A number of recent specific advice rulings from the ATO show the fine line in determining whether an apartment in a resort complex will be considered business real property for the purposes of the Superannuation Industry (Supervision) Act and regulations.
In the first case, SMSF members – let’s call it the My Retirement SMSF – bought an apartment in a resort complex. The intention was to transfer the apartment to the SMSF once it had sufficient assets and cash flow to buy the property.
The arrangement under which the property was purchased was as follows.
Prior to purchase, the property was managed by the resort operator to provide short-term accommodation for “leisure, conferences and similar functions”. The facilities in the resort included a conference room, swimming pool, spa and restaurant. The apartment acquired by the fund members in their personal capacity was subject to a five-year lease with a five-year extension between the vendor and operator. After the acquisition of the property by the fund members, the lease would continue. Under the lease arrangement the operator would grant the use of the apartment to guests for short-term stays of up to three months.
There are no restrictions on the sale of the property but it is on the condition that the property remains subject to the lease. The terms of the lease do not give the owner the right to occupy the property in any circumstances.
The contention put to the ATO was that the property constituted business real property in view of paragraph 194 of SMSFR 2009/1 and example 19 of that ruling. The strata title and the lease arrangement were considered to constitute business real property as the apartment was used in the hotel business of another entity. The circumstances of example 19 were similar to this case, if not identical, as the operator had been given exclusive rights to manage the property subject to the terms of the lease. In other words the business use test was satisfied.
The ATO accepted the argument that the arrangement fell within example 19 of SMSFR 2009/1 as the apartment owned by the members was used wholly and exclusively in the resort accommodation management business of the operator as lessee. It therefore met the business use test and it was possible for the SMSF to acquire the property providing there was no change in the arrangement with the operator.
In the second case – let’s call it the Retire Now SMSF – the circumstances appeared similar. But in this case the property did not fit the definition of business real property. Why?
The facts broadly were that an SMSF bought a strata title unit that was in a beach resort complex. The unit provides accommodation for short-term tenants for up to three months. The resort complex includes restaurants, shops, professional offices, conference and wedding facilities as well as the accommodation.
The manager of the complex has an agreement with the body corporate of the complex to carry out a letting business from the resort and undertake caretaking duties. The terms of the letting agreement refer to the manager as the “agent” to attend to the letting of the strata title on the terms set out in the agreement. The agent is appointed as the sole and exclusive agent to let the property.
Under the agreement the owner is able to occupy the property on giving notice in writing to the agent. The agreement is able to be terminated within the time indicated in the management agreement.
The argument put to the ATO was that the property was business property because it was being used in the business run by the manager. That is, it was argued that the business use test was being met in relation to the property as the rights to use being granted to the manager involved in the carrying on of a business.
The ATO’s response was that the property did not qualify as business real property as defined in section 66 of the SIS Act as the fund was merely renting the property, albeit on a short-term basis. It did not meet the business activity test unless that activity formed part of a property investment business being carried on by the fund.
In support, the commissioner referred to paragraphs 193 and 194 of SMSFR 2009/1, which distinguish arrangements where short-term accommodation arrangements constitute business real property and those that don’t. In this case the Commissioner considered the fund did not appear to be in the business of property investment as the apartment was not being used wholly and exclusively in the business of the fund. In relation to the manager, the commissioner considered it to be acting as agent of the fund to provide services as a letting agent and management services to the apartment to enable the owner to grant rights to occupy it to holidaymakers.
In coming to the conclusion that the property was not business real property as defined, the letting agreement provided that the manager had been engaged by the fund as letting agent, and the right to grant a licence to occupy the property was that of the fund that did not carry on the business of property investment. Under the terms of the letting agreement the commissioner considered the manager was either an agent for the SMSF or could hold a licence to use the apartment in its business and assigned the benefit of the licence to each person occupying the property short term.
What are the lessons to be learnt from these two cases?
The first is that a thorough examination needs to be made of every arrangement where real estate owned by the fund or related party is being considered for SIS Act purposes. Also, the form and substance of that agreement may be considered by the ATO as satisfying the business use test whereas in relatively similar circumstances no business use test may be met.
In the first case the property purchased by the members in their own name was for its exclusive use of the property with no opportunity for the owners to use the property. A number of conditions applied to the acquisition of the property. The property formed an integral part of the manager’s business.
In the second case the property was acquired by the fund from an arm’s length party. However, the arrangement for the manager to lease the property for short periods was in the position as a letting agent or, if that was not the case, the arrangement was a licence granted to tenants for the use of the property.
These cases show the importance of considering the details of each arrangement and the relationship that is created between the owners of the property and the property manager to conclusively establish the property constitutes business real property or otherwise, depending on the context in which the acquisition is to be made.