As a general principle, SMSFs must make their investments on a commercial, arms length basis.
One of these rules is Section 66 of the Superannuation Industry (Supervision) Act 1993 (SIS Act), which imposes a general prohibition on SMSF Trustees acquiring assets from related parties of the SMSF - including fund members and associates.
A specific exception to this rule applies to assets which meet the definition of Business Real Property (noting there are other exceptions that I will not cover here today) - assets which qualify as Business Real Property (BRP) may be purchased from related parties.
Business Real Property Definition
BRP is property used ‘wholly and exclusively in the running of a business’ and the definition is explained further in ATO ruling SMSFR 2009/1. The definition generally precludes any part of the property being used for any other purpose (such as private dwelling) unless that other use is 'minor, insignificant or trifling'.
It is important to be certain that the asset being acquired meets the definition, as failing to do so will mean it is considered an ‘in-house asset’ which will have detrimental consequences if the 5% in-house asset cap is exceeded.
Common Strategies Utilising BRP Exception
A common and popular strategy for small business owners involves using their SMSF to purchase their business premises (where the premises are BRP) at market value, and for the business to then lease the premises from the SMSF. The SMSF’s acquisition may be funded with cash/contributions, or by entering into a Limited Recourse Borrowing Arrangement (LRBA) to help fund the purchase.
In such an arrangement it is important that the lease is formally documented on arms length terms, with a market rate of rent charged, and that the terms of the lease are complied with on an ongoing basis.
Assuming the acquisition fits in with the investment strategy of the fund, some of the potential benefits of such a structure may include –
- Asset protection – the SMSF environment may help protect the business premises, which are often a significant asset, in the event the business or its owners experience financial difficulties.
- Taxation – earnings on SMSF investments are generally subject to a maximum 15% tax rate (can be lower where fund members are in pension phase). SMSFs are also able to access the CGT discount where an asset is disposed of after being held for a minimum of 12 months. The business can claim a tax deduction for rent paid to the SMSF.
- Capital – by having the SMSF own the property, the business may use its capital to invest in growth and operations instead.
The SIS Act and ATO rules around SMSF investments are complex and the above is only a very general introduction. BLG Business Advisers provide high quality taxation and technical advice in relation to SMSF matters – get in touch with us online or call (02) 4229 2211 today to discuss your circumstances!