Contributed by Domenic Festa, Principal, Steps Law
An often asked question by the trustees of self managed superannuation funds (SMSF) is whether they can make investments involving associated or related parties. The answer to the question requires a consideration of two key tests: the in-house asset rules and the sole purpose test in s 62 and 71 of the Superannuation Industry (Supervision) Act 1993.
Refer to CCH Books’ Superannuation and SMSF Collection for more guidance and insights.
Mr Benson was engaged as Victorian State Manager of DomaCom, a promoter and manager of various managed investment schemes established to provide investors with the opportunity to invest in fractional interests in property. He expressed a desire to “test the ability for residential properties held by self-managed superannuation funds be used by related parties”.
The following transactions occurred:
- Mr Benson’s SMSF invested in a DomaCom Fund (DCF), a widely-held unit trust. The investment comprised less than 1% of the units in DCF, and 7.83% of the SMSF’s assets.
- Under the terms of the DCF, the investor could nominate a property to be acquired by the DCF. Mr Benson’s SMSF nominated an apartment in a student accommodation complex in Burwood, Victoria. DCF subsequently acquired the Burwood property.
- Upon acquisition of the Burwood property, a sub-fund was created in the DCF and the SMSF’s investment was converted into units of a class dedicated to that sub-fund. Mr Benson’s SMSF held all of the units in the sub-fund.
- Investors in a sub-fund did not have a direct investment in the underlying property but were entitled to 100% of the net income and proceeds of sale of the underlying property of that sub-fund.
- Exclusive management of the property was granted to Student House in Australia (SHA). The first tenancy of the property (for a period of approximately 12 months) and the second tenancy (for a period of approximately 12 months) were granted by SHA to persons not related to Mr Benson.
- The third tenant of the property was Mr Benson’s daughter at the same rental and on the same terms as that provided to the first two tenants.
- Prior to the acquisition of the Burwood property, the constitution of the DCF was amended to provide that notwithstanding the existence of sub-funds, the DCF was a single trust. However, other trust documents described a sub-fund as a separate trust.
In-house asset rules
The in-house asset rules limit the in-house assets of a superannuation fund to 5% of the market value of the total assets of the superannuation fund. In this case, the investment by the SMSF totalled 7.83% and therefore exceeded the threshold.
The term in-house asset includes an investment in a “related trust”. A key test of a related trust is that a group has a fixed entitlement to more than 50% of the capital or income of the trust. The relevant threshold is exceeded if the relevant trust is the sub-fund, but not if it is the DCF.
The taxpayer contended that the relevant asset is the investment in DCF rather than a sub-fund, and DCF was a widely-held unit trust, and therefore excluded under para (h) of the definition of in-house asset in s 71(1) of the Superannuation Industry (Supervision) Act. A key question was whether the sub-fund was a separate trust.
The basic concept of a trust is a relationship whereby a trustee holds certain property on certain terms, usually set out in a trust deed, for the benefit of one or more beneficiaries. The constitution of DCF specifically provided that each unit confers a beneficial interest in the assets as an entirety and does not confer an interest in a particular asset. It might be contended that the underlying property is not property of the sub-fund, but rather the sub-fund is a means of calculating the entitlements of unit holders — 100% of the net income and net proceeds of sale of a particular property.
The court did not concern itself with these interesting questions because the constitution of DCF provided that investments were in conformity with relevant disclosure documents, and the product disclosure statement described a sub-fund as a separate trust. It therefore concluded the investment by the SMSF was in the sub-fund which was a related trust and not a widely-held unit trust, and the investment was an in-house that breached the 5% threshold. The constitution also contained specific provisions for scheme assets which was against the SMSF’s argument.
Sole purpose test
The sole purpose test requires the trustee of a regulated superannuation fund to maintain the fund solely for one or more core purposes (essentially to provide retirement benefits) and one or more ancillary purposes.
Mr Benson had stated that he wished to test the ability for residential properties held by SMSFs to be used by related parties. Based on that statement, the court concluded the sole purpose was to provide residential accommodation to a related party, despite the market value terms upon which that property was provided.
This conclusion was reached notwithstanding the court referring to principles that an inquiry into purpose is not an inquiry into motive (News Limited v South Sydney District Rugby League Football Club Limited & Ors (2003) 215 CLR 563) and where property is used for a permitted purpose, the purpose test is not breached merely because there is an incidental benefit (Ryde Municipal Council v Macquarie University (1978) 139 CLR 633 per Gibbs ACJ).
The nature of the property is such that the sole purpose test would not be called into question were it not for the rental to a related party. It is therefore the case that the property has been used for a permitted purpose, even though there may be an incidental benefit (the use by Mr Benson’s daughter). It is also questionable whether there can be any benefit where property that is a suitable investment for a superannuation fund is provided at market value on commercial terms.
- A factor that weighs in favour of satisfying the sole purpose test is providing property on arm’s length commercial terms.
- Example 1 — SMSF investing in holiday apartments managed by a property syndicate at which members pay normal market rates when staying at the apartments (not a breach).
- Example 3 — members paying market rates when staying at a beach house to make repairs (not a breach).
- Example 4 — members paying market rates when staying at residential units owned by an SMSF, on a short-term basis as part of work travel (not a breach).
- The sole purpose test requires a holistic assessment of all of the activities of the SMSF. In this context, the ruling refers to the Swiss Chalet case in which all of the assets were assets available for private use — a holiday house, shares in a golf club and a chalet in Switzerland. To the contrary is the circumstances in Aussiegolfa in which the investment in DCF comprised a minority share of 7.83%.
The application of the sole purpose test is particularly relevant for grandfathered trusts that own residential property made available to related parties. Then, does Aussiegolfa represent a change in the ATO view?
The court concluded in Aussiegolfa that the purpose of the SMSF in acquiring units in DCF was to provide housing for Mr Benson’s daughter.
The provision applies where:
- there is an investment by a superannuation fund that is not an in-house asset (this is the case if the investment was in DCF)
- the investment is made as a result of an agreement, arrangement or understanding (there was at least an understanding of providing housing to Mr Benson’s daughter)
- any of the persons involved were aware that a result of carrying out the agreement, arrangement or understanding was that an asset of the fund would be subject to a lease or lease arrangement with a related party (in this case the lease to Mr Benson’s daughter).
Notwithstanding rental of the property to the first two tenants who are unrelated, the court’s conclusion regarding the purpose of the acquisition of units in DCF, in the author’s view, triggers the operation of s 71(2). This aspect was not raised in argument or considered by the court.
Superannuation funds contemplating investments, or the change in use of investments, must obtain advice from appropriate experts in the area. In particular, the application of s 71(2) should always be considered.
The decision in Aussiegolfa may represent a change in the ATO view regarding the application of the sole purpose test (particularly in arrangements that involve market rental of property that is not otherwise caught by the in-house asset rules).
This position will be of particular importance for transactions by grandfathered trusts that are not subject to the in-house asset rules.