In the SMSF world, where a reg 13.22c entity can only invest in business real property and cash, can an investment in a partnership comply with the SIS legislation?

The answer is no.

What if the partnership only invests in allowable assets under reg 13.22C SISR, such as property and cash?

The answer is still no, and here are the reasons why.

Background of Div 13.3A

The explanatory statement issued by the Treasury introducing Div 13.3A enables “a small superannuation fund to jointly own business real property with related parties of the fund (through a company or unit trust)”.

The specific policy objective was to provide a new class of related companies and trusts called reg 13.22C entities, non-geared entities or ungeared entities. These could be used by small superannuation funds and related parties to jointly invest in business real property without the investment by the fund being treated as an in-house asset.

The purpose was to provide increased flexibility to SMSFs through this new investment class to invest in business real property with related parties.

It allows ownership changes to occur by selling shares or units rather than transferring direct ownership of the real property.

The intent was to provide a new structure that enables an SMSF to invest in a non-geared entity that jointly owns business real property with a related party, not to have a partial interest in business real property.

Requirements of Reg 13.22C SISR

Section 71 SISA sets out an exclusion to the in-house asset rules where an SMSF can invest in a related entity if it meets the conditions of reg 13.22C SISR at the time of acquisition and at all times during the year. 

The requirements are that it cannot hold:

1. An interest in any other entity except property and cash at bank
2. A borrowing in any form
3. A lease with a related party unless the asset is business real property and is legally binding

Once the entity meets the rules of reg 13.22C SISR, it must meet all the requirements of reg 13.22D SISR, which broadly state that:

1. If the trust fails to meet the rules in reg 13.22C SISR, it will become an in-house asset of the fund
2. It cannot hold an interest in another entity
3. It cannot operate a business
4. All transactions must be at arm’s length
5. The SMSF cannot have more than six (6) members

Failure to meet these requirements can easily occur, such as when rent from a related party is not paid at market value or if there is an investment in another company or trust.

Under those circumstances, the entity can never meet its former exempted status and must be disposed of by the end of the following income year to avoid a breach of sec 82 SISA.

While the rules are straightforward and allow no wriggle room, is a partnership considered an “entity”, and could a non-geared entity invest in a partnership that meets the investment requirements of reg 13.22C SISR?

Is a Partnership An “Entity”?

While there is no formal definition of a partnership in SIS law, the general interpretation reverts to tax law, generally found in ATO rulings (such as SMSFR 2008/1).

The ITAA 1936, s995-1, defines a partnership as “an association of persons (other than a company) carrying on business as partners or in receipt of ordinary or statutory income jointly”.

The ATO defines an entity as a “company, trust, partnership, any incorporated body or association and an individual” (ATO website, QC 48149).

It aligns with the definition of an entity in sec 10(1) of SIS, which means “an individual, a body corporate, a partnership or a trust”.

So, by the power invested in sec 10(1) SIS, a partnership is an entity for the purposes of reg 13.22C SISR.

Partnership Confusion

The confusion as to whether a partnership is an entity stems from the fact that it is not a separate legal entity, which is at odds with the intent of Div 13.3A and the definition found in sec 10(1) SISA.

It means the partnership cannot own property, enter into contracts or be sued in its own name. Each partner has joint and severable liability and is taxed on their share of the partnership’s profits or losses.

This conundrum lulls SMSF professionals into a false sense of security where, as long as the partnership meets all the other requirements of reg 13.22C SISR, the fund’s investment in the non-geared entity appears to comply.

What the partnership does or does not do is irrelevant for SIS compliance purposes. The reg 13.22C entity fails to comply with reg 13.22D SISR when it holds a partial interest in a property through a partnership.

Conclusion

As SMSF trustees with cash flow issues look for more innovative ways to invest in property and maximise returns, investing in a partnership through a reg 13.22C entity may seem a viable option.

Unfortunately, it is not a compliant one.

Regardless of whether the partnership meets all of the requirements of reg 13.22C SISR, it still results in blowing up the structure.

Like oil and water, reg 13.22C entities and partnerships do not mix. It is best to keep it that way to ensure SIS compliance.

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