Bruce Brammall, 10 October, 2018, Eureka Report
SUMMARY: Is the Aussiegolfa decision a small crack in the dam for SMSFs wanting to lease residential properties to related parties?
DIY funds have always operated under a simple rule when it comes to residential property – never, ever, lease it to a related party.
Just steer clear, as it would be a clear breach of the “sole purpose test”. And the consequences are potentially enormous.
But a senior court has now opened to the door, ever so slightly, to allowing super funds to lease properties to related parties.
I must emphasise, EVER SO SLIGHTLY. And don’t try this at home without top-quality legal advice.
In what is becoming known as the Aussiegolfa decision, the full bench of the Federal Court voted that it wasn’t a breach of the sole purpose test, in this instance, where the self-managed super fund leased a property to the daughter of a member of the fund. (And the ATO is yet to decide whether to appeal the ruling.)
The facts of the case were quite a bit different to almost anything that a regular mum and dad SMSF might encounter. And anyone thinking they might look into this … you will need a seriously good SMSF lawyer’s (likely expensive) legal opinion before you do.
In the Aussiegolfa case, the fund had invested in a managed investment scheme (MIS) known as DomaCom. The sole SMSF member was not just an investor in DomaCom, but also the general manager of the Victorian division of the DomaCom business. DomaCom subsequently issued a supplementary product disclosure statement (PDS) in regards to a sub-fund which covered a particular investment in a Burwood property, in which Aussiegolfa was to invest.
The daughter of the member eventually leased the property (but several years after it was purchased. I’ll come back to this.)
There were plenty of legal arguments that I’m not going to cover today, including whether the sub-fund should be regarded as a separate trust for tax purposes.
But let’s start with the “sole purpose test”. This is a rule designed to make sure the SMSF considers first and foremost that the point of all investments made by the SMSF is to provide retirement benefits for the members.
That is, members and their related parties cannot obtain benefits from the SMSF prior to retirement. And if a member of the fund, or their related party, were receiving a benefit, then this would be a breach, which could potentially render the fund non-compliant.
A related party leasing a residential property in this circumstance is generally seen as obtaining a benefit. However, there is no such consideration around commercial properties, where a SMSF can lease the property to a related party business (a business owned by one of the members).
What was one important difference in the Aussiegolfa case was that the investment in the property was made several years prior to the daughter taking up residence.
For the two previous years, the property had been leased to unrelated parties. In the third full year, the property was leased to the daughter, for the same rent as had been received by the unrelated parties previously.
In this instance, therefore, the trustees were able to clearly demonstrate that the decision to invest in the property had not been made so that a related party could rent it from them, because of the time elapsing between the purchase and the daughter starting to pay rent.
It was argued, therefore, that it had not influenced their decision to invest in the property. Further, because it was a sum paid by previous tenants, the rent received was considered to be “arm’s length”.
In the case, it was also considered to have helped that the property was leased by an unrelated third party without any direct involvement by members of the fund. The court took the view that given those circumstances, it was irrelevant who the tenant was.
It’s important to understand that the Australian Taxation Office has yet to decide whether to appeal the case. ATO deputy commissioner James O’Halloran said it was still considering its formal position.
What is still certainly clear?
The ATO won’t be fans of this decision. They have always stated that residential properties cannot be leased to related parties by SMSFs. Simply, they don’t trust members to do it in a way that wouldn’t lead to the fund being either advantaged, or disadvantaged.
A SMSF could, obviously, be disadvantaged if too little rent was paid by the tenant. A relative could be living there for a discounted rent or free, or even one of the the members themselves could be the tenant.
It could be advantaged if too much rent was paid. For instance, it could be a way of getting around the contribution rules. If a related party tenant was paying $500 a week instead of the market rate of $300 a week, then an extra $10,400 is being paid into the fund, which would certainly be advantageous to the fund if the member was already maximising their contributions, either concessional, or non-concessional.
Under this circumstance, you could hand your daughter an extra couple of hundred dollars a week in cash to pay the overs on rent, as a backdoor way of getting money into the fund.
Even if this case potentially represents a small watering down of the rules in regards to leasing a residential property to a related party, don’t for a second think the rules are being generally relaxed. They’re not. This is a very specific set of, somewhat unusual, circumstances.
So, don’t buy a home or holiday home in your SMSF and try to use it yourself, even if you don’t start to use it for years after the purchase. That would be, under current interpretations, even after this ruling, still likely to be a clear breach of the sole purpose test. Don’t let a related party or family member stay in it. Ever.
Don’t buy a property in an area that you think your kids might be going to university in the next few years. And even if you guess where your kids are likely to go to uni correctly, the Aussiegolfa case didn’t necessarily open the doors here.
Stick to properties that are chosen purely for their investment potential.
The Aussiegolfa decision might end up being a crack in the dam for SMSFs and residential property and leasing to related parties.
But, until further rulings are made, or the ATO decides to open the doors themselves, I wouldn’t be putting my super fund forward to be a test case by leasing anything to a related party.
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.
Bruce Brammall is managing director of Bruce Brammall Financial and is both a licensed financial adviser and mortgage broker. E: firstname.lastname@example.org . Bruce’s sixth book, Mortgages Made Easy, is available now.