Saturday morning: your clients James and Marie, armed with some awareness of SMSFs, attend an auction. They are convinced the property will make a perfect investment for that SMSF they keep meaning to set up. They make the winning bid. They then sign the contract and hand over a personal cheque for the deposit. On Monday morning, James and Marie call you requesting that an SMSF be set up straightaway.
The big issue
Unfortunately for James and Marie, there are some major issues with their ‘I’m sure it will all be fine’ approach to SMSF property investing. James and Marie’s first and most pressing problem is that under general law it is not possible for an asset to be acquired by an entity that does not exist yet.
Therefore, as James and Marie hadn’t already set up their fund, they will be treated as the legal purchasers in their personal capacity and will be liable for completing the transaction and paying any transaction costs, including stamp duty. If James and Marie were then able to negotiate with the vendor to amend the sale contract to name the corporate trustee of their SMSF as the purchaser of the property, they will then have entered into a sub-sale arrangement. In this case, James and Marie would incur ad valorem stamp duty on the original sale arrangement and the corporate trustee of their fund would also incur ad valorem stamp duty on the second arrangement to transfer the property into the fund. As a result, depending on which state or territory the property is located and any stamp duty concessions available, James and Marie may effectively incur double stamp duty.
Other potential issues
Were James and Marie to proceed with this course of action they would also be faced with a number of other issues.
Prohibition on acquiring assets from related parties
If James and Marie were to change the name of the purchaser to their corporate trustee of their SMSF, it could be argued that unless the property was a Business Real Property (BRP) they will have breached the prohibition on trustees acquiring an asset from a related party, as the corporate trustee will have acquired the property from themselves.
Where the property was a BRP, James and Marie would also need to consider what they would want to happen with the deposit. In this case, they could either treat the deposit as a contribution to the fund or arrange for the fund to reimburse the deposit back to them. However, a reimbursement may take some time depending on how long it takes to set up the fund and then transfer monies via rollovers – which may cause problems with the requirement that a reimbursement be paid immediately to avoid it being treated as a borrowing by the fund.
The potential solution
To resolve their double stamp duty issue James and Marie could consider rescinding or annulling the original contract and then entering into a new contract naming the corporate trustee as the purchaser once the fund was properly established. While in this case stamp duty would still generally apply to the rescinded contract, concessions may apply to exempt it from stamp duty in certain situations.
For example, in NSW a contract for the transfer of dutiable property that is subsequently annulled or rescinded will be exempt from stamp duty (or eligible for a refund) where the purchaser under the original contract and the purchaser under the new contract are related parties. In this case, a related party of a person includes a trustee of a trust (other than a public unit trust) of which the person is a beneficiary. Therefore, assuming NSW rules, if James and Marie were able to rescind the original contract and then enter into a new contract with the corporate trustee of their fund as the purchaser, ad valorem stamp duty would generally only apply to the new contract and not the original contract – avoiding double stamp duty.
Annulling the contract would also avoid any problems around the acquisition of assets from related party rules as it would involve the fund acquiring the asset from the unrelated vendor. However, the deposit would likely need to be refunded by the vendor and then paid by the fund. In this case, consideration will need to be given to the timing of the arrangement to ensure the fund will have the necessary cash at the bank to fund the deposit. Finally, it is important to note that any arrangement to annul or rescind a contract will require the consent of the vendor, who may not agree. Alternatively, where the vendor did consent, James and Marie would also need to consider the risk that the vendor could then put the property back to market or try and negotiate for a higher sale price. Given the complex stamp duty rules that apply in the different states and territories and all the additional issues that will need to be considered and negotiated, it will be essential that a client seek specialist legal advice before entering into any such arrangement.
The ‘long shot’ solution
An alternative solution could be for James and Marie to complete the purchase as per normal and to then take the view that they had already established the required SMSF trust arrangement at the time of the auction as: they had previously verbally expressed their intention to establish an SMSF and appoint themselves as trustee, and they were acting as individual trustees at the auction, and they made the initial contribution to establish the trust by paying the deposit.
The benefit of this is that James and Marie will not have entered into a sub-sale arrangement and therefore they will avoid having to pay double stamp duty. While it may be technically possible to create an SMSF by verbal declaration under general law, clients generally don’t wake up on Saturday mornings intending to do so. It is also highly likely that such an approach would not be viewed positively by the relevant state revenue authorities and could also cause issues with the fund’s auditor and the ATO. In addition, such an arrangement would likely set the fund up for legal problems should there ever be a dispute in relation to the fund’s establishment or governing rules in the future.
By Craig Day, executive manager, technical services, Colonial First State