Choosing an investment structure to meet the in-house asset rule
An SMSF investing with a related party must be careful not to breach the in-house asset rule.
Donald and Melania are members of the Trumpet Super Fund and directors of the corporate trustee, D & M Pty Ltd. Their son Louis runs a building business and is a sole director and sole shareholder of LT Builders Pty Ltd. They are considering a property development as a joint venture whereby the super fund provides the capital and LT Builders Pty Ltd provides its expertise in actually carrying out the building. They enter into a joint venture agreement and acquire vacant land in the name of the super fund trustee and the building company as tenants in common. Does this arrangement breach the in-house asset rule?
It not uncommon for SMSF trustees to team up with related parties for an investment. Whether it is a property development project or other types of investment, the main compliance hurdle for SMSFs when related parties are involved is the in-house asset (‘IHA’) rules.
In simple terms, the IHA rules require trustees to ensure that the fund does not have more than 5% of its investment in in-house assets. Broadly, this can be categorised into two:
(1) ‘prohibition on acquisition’ of new IHAs if the level of IHA is over 5% prior to acquisition or will be over 5% after the acquisition; and
(2) ‘requirement to dispose’ of sufficient IHAs if the level is exceeded.
In keeping the level of IHA under the 5% limit, it is important to consider whether your proposed structure will give rise to IHAs. To demonstrate the importance of choosing and properly setting up the right structure from a superannuation law compliance perspective, we will compare the different IHA implications a joint venture structure and partnership structure would have in a property development project of an SMSF and its related parties.
A joint venture has no uniform legal meaning under the superannuation law and generally refers to a commercial arrangement between two or more individuals or entities for the purpose of undertaking a particular business.
On the other hand, the Superannuation Industry (Supervision) Act 1993 has adopted the tax law definition of partnership for IHA purposes which is broader than the general law definition of a partnership. This broader definition includes arrangements whereby two or more individuals or entities are simply in receipt of income jointly.
LT Builders Pty Ltd is a related party of the Trumpet Super Fund (a company that is sufficiently influenced by the members’ son). However the property owned by the SMSF with its related party as tenants in common is not an IHA due to s71(1)(i) of the SIS Act which excludes such property from the definition of that term.
Further, the joint venture is a commercial arrangement between parties and is not by itself a related party of the fund if it is properly set up with necessary features of a joint venture. With this structure, the SMSF would not have an investment ‘in’ a related party and accordingly does not acquire any IHAs by the project.
If however the arrangement is not properly set up as a joint venture and the SMSF and LT Builders Pty Ltd receive income jointly, the arrangement will be deemed as a partnership under the superannuation law for IHA purposes.
Being properly set up means that the agreement between the parties (and all the documents they issue to or enter with third parties) make clear that neither party is liable for any defaults or wrongful acts of the other and each is only entitled to a half share of any profit from the enterprise.
In contrast to a joint venture, a partnership would itself be a related party of the fund and the SMFS’s investment in the partnership would be an in-house asset of the fund, being an investment ‘in’ a related party.
The issues discussed above are not exhaustive and the issues surrounding whether an investment structure is a joint venture or a partnership for IHA purposes are not only complex but are also the subject of some legal uncertainty.
The above is a simplified and general example to highlight the potential IHA implications of different investment structures and a trustee considering a joint investment with related parties should obtain appropriate advice to ensure compliance.
For further information, please contact Townsends Business & Corporate Lawyers on (02) 8296 6222 or email firstname.lastname@example.org should you require legal advice in relation to your proposed SMSF investment.