitly state that it can’t be done, The Regulator’s Bulletin suggested that it can’t be done due to the challenge in obtaining evidence from an arm’s length lender.
“You’re not within the safe harbour [terms] of PCG 2016/5, and therefore, in order to be able to do it, you would have to show than an arm’s length lender would have lent in those circumstances,” Mr Figot explained in a recent SMSF Adviser podcast.
Mr Figot said the ATO pointed out that you’d be very hard-pressed to find an arm’s length lender willing to lend in those exact circumstances.
“They don’t make the final leap but the conclusion that they push you toward is that you’re not in the safe harbour and you’re not going to be able to show that the terms are consistent with an arm’s length dealing in the exact same arrangement,” he said.
“You would have to have some truly extraordinary evidence showing arm's length terms to lend in those circumstances.”
Where the Commissioner did decide to issue a non-arm’s length-related assessment, he warned that the onus is on the taxpayer to prove that it is excessive.
“I’ve never seen good evidence as to what an arm’s length lender would lend to an SMSF to buy units in a related unit trust,” he cautioned.
Another issue that can arise in terms of SMSFs, related unit trusts and property development, he said, is the in-house asset rules.
“Where SMSFs are looking to buy units in a unit trust and it’s a related unit trust, obviously on the face of it is an in-house asset so you would hope an exemption to the in-house asset rules applies, particularly where the investment is more than 5 per cent of the fund,” he explained.
“The obvious one is the one listed in the regulations in division 13.3A, which says that amongst other things the unit trust can’t have a borrowing, it has to conduct itself on arm’s length terms and can’t run a business.”
The ATO alluded that if an SMSF invests in a related unit trust that wants to buy real estate and develop and sell it or even buy it, develop it and lease it, they suggested that this may well be a business, said Mr Figot.
“I think this is a very legitimate comment and I think there’s a lot of overly optimistic people out there who think that it can’t be a business because it’s a brand-new unit trust and it’s never done that before,” he stated.
“Well, that’s not what the ATO is getting at in the Regulator’s Bulletin and I think the ATO is correct [in providing] that warning.”
Miranda Brownlee is the deputy editor of SMSF Adviser, which is the leading source of news, strategy and educational content for professionals working in the SMSF sector.
Since joining the team in 2014, Miranda has been responsible for breaking some of the biggest superannuation stories in Australia, and has reported extensively on technical strategy and legislative updates. Miranda has also directed SMSF Adviser's print publication for several years.
Miranda also has broad business and financial services reporting experience, having written for titles including Investor Daily, ifa and Accountants Daily.