SMSFs considering real estate developments using a 13.22c unit trust arrangement should seek ATO input first after a recent legal case strengthened the view these types of activities were deemed as carrying on a business, an SMSF legal expert has warned.
DBA Lawyers special counsel Bryce Figot said a recent appeal to the Administrative Appeals Tribunal (AAT) against an ATO decision, McCarthy and FCT [2021], ruled the regulator was correct in its view that a real estate development could be considered as carrying on a business.
Figot said this case was an important ruling as SMSFs are able to engage in real estate developments, but do not always have sufficient funds and use 13.22c unit trusts to access funds from related parties.
“The classic strategy for an SMSF is to put money into the 13.22c unit trust and the family trust does the same and that makes it a related trust and also an in-house asset,” he said during a webinar late last week.
“In order for an investment in a unit trust to be exempted from being an in-house asset, the unit trust can’t borrow, put charges over assets, conduct non-arm’s-length transactions, acquire assets from related parties or conduct a business.
“The question then is: ‘When is a real estate development a business?’ and, in my experience, people are overly optimistic as to what constitutes a business.”
He pointed to the AAT decision, which concerned a couple who purchased a residential property from an unrelated party, demolished the premises on that property, subdivided the land and then sold the two vacant lots for a profit in the space of 18 months, and noted the decisions of the ATO and AAT.
“The ATO said the conduct was a business and it went to the AAT who also said it was a business. It was not an SMSF case, but the only real difference was that it involved borrowings. Would the outcome have been different if McCathy had not borrowed?” he said.
“It is hard to say with certainty, but I have real concerns if that sort of arrangement constitutes a business and it should create reservations for those using a regulation 13.22C unit trust to pool money with a related party for real estate development.”
He said the ATO had already expressed concerns about real estate development in 13.22 unit trusts in SMSF Regulators Bulletin 2020/1 and SMSFs should test the waters with the regulator before using those vehicles.
“My practical tip is before using one of these unit trusts for real estate development, strongly consider prospective ATO input. Look at the McCarthy decision and then get a long shopping list of reasons why what you will be doing will be different to what McCarthy did,” he said.
