SMSFs undertaking property acquisitions or developments that require the trustees to provide a guarantee may find they have breached the non-arm’s-length income (NALI) provisions by doing so, a specialist superannuation lawyer has warned.
DBA Lawyers director Dan Butler said guarantees were commonplace in dealings involving a company, such as a corporate trustee for an SMSF, but these were not often identified as a potential NALI issue when the super fund bought or developed real estate.
“Most contractual dealings involving a company require a guarantee and, generally, a lawyer would be negligent if they did not insist on a guarantee when dealing with a company because they might hide behind limited liability, so guarantees are very popular,” Butler said in a recent webinar.
“When you buy real estate with a corporate SMSF trustee, you have to provide a guarantee.
“Will that give rise to NALI because the directors are not compensated for the risk they’re taking on because now they’re personally liable under that transaction?
“What about director guarantees in relation to property development?”
He pointed out the ATO had addressed this issue in SMSF Regulator’s Bulletin 2020/1 where it gave an example of two SMSFs that engage in a 50/50 joint venture company to develop property and where each fund acquires $200,000 of shares in the joint venture company for a total equity of $400,000.
The company seeks a bank loan of $4 million, which requires the directors to provide personal guarantees, and it also borrows $3 million from related parties.
“The development proves successful and in two years pays fully franked dividends and the ATO says there is NALI because, but for the guarantees, you would not get the loan, and but for those guarantees you would not make that money, therefore it’s all NALI,” Butler noted.
“So watch out for guarantees because they are on the ATO’s watch list and property development is on the ATO’s watch list.
“Watch out also if you’re doing a property development in a super fund and be very careful if that development is being done under a unit trust or a company under that fund.”
