30/01/2020

Thinking of your SMSF co-owning residential real property with a non-related entity?

Thinking of your SMSF co-owning residential real property as part of your superannuation investment strategy with part of that property being co-owned by an unrelated party?  Important super compliance and contract considerations arise that you’ll need to consider.
 
Bikini Bottom Holdings Pty Ltd is the corporate trustee of the Squidward Superannuation Fund. Ms Squidward, the sole member of the Fund and the sole company secretary/director of the corporate trustee, is looking to buy an apartment in Bikini Bottom as part of her superannuation investment strategy.

The two-bedroom apartment will be jointly owned by Ms Squidward’s life-time friend, Mr Spongebob.

Under their proposed co-ownership agreement, both Ms Squidward and Mr Spongebob will each own a 50% share in the property as tenants in common.

Does this transaction violate the provisions of the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act)? The Australian Taxation Office has greatly emphasised the need for SMSFs to formulate and incorporate a clear and transparent ‘investment strategy’ when acquiring real property.  Generally, this involves the Trustee proving that they have developed a methodology for the purpose of accumulating the Fund’s superannuation benefits.

The issue here is whether Bikini Bottom Holdings Pty Ltd and Mr Spongebob have entered into a valid transaction. Where Bikini Bottom Holdings Pty Ltd is concerned, co-ownership of real property is not prohibited provided that both entities deal ‘at arm’s length’.  

Essentially, the term ‘at arm’s length’ primarily refers to:

1.    the relationship between the two parties (section 70B to 70E of the SIS Act); and

2.    any requirement under the SIS Act relating to limited recourse borrowing arrangements and the giving of security over the property.

Here Ms Squidward (as a member of the Fund) and Mr SpongeBob are not related parties for the purposes of section 70B to 70E. Whilst the term ‘related-party’ is a relatively broad term, it is generally understood as;

•    relatives of each member of the fund (spouse, children, siblings etc.)
•    business partners of each member of the fund
•    any spouse or children of those business partners
•    any company controlled by the member or any of the above associates, or
•    any trust controlled by the member or any of the above associates.

The proposed co-ownership agreement will also have a substantial influence on the transaction and may affect the Fund’s investment strategy in the future. Generally, a co-ownership agreement will state the rights and obligations of each co-owner with regards to the administration of the property. Important provisions may refer to, but are not limited to, the right to sell or force a sale of the property and the right to refuse proposals of sale.

As Ms Squidward’s fund trustee is purchasing the property as part of that fund’s investment strategy, the right to sell (and refusal to sell) are important prerogatives which ought to be formalised in a co-ownership agreement.

Should the Fund need to sell the property in order to make payments to its member, the right to sell and/or the right to refuse sale will be of paramount importance.

In the absence of a co-ownership agreement, the matter is likely to end up in Court, causing excessive financial and emotional distress, not to mention the huge amount of time usually required from the Court system.
 
At Townsends Business & Corporate Lawyers we provide experienced legal advice on compliance with superannuation law. If you’re thinking of purchasing property with a co-owner as part of your SMSF investment structure and would like to have a co-ownership agreement drafted, get in touch with one of our expert lawyers for an outline of how we might assist. 

For further information, please contact Townsends Business & Corporate Lawyers on (02) 8296 6222 or email info@townsendslaw.com.au to see how we can assist.