The evolution of new processes reshaping BRP applications for SMSFs
Questions around the definition of business real property and its application for SMSFs will continue to evolve as new technology and processes emerge, with advisers urged to keep abreast of emerging issues, says a technical specialist.
With 12 years passed since the ATO released its business real property (BRP) ruling, there has been significant changes in the technology, economic and legislative landscape. As a result, there has been significant developments in the application of the BRP definition as well as the emergence of new issues and threats that professional advisers need to be aware of.
Colonial First State head of technical services Craig Day said that there are increased queries and complexities being seen in relation to business real property. He noted that when looking back at the ATO’s ruling SMSFR 2009/1, there are a lot of questions raised around the definition of business real property and how it is applied for SMSFs in the current environment.
Mr Day said, recently, there have been major changes seen in the sharing economy with the emergence of technology platforms to address issues such as matching supply and demand and the lack of trust between consumers and providers.
In terms of property, new platforms such as Airbnb and Stayz have emerged which were launched after the ruling of the business real property, allowing people to offer property for short-term accommodation and manage property themselves.
One of the major considerations seen for SMSFs at the moment is if running services on a platform like Airbnb is considered business real property.
With various management and administrative considerations involved with running this type of service, Mr Day noted the question is, can a person transfer one of these properties into their SMSF on the basis that it is business real property because they are running the business of providing short-term holiday accommodation?
In an example provided, Derrick owns a two-bedroom property in Sydney that he has available for short-term accommodation throughout the entire year. It is also advertised by multiple platforms, with Derrick managing all aspects of the property himself and then paying any refunds, repairs and maintenance and doing his tax returns for the year.
Derrick has never lived in or stayed at the property. He purchased this property specifically to generate rental income from it and he earns $45,000 a year. If Derrick decides that he wants to transfer this property into his SMSF, he has to rely on the business real property definition.
When considering the application of BRP, Mr Day said the key things to remember is, does the service being provided have a commercial character and purpose; is there a profit motive; and is there sufficient scale and complexity?
“It’s only one apartment, so that’s not a lot of scale in terms of complexity and not very complicated,” Mr Day said.
“However, it is important to note there has been a recent decision from the AAT that looked at a property development business, and what this involved was a person going and buying one block of land and subdividing it in the most simple way possible by turning one block into two. What the ATO said in that situation is that constitutes a property development business.
“Now, in this case, we’ve only got one apartment, but do we have enough profit motive here and do we have enough sufficient scale and complexity to argue that we’re actually running a short-term accommodation business?
“The business can also be considered regular and repetitive as it’s available 365 days a year and there is possibly a lot of time and effort involved, but is that enough to indicate that a business has been carried on or is this just a passive investment?”
Mr Day said that if Derrick was to go to the ATO and put in a PBR request on the basis of calculating tax deductions for travel expenses in running a short-term accommodation business, he would likely be denied.
“Purely and simply because you don’t have that sufficient size and scale to really differentiate yourself from someone that is actually running a business,” Mr Day explained.
“Unless that one property involves a lot of different functions like a tourism facility where you’ve got people coming in and there’s multiple accommodation units on that one particular block of land and you might have someone there that is managing that.
“However, it really depends on particular circumstances, but generally, for one apartment that you make available through Airbnb for 365 days a year, I think it is still unlikely that you would be considered to be running a business. I could be proved wrong, but that’s the way I kind of see it now.”
Applications when charging service to the fund
While providing a holiday home is a popular option, another common situation is the use of hosting services through these platforms which could present different risks when applying BRP, according to Mr Day.
In another example, Sandra provides a hosting service for 15 different properties available via Airbnb in inner-city Melbourne. She works 30-plus hours a weekend and has two part-time employees to help manage it. Sandra wants to purchase an apartment via her SMSF and make it available via Airbnb.
With hosting services a different form of provision, Mr Day noted the main question is, could Sandra provide hosting services to her SMSF and effectively charge the fund?
He said: “You’re going to have to think about how the person is charging for that service, and there was always this kind of uncertainty in relation to this concept.
“Previously, the ATO had come out and amended the SIS act for Trustee Remuneration requirements in Section 17b and it notes a trustee can actually pay a related party for services that they provide to the fund so long as they are qualified and licensed to provide that service. They can carry on a business of providing similar services to the public, there’s arm’s length remuneration shown and, importantly, they’re acting in a capacity other than as trustee.
“In this case, Sandra is making herself available to provide hosting services to the public, so therefore, potentially, she can tick all those boxes, as she is doing this in a capacity other than as a trustee.”
However, the next hurdle Sandra would face is if all the properties qualify as BRPs. Mr Day noted that the identity of the entity granting rights in this case is critical.
He explained: “In that situation, you’re looking at who actually owns the property in this and who owns the rights that are being relied upon here.
“If Sandra acts as agent and the owners grant rights, that’s an agreement between the owner of the property and the guest; Sandra is simply an agent acting on behalf of the owner to facilitate all of this happening, and in this situation, they will not be business real property unless the owners themselves are running a business of providing short-term holiday accommodation.
“However, if Sandra had leased all 15 properties and was granting rights of use to guests through her leasehold interests, then it could be a business real property if she’s running a short-term accommodation business in that situation.”
Ultimately, if the property is acquired from an unrelated party and managed by the SMSF, Mr Day said there are still a lot of things to consider for advisers.
SMSFs will need to make the investment strategy work and will probably need to write a quite complex investment strategy. The fund would also need to consider sole purpose breaches such as the private use of this property.
“In terms of acquisition of assets, if I were to go and use the SMSF to acquire assets from myself and use it to run a business, consider the nature of acquisition, as there’s no exemption from the acquisition of assets from a related party,” Mr Day said.
“SMSFs also need to consider in-house asset risks. If I did go and stay at the property, it is more than likely you’re going to blow the 5 per cent limit sky-high.
“Also, you need to consider NALE implications, as the fund must acquire and pay for absolutely everything. You do not want the members dipping into their pocket for anything because as soon as they are covering some sort of expense on behalf of the fund, you now have a NALE situation and you’re potentially creating NALI for that particular asset.”
Tony Zhang is a Journalist at 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 2020, Tony has covered various publications across the legal, financial and professional services sectors including Lawyers Weekly, Adviser Innovation, ifa and Accountants Daily.