Does a joint venture pass the sole purpose test?
In the last part of our feature series on property development, we discuss related-party joint ventures and the difficulty of meeting the sole purpose test.
The overriding requirement of s62 SIS for SMSF trustees is to ensure that the sole purpose of the fund is to provide retirement benefits for members and their beneficiaries. Ensuring that joint venture arrangements pass the sole purpose test can be difficult, especially where related parties are involved.
A joint venture is “an association of persons for particular trading, commercial, mining or other financial undertakings or endeavours with a view to mutual profit”. The most common way for a joint venture to be carried out is through a company, partnership, trust or another arrangement.
Care must be taken by all those involved to ensure that property development via a joint venture is a real joint venture.
The most critical aspect of a joint venture is that fund members (or their relatives) do not receive a benefit by way of investment in the joint venture that would not have been possible but for the monies provided by the superannuation fund.
Where the fund receives excessive income compared to their investment or input into the arrangement, there are concerns that the revenue could be classified as non-arm’s length income (NALI).
Related-party joint ventures
In 2009, the ATO issued SMSFR 2009/4 affirming that a joint venture involving related parties is an “in-house asset” under section 71 SIS. Additionally, TA 2009/16 also confirmed this type of investment as an “in-house asset”.
It is essential, therefore, that the fund holds a proprietary interest in the real property being developed, with the ATO comfortable that the SMSFs investment is “in” that property and not an investment “in” the related party.
As a result, if the ATO questioned a fund’s investment in a joint venture, the trustees must be able to demonstrate the investment is not an “in-house asset”.
Where the fund provides capital for the joint venture and has no other rights other than receiving a return on the final investment, the ATO has flagged this may be an in-house asset depending on the terms of the joint venture agreement.
Is it financial assistance?
SMSF trustees cannot provide financial assistance to members or relatives using the resources of the fund (section 65).
The ATO has stated that the following circumstances would cause them concern:
- The SMSF becomes an investor in the property development being carried out by the related entity because there would be insufficient funds to complete the property development otherwise.
- Engaging a related party to provide services as a means of ensuring employment or where their remuneration is more than market value.
- Using SMSF funds to finance elements of the property development on non-arm’s length terms, or in situations where the SMSF receives little or no consideration.
Sole purpose test and record keeping
While property development is complex and involved, the fund needs to keep the necessary records to ensure compliance with SIS and not give rise to NALI.
Careful documentation should be established and maintained to ensure there is proof of arm’s-length dealings. A solid paper trail will show that there is no unintentional acquisition of assets from a related party and that the correct entity is paying for the proper expense.
Most importantly, the trustees must be able to demonstrate that their decision-making in respect of the property development is solely pursuing the retirement purpose of the SMSF.
Where outside influences affect the trustee’s decision, such as ceasing paying a pension to make a cash injection into a struggling property development venture, a contravention of the sole purpose test may occur.
SMSF trustees are required to take into account the various investment restrictions imposed by the SIS legislation.
Entering into a joint venture for property development purposes is no different, primarily where transactions between related parties may provide a benefit to a member or related party.
Remember, too, that the SMSF is not there to ensure the success of a property development joint venture at its peril. The antidote is excellent record-keeping skills, attention to detail, and carefully documenting all arm’s-length property development transactions so that the joint venture passes the sole purpose test.
Shelley Banton, head of education, ASF Audits