The acquisition of residential property from a related party of an SMSF trustee is ordinarily prohibited, even though this may form part of a sound investment strategy for the fund. There are however exceptional circumstances where such a prohibition does not apply.
There is a certain exemption available under s66 of the Superannuation Industry (Supervision) Act 1993 (SIS) to acquire an asset from a related party of a superannuation fund when this is “business real property”. Included in these assets are a residential property of an entity that is in the business of property leasing, and also residential property of an entity that is in the business of property development.
SMSF trustees have considerable freedom when making investment decisions. But they must be prudent, apply the fund’s savings for retirement income purposes, and meet all the associated SIS provisions together with the fund investment strategy.
Under the SIS provisions trustees are prohibited from acquiring assets from a related party of the fund. No specific exemption applies to the acquisition of residential property from a related party by the trustee of a fund, so in the vast majority of cases such an acquisition is prohibited. But in very limited circumstances, as mentioned, it is possible to acquire residential property from a related party.
These circumstances rely on the ruling SMSFR 2009/1. While the ruling provides some level of comfort in respect of the general application of similar strategies, a number of issues probably still need to be covered.
Related party and in-house asset
While the full definition of a related party is more extensive, for these purposes a related party of a superannuation fund is a member of the fund, a standard employer-sponsor of the fund, or an associate of a member.
Any asset acquired from a related party of a fund is deemed to be an “in-house” asset, except in cases where the ATO determines otherwise when it is acquired by an SMSF. Listed securities and business real property (SISA s66), certain related trusts (reg 13.22) or other related party investments (not covered by such exemptions) that represent no more than 5% of the fund assets represent instances of certain related party assets not being considered to be in-house assets.
Business real property
Business real property as it applies to SMSFs is defined in s66 of SIS (scroll down to subsection 5). Business real property assets may be:
- any freehold or leasehold interest of the entity in real property, or
- any interest of the entity in Crown land, other than a leasehold interest, being an interest that is capable of assignment or transfer, or
- if another class of interest in relation to real property is prescribed by the regulations for the purposes of this paragraph, any interest belonging to that class that is held by the entity.
For such assets to be business real property the real property must be used wholly and exclusively in one or more businesses (whether carried on by the entity or not), but does not include any interest held in the capacity of beneficiary of a trust estate.
Two basic conditions must be satisfied for an SMSF to be said to hold business real property:
- the SMSF must hold an eligible interest in the real property (the asset outlined above), and
- the underlying land must satisfy the business use test in the definition, which requires the real property to be “used wholly and exclusively in one or more businesses” carried on by an entity.
Business real property is treated as a concessional asset under SISA because its acquisition at market value by an SMSF trustee or investment manager does not contravene the prohibition on related party asset acquisitions in subsection 66(1).
The “wholly and exclusively” threshold
Any and all uses of the property must be tested against the requirement that the property be used wholly and exclusively in one or more businesses. This requires an assessment of whether the property in its entirety is used in one or more businesses to the exclusion of any other types of use of the property. By its nature the wholly and exclusively threshold is onerous and suggests an entire or complete use of the land for the purposes of one or more businesses. A common sense approach accommodates some departure from a literal application of the test.
On their own, the “wholly” and “exclusively” elements of the test involve similar but not identical requirements. Wholly suggests that the entire area of the property should meet the business use requirement. Exclusively suggests that the property is required to meet the business use requirement to the exclusion of any other uses. As the test requires whole and exclusive use, it is necessary to give both aspects of the test some meaning.
If the property that is the subject of the test is used to an appreciable degree or extent, the fact that a part of the real property is not used at all will not result in failure to meet the “wholly and exclusively” test. In these circumstances, it is necessary to consider whether that part of the real property actually in use is used in one or more businesses to the exclusion of any other uses. A minor, insignificant or trifling non-business use of the property can also be accommodated under the wholly and exclusively threshold.
An SMSF may not acquire an asset from a related party of the fund unless there is a specific exemption to the prohibition. As we’ve seen, under s66 an exemption applies for business real property. Where residential property meets the business use of a related party of the fund to the exclusion of any other use, it may then be possible for the fund to acquire the residential property, but the acquisition is seen to be that of “business real property”.
The following outlines two particular scenarios under which such an outcome might apply. If this is the case then the s66 exemption for business real property applies and the residential property acquisition by the fund would not be in breach of superannuation law.
- Business of renting properties. Residential property used by a related party of the fund in the business of renting properties fall into this category. The residential property/ies are seen to be part of the central or core assets of the business and the business is involved in renting those core assets, namely the residential properties.
- Business of a land developer. The same situation may also apply to residential property that is used in the business of a land developer. In this case each of the properties is viewed as being part of the central or core assets of the business, or part of the trading stock of the land developer. The land developer is a related party of the SMSF.