Trustees should be wary of using ungeared related companies or unit trusts to invest in property development via their SMSF without fully understanding the key conditions, the ATO has said.
In its recent “SMSF Regulator’s Bulletin 2020/1”, the ATO highlighted the many SMSFs using an ungeared related unit trust or company to invest in property development and the lack of understanding among trustees about the conditions that needed to be met in order to benefit from such an arrangement.
“Of particular relevance to property development is the in-house asset exception for investment in ungeared related companies or unit trusts as this is often a popular option for SMSFs undertaking property development investments,” it said.
The regulator noted related companies or unit trusts being used by SMSFs in order to meet the exclusion to being an in-house asset would have to meet a set of conditions both at the time the investment was acquired and for the duration of the time the investment was held.
It listed holding an interest in another entity, including units in another trust, borrowing money and conducting a non-arm’s-length dealing as some of the activities companies or unit trusts would be restricted from in order to meet the necessary conditions.
“If any of these events happen, the investment in the related company or unit trust will no longer meet the exception to being an in-house asset with the result that all investments held by the SMSF in that related company or unit trust, including future investments in it, will be in-house assets,” it warned.
“The asset can never be returned to its former excluded state, even if the trustee fixes the issue that caused the asset to cease meeting the relevant conditions.”
It urged trustees to consider how they would meet and maintain the set conditions when making use of ungeared related companies or unit trusts in order to avoid having to dispose of shares or units held by the fund.
“If the shares or units cease to meet the in-house asset exception, the fund will be required to dispose of the shares or units it holds in excess of the 5 per cent limit within 12 months. In many cases this requires the sale of underlying property or a significant restructure that could be costly to both the development and the SMSF,” it said.
A lack of understanding among trustees about how their ungeared related company or unit trust exception operated could also result in contraventions of the Superannuation Industry (Supervision) Act 1993 and additional costs associated with bringing their SMSF back in line with the in-house asset rules, it added.
Last year, HLB Mann Judd superannuation director Andrew Yee said trustees of SMSFs partaking in property development should proceed with caution.