Sharif Eldebs, Senior Manager - SMSF Audit and Andy Briggs, Principal - Tax Consulting

Since 2007 it has been possible for self managed superannuation fund (SMSF) Trustees to borrow funds to acquire property, but is it possible to develop property owned by a SMSF?

The major appeal of having a SMSF comes from the investment choice and flexibility granted to the Trustee combined with taxation benefits - and one of the most popular investment choices over the years for many Australians has been, and remains, property.

So it is no surprise that this asset class has been a favourite investment of SMSF Trustees. Finding a property and enhancing the value is often the name of the game.

However, SMSF's are subject to tight regulation. Here we ask two of our experts for their opinions on property development within a fund.

Andy Briggs is a Principal in our Taxation Consulting Division and Sharif Eldebs is a Senior Manager in our Self Managed Superannuation Fund Audit Team.

We posed the question and asked our experts to highlight not only the opportunity and practicalities, but what we should look out for as well.

AB: As we all know, when a SMSF is in accumulation phase the Trustees pay tax at 15% on income and 10% on capital gains when the asset has been held for more than
12 months.

When the SMSF is in pension phase, the Trustees pay no tax at all. As a Trustee is almost always also a member, they have a vested interest in the investment doing well and the taxation benefits can be compelling when they compare the tax rates that might be suffered on profits and income from the same investment outside of super i.e. up to 46.5%. It is clear why investing in property is a popular choice for SMSF Trustees who are looking to build capital that will one day pay retirement benefits to the members.

SE: Whilst what you say is true, as a guiding principle, a Trustee must always remember that the primary purpose of an SMSF is to provide retirement and/or death benefits for the members when making an investment decision.

A Trustee must be able to demonstrate that they have met this principle through not only their actions but by developing and adhering to a well considered investment strategy that is set out in writing in the funds trust deed.

As part of my role as an independent auditor of many funds, I see numerous examples each year of Trustee breaches. The majority of these arise because the Trustees fail to take appropriate advice when embarking on their chosen investment strategies or the implementation is flawed. These can have a serious impact on the financial viability of the fund particularly if the ATO decide that penalties should be applied.

AB: The key issue for most Trustees and their advisers is the interaction of superannuation laws, income tax principles and indirect taxes such as GST. When you consider a property development project many issues need to be considered but one
of the most fundamental is whether the project will be a one off transaction or part of an ongoing business strategy.

SE: That's right, the ATO have recently clarified that running a property development business in a SMSF is not prohibited. However, if a business is run by the Trustees then it is their view that it will cause a breach of some of the key superannuation principles.

AB: So it is crucial for the Trustee to have a clear understanding of what they want to
achieve from the project and to correctly structure the property development activity from the start. Then be prepared to revisit the fundamentals of the project for as long as it lasts to ensure that it is still complying with the SMSFs mandate.

With this in mind, it is possible therefore to successfully carry out a property development project. It is the aims of the SMSF Trustees and any related parties that will determine how the project should be structured within the boundaries of the legislation.

Four common forms I've seen with clients include:

Using capital already in the SMSF

This is by far the simplest way from a structuring perspective to run a one-off property development project and one with the lowest risk.

Developing property through a "related" trust

When an SMSF does not have sufficient funds to carry out a property development project then we sometimes see a member effectively entering into a joint venture with the SMSF through a trust arrangement.

This broadly involves the SMSF Trustee and the member injecting monies into the trust to carry out the project. The key factor here is that the property cannot be used as security for any borrowings. The percentage ownership of the project by the SMSF will be subject to concessional rates of tax.

Developing through a unit trust structure

This usually involves a number of parties coming together to enter into a property development project. It is usual that SMSF's would be less than 20% of the total unit holders but certainly less than 50% because of various taxation rules.

However, the unit trust can use the property as security for borrowings to fund part of the project.

Developing through a joint venture arrangement

This is the most complex type of arrangement but one that can be very efficient from a taxation perspective. This broadly involves a SMSF acquiring property and then entering into an agreement with a related party to develop the property on the SMSF's behalf.

The related party would be paid a fee for funding and carrying out the development project and a commercially appropriate proportion of the profit is "sheltered" in the SMSF.

SE: Given the complexities of investing through a SMSF, it is important that
Trustees take advice from experts who have knowledge of all of these issues or
from a firm that has access to specialists who can work as a team to provide comprehensive advice as we do at WHK.

Financial Planning Pty Ltd ABN 51 060 092 631 (WHKFP). This is an information service only and is not financial advice. WHK and WHKFP do not provide any warranty regarding the accuracy and completeness of information in this newsletter. All material contained in this newsletter is based on opinions, conclusions and forecasts that are reasonably held at the time this newsletter was compiled. WHK and WHKFP assume no obligation to update the material to reflect any changes.

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