Once again, the ATO has targeted SMSF property development schemes that divert profits of a property development project to an SMSF. This time, the focus is on using a special purpose vehicle (“SPV”) which the SMSF directly or indirectly owns.
It appears that some SMSF trustees may not have learned much over the last three years.
The ATO concerns were first evident in SMSFRB 2020/1, which identified schemes and arrangements entered into by an SMSF, which can be with a related or unrelated party involved with purchasing and developing property to sell or lease.
The problem is the structure of those arrangements, which diverts income into super, creating potential breaches of the sole purpose test and other SIS issues.
SMSFRB 2020/1 specifically discussed related and unrelated party property development arrangements such as joint ventures (“JVs”), partnerships and ungeared related entities and the various aspects of the SIS rules that apply to them.
It identified these structures in detail, how they can fail and whether they lead to the investment ending up as an in-house asset. One of the simplest ways this can happen is when an ungeared related entity runs a property development business not permitted under r13.22D SISR, causing the in-house asset exception to cease under r13.22C SISR.
SMSFRB 2020/1 also clarified that the non-arm’s length aspects of these arrangements could lead to NALI, with particular emphasis on JVs and whether or not the fund is providing financial assistance to a related party.
Interestingly, these issues also form the cornerstone of TA 2023/2, the ATO’s recent release on property development schemes, indicating that the ATO is much less tolerant of the new arrangements it is now seeing.
How Does TA 2023/2 Differ?
The issue is that SMSF trustees have taken the parameters contained in SMSFRB 2020/1 to heart and have developed new arrangements outside the scope of that bulletin.
The ATO has responded by setting an extremely high bar for these property development schemes in TA 2023/2.
The immediate difference is that the ATO does not mention a specific entity or structure in the Alert. It just refers to an SPV.
The focus is now on a “controlling mind”, which makes the decisions for one or more property development groups by selecting the project and establishing an SPV.
What Is A “Controlling Mind”?
While there is no explicit definition of a controlling mind in the Alert or SIS, a controlling mind is typically the members of their respective SMSFs.
It means that the definition of a related party or a Part 8 Associate is no longer the rigid criteria for identifying potential compliance breaches.
The ATO has omitted the related party rules in this Alert and defined the controlling mind with a broader application.
Where the controlling mind is the members of their SMSFs, the SPV contracts with related entities owned by the controlling minds.
TA 2023/1 Casts a Wider Net
The ATO is no longer prescriptive about arrangements that can potentially fail with property development.
TA 2023/1 casts a much wider net to ensure trustees cannot circumvent the rules and try to get more money into an SMSF.
The ATO wants all property development arrangements to comply with the strict letter of the tax and SIS laws, which is not unfair considering that income is being diverted from a fully-taxed environment to a concessionally-taxed SMSF environment.
The Commissioner can also make a determination under Part IVA regarding an imputation or tax benefit from this type of arrangement.
So the ATO is focusing on those non-arm’s length arrangements that shift profits into an SMSF that can result in NALI.
Direct v Indirect Investment: Does it Matter?
In the Alert, the ATO acknowledges the industry view that because an SMSF is not directly involved in the investment, the NALI provisions cannot apply.
The response is that non-arm’s length dealings by any party, in respect of any step in relation to a scheme, can give rise to NALI as defined in the Tax Act.
The types of situations the ATO is concerned with regarding NALI are:
- An SMSF may acquire shares in an interposed entity at an arm’s length price, but the interposed entity may not have acquired shares of another entity at an arm’s length price.
- The interposed entity could enter into an arrangement to sub-contract the property development on non-arm’s length terms to increase profits and ultimately benefit the fund.
- The interposed entity borrows money from another entity on non-arm’s length terms with no interest to maximise profits.
The ATO has warned SMSF trustees that any involvement in a property development scheme will be subject to scrutiny, which may result in a massive tax bill for those using the arrangement to break the rules.
And it is not just the schemes identified in TA 2023/2 that the ATO is reviewing because trustees can structure these arrangements in many different ways.
What are the SIS Concerns?
The ATO has a long list of potential SIS concerns that include:
- Does the investment meet the requirements to provide retirement benefits for members and beneficiaries under s62 SIS?
- Are fund assets valued at market value (r8.02B SISR), and are SMSF assets kept separate from the trustee’s assets personally (r4.09A SISR)?
- Is there an IHA issue, and does it exceed the 5% limit (s71 SIS)?
- Does the LRBA fail to meet the exemptions in s67A & B?
- Does the arrangement result in a loan or financial assistance to a member or relative (s65 SIS)?
- Does the arrangement include the fund acquiring assets from a related party (s66 SIS)?
- Have payments been made under the arrangement where the member does not meet a condition of release in contravention of the payment standards (r6.21 SISR)?
- Are all the terms and conditions of the arrangement on commercial terms, or do they benefit the other party (s109 SIS)?
And once again, all roads lead to NALI.
Documentation Is Key
Documentation is an essential source of evidence to prove that transactions have been conducted on commercial terms.
It becomes more complicated when many related parties are involved in a property development venture, especially when one is the controlling mind.
The alternative, however, is the inference that the parties are not dealing with each other at arm’s length.
Ensure all records are kept and made available in case the ATO comes knocking, which could be as simple as a similar quote provided to an unrelated third party showing the rates charged for all services and works are on commercial terms.
The ATO is targeting SMSF property development schemes that provide new obligations and responsibilities for SMSF trustees.
As long as property remains a sought-after investment, SMSF professionals must keep ahead of the legislation to ensure that funds with property development investments continue operating compliantly.
On the other hand, it will be up to SMSF trustees to determine whether property development is a good idea or a compliance nightmare.
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