Disposing of in-house assets when the 5% limit is exceeded
The SMSF Association has received numerous member inquiries in relation to the proper treatment of in-house assets – specifically what happens if a fund exceeds the permitted five per cent in-house asset level at the end of an income year.
Of relevance to this particular issue is that where a fund’s in-house asset level exceeds five per cent, on 30 June of a particular financial year, superannuation legislation broadly requires the fund trustee(s) to:
- Prepare a written “plan” before the end of the following financial year.
- Ensure that the “plan” is carried out.
Section 82(4) of the SIS Act stipulates that the “plan” must set out the steps the trustee proposes to take to ensure that [Emphasis added]:
(a) One or more of the fund’s in-house assets held at the end of that year of income are disposed of during the following year of income; and
(b) The value of the assets so disposed of is equal to or more than the excess amount.
On the surface, this might appear relatively clear. However, the question that has arisen revolves around the way in which an asset may be disposed of to meet this requirement.
To better highlight the issue, let’s consider an SMSF whose only assets are listed shares, some cash, and a residential property that is being leased to a related party (say to the nephew of a fund member).
Based on the facts provided, there could be no argument that this would result in the property being treated as an in-house asset of the fund. That is, the property is “an asset of the fund subject to a lease or lease arrangement between a trustee of the fund and a related party of the fund” (Section 71(1) SIS Act).
In such a scenario, the value of the property would likely represent more than five per cent of the fund’s value. As a result, the fund will have exceeded the permitted 5 per cent in-house asset limit (at 30 June of the relevant income year).
With the property being the fund’s only in-house asset, this invokes the need for the fund trustee(s) to prepare and subsequently carry out a plan to dispose of that asset as outlined above.
But what does it mean to dispose of the offending in-house asset? And will the simple termination of the lease (or lease arrangement) satisfy this requirement?
Interestingly enough, this very question was put to the ATO in July 2012 via the former NTLG Superannuation Technical Sub-group. The ATO’s response provided at the time appears consistent with the provisions of the SIS Act and clearly stated that [Emphasis added]:
“As it is the residential property [sic] the subject of the lease to the related party of the fund, rather than that lease, that is an in-house asset, the ATO considers that the cessation of a lease of an asset to a related party of the fund does not result in the in-house asset (the residential property) being ‘disposed of’ for the purposes of section 82 of the SISA. The residential property remains an asset of the fund after the cessation of that lease.
Accordingly, cessation of the lease to the related party of the fund would not satisfy the requirements of section 82, notwithstanding that it might reduce the market value ratio of the fund’s in-house assets to below the 5% limit. As a consequence, the scenario raised in this question could also lead to a contravention of section 82 and consequently another contravention of the civil penalty provision in section 84 of the SISA.”
So, where an SMSF exceeds the permitted five per cent in-house asset level on 30 June of a financial year, and the only in-house asset of the fund is a property that is the subject of a lease (or lease arrangement) between the fund trustee(s) and a related party, to meet the requirements of section 82 of the SIS Act a fund trustee will need to dispose of that property – in accordance with the plan that it has devised.
Merely bringing the lease (or lease arrangement) to an end will not satisfy this requirement and may lead to the fund trustee(s) facing further penalties.
Of course, in practice, fund trustees have the option of engaging early with the ATO through the voluntary disclosure process to explore potential alternate rectification plans – which may even include the trustee(s) proposing an enforceable undertaking.
However, while early engagement with the ATO ahead of an ACR being lodged is encouraged in these cases, there are no guarantees as to the final outcome – with the Commissioner having to consider all the facts specific to each case.
In the meantime, the SMSF Association will continue to work alongside the ATO with a view to additional guidance being made available in due course.
