Property development via an SMSF can be a viable strategy if done properly. Complexities can arise, which need to be thought out properly at the outset so not only is the development compliant with the underlying rules and regulations, but that there are no nasty or expensive surprises down the track. How a property development is structured and the level of an SMSF’s involvement is a case-by-case scenario. One such structure, however, is via a joint venture agreement.
A situation may occur where an SMSF owns a block of land, but does not have the funding to develop it. Under a joint venture agreement entered into between an SMSF and a related party, the SMSF owns the land and the related party would fund the completion of the development. On completion of the development, each party would share the output based on their proportionate interest in the joint venture. An arm’s-length third-party agreement would be entered into with a builder.
The main advantage of this structure is that the SMSF can use equity outside of the fund so as to leverage the potential return to the fund. It is important at all times that all transactions satisfy the arm’s-length test and the agreement is entered into in such a way that it does not breach the in-house asset rules under section 71 of the Superannuation Industry (Supervision) (SIS) Act.
Each party to the agreement would have a defined interest in the output and as such represents a tenants-in-common interest in the investment. Under subsection 71(1)(i) of the SIS Act, an exception to the in-house asset rule is “property owned by the superannuation fund and a related party as tenants in common”.
It is critical the joint venture agreement is structured properly so section 71 of the SIS Act is not breached. The Australian Taxation Office’s (ATO) Taxpayer Alert (TA) 2009/16 describes an arrangement where a joint venture agreement was established between an SMSF and related trust.
In this arrangement, the SMSF contributed capital to the trust for the acquisition of an asset by the trust. The trust used the funds from the SMSF as well as borrowed amounts to purchase and develop the asset. Any income or benefit received from the investment was split proportionately between the SMSF and the trust, based on the capital invested. All expenses were met by the trust. The ATO stated this arrangement may not only breach the in-house asset rules, as it was regarded as an investment in a related trust, but the arrangement was at risk of subjecting the SMSF to other legislative breaches.
Another important point to consider is that the related party may borrow to acquire its interest in the joint venture, but it is not recommended to use its proportionate interest as security for any funding. This point was covered in the June 2011 National Tax Liaison Group superannuation technical minutes. The ATO was inconclusive on whether the SMSF was charging its assets under regulation 13.14 of the SIS Regulations, however, it did feel it could raise other SIS-related issues, such as the provision of current-day benefits to the members, potential provision of financial assistance and leaving open the possibility that the SMSF’s share of any sale proceeds could be used to meet the liability of a mortgagee or charge in relation to another co-owner’s interest.
GST Ruling 2004/2 and the subsequent addendum 2004/2A set out the ATO’s view on the differences between a joint venture versus a partnership for GST purposes. This is important because a partnership finding may invite a characterisation of the development as an in-house asset.
To ensure a joint venture arrangement, the ATO considers the following factors:
Whether each participant receives an agreed share of the product or output to its own account, rather than a share of jointly earned profit.
The documentation provided by way of evidence of a contractual agreement: evidence of a written agreement establishing the operation, management and joint control of the specified project, as well as disclaimers by the participants that each is liable for its own debts that are incurred individually as principals.
Demonstration of objective joint control.The joint venture agreement should specify the nature and extent of the joint control. Responsibility for the day-to-day management of the venture may rest with a manager/operator appointed by the participants. The manager/operator may be one of the participants, or a management company formed by the participants, or a third party.
It is also critical the investment by the SMSF in the joint venture agreement is allowable under the governing rules, satisfies the sole purpose test, and is in line with the investment strategy of the fund.
Julie Dolan is principal of SMSF Consulting.
