Property Development In An SMSF: ATO Guidance

Background

In fact, the ATO has clearly stated in the past that this is a legitimate investment for SMSFs. In a regulatory bulletin, the ATO stated:

“Property development can be a legitimate investment for SMSFs, and the Commissioner does not have any concern with SMSFs investing in property development where it complies with the Superannuation Industry (Supervision) Act 1993 (SISA) and Superannuation Industry (Supervision) Regulations 1994 (SISR).”

The key issue is that all activities must be within the strict compliance regime that all SMSF trustees need to work within.

We will cover these compliance requirements shortly, but first we need to look at the tax concerns raised by the ATO, which focus on the diversion of property development profits into an SMSF.

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Concerns around profit diversion

In 2023, the ATO released a taxpayer alert outlining its concerns around property development activity involving an SMSF where the arrangement is intended to divert the profits from that development into the concessionally taxed superannuation system.

The ATO’s concerns stem from the fact that the tax rate applicable to these activities is considerably lower within the superannuation environment than it would be if these activities were carried out through more traditional entities like companies.

Complying super funds pay a maximum tax rate of 15%, whereas a company’s profits are generally taxed at the applicable company tax rate, being either 25% or 30%. After-tax profits can then be paid to the shareholders of that company who receive a credit for the tax which has already been paid:

• If the shareholders’ own personal tax rate is less than the company tax rate, they receive a refund of tax already paid
• Where the shareholders’ own personal tax rate is higher than the company tax rate, they pay an additional amount of tax to reflect this. 

If the shareholders of that entity include a complying SMSF that pays a maximum 15% tax, you begin to see how a tax benefit can arise.

Consider a more standard arrangement where a property development would be carried out through a company with profits paid out to the individual shareholders. The individuals would usually have a marginal tax rate considerably higher than the 15% tax rate of a super fund.

This is one of the issues sparking Australian Taxation Office (ATO) concerns: property development carried out through an entity set up solely for that purpose, where the shareholders include tax-concessional entities like SMSFs.

Taxpayer alert 2023/2

Issues raised in this taxpayer alert cover situations that include:

• Where there is an intention to shift profits from property development activities from a related entity to an SMSF where the profits are concessionally taxed
• Where the SMSF has either a direct or indirect ownership in a ‘special purpose vehicle’ (SPV), which is established for the purpose of carrying out the development 
• Where that SPV then engages with other related parties that are controlled by the SMSF members (or their associates) to complete the development activities
• Where these services are not carried out on arm’s-length terms 
• Where the above results in an increase to the profits generated from the property development and those profits are shifted into the lower tax environment of super.

If these issues are present within the arrangements entered into by an SMSF, the ATO has said it will consider applying the general anti-avoidance tax rules, which can result in additional tax and penalties being imposed.

This can also result in all income from the development, including capital gains, being taxed at the top marginal tax rate rather than at the concessional rate generally available to complying super funds.

It is also interesting to note the following comments made by the ATO regarding this issue:

• That it is looking to impose penalties on professionals who are promoting these arrangements to their clients
• It has encouraged trustees who have concerns about activities they’ve entered into within their own SMSF to make a voluntary disclosure or seek a private binding ruling.

Compliance considerations

Beyond tax and profit diversion, SMSF trustees also need to meet the usual superannuation compliance requirements.

Many of these issues were covered by the ATO in SMSFRB 2020/1, their regulatory bulletin on SMSF and property development.

The main issues covered in the bulletin include:

Where the entity carrying out the development is a related party of the SMSF, it is absolutely necessary for all interactions between these parties to be entered into and then maintained on an arm’s-length basis.

All parties need to ensure they deal with each other the same as they would if they were unrelated, so neither party to the transaction is treated any more favourably.

It is also important that evidence is obtained and retained to prove that this has in fact occurred.

Where the terms of the arrangement are not at arm’s length, or where there is insufficient evidence to prove this, it can result in either a superannuation compliance issue, a tax issue or both:

• Where the terms of the arrangement are more beneficial to the other, non-SMSF party, then there would be a breach of the SIS arm’s-length rules (Section 109). This will often lead to a contravention that needs to be reported by the fund’s auditor.
• Where the terms of the arrangement are more beneficial to the SMSF, it would create a non-arm’s-length income issue under the tax rules, resulting in all SMSF income (and capital gains) from the development being taxed at the top marginal tax rate.

Sole purpose test

Any SMSF involvement in a property development must be for the sole purpose of providing fund members with retirement benefits.

There can be no form of current-day benefit given to members by including the SMSF in the project, so this will require clear reasoning as to why the SMSF is involved in the development and what the trustees expect to achieve when it is complete.

Where a related party is involved in the development, it is important that the SMSF trustees act only in the best interests of the fund members.

SMSF trust deed rules

It is important that activities and investments entered into or carried out by the fund’s trustees are in accordance with the fund’s trust deed.

It is essential that you refer to your trust deed before considering any form of fund activity or investment. You should be looking for clear guidance around these activities and that they are not prohibited or restricted by the rules set out in the trust deed.

SMSF investment strategy

Consideration must be given to the fund’s existing investment strategy and what it allows. In many cases, trustees will need to update the fund’s strategy documentation prior to any investment taking place.

Trustees should consider clearly defining why the SMSF is involved in the property development. The outcomes likely to be achieved should also be contained within the fund’s investment strategy.

Of course, where there are related parties involved in the development, then this becomes even more relevant.

The bottom line

SMSF trustees considering a property development within their fund need to have a clear understanding of the relevant rules and restrictions they must adhere to.

Property development arrangements can have complex tax and superannuation consequences, so trustees should seek professional advice before proceeding.

If you’ve had advice about using an interposed entity for the development, it’s worth discussing with your adviser, and getting a second opinion if you think it’s warranted.

Be sure to obtain and retain clear and concise evidence on all activities and transactions that take place, particularly where those transactions involve a related party.