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In-house assets are a tricky area for self-managed superannuation funds. They remain one of the most common breaches by SMSF trustees (at 18.5%), only exceeded by contraventions involving loans (at 21.5%), according to the Australian Taxation Office (ATO).
Trustees might therefore need to brush up on their understanding of an in-house asset to ensure they are complying with the 5% limit (of a fund’s total assets) that the ATO applies on such assets.
Why is there a limit?
In-house assets are a complex area even for those professionals advising SMSFs. To raise awareness, director SMSF technical and education services at Heffron SMSF Solutions, Leigh Mansell, presented a session on the ins and outs of in-house assets at the recent (virtual) SMSF Association’s annual conference.
She reminded attendees that the purpose of the limit is to manage the risk associated with holding in-house assets. The main risk of having a too large allocation to an in-house asset is that the fund could be used for something other than providing retirement benefits to members or death benefits to the beneficiaries of members – which would contravene the Superannuation Industry Supervision (SIS) Act.
“Breaking the rules can be a really big deal. SIS imposes various penalties if the in-house asset rules are broken and the penalties can include such things as administrative fees or monetary penalties and these would be issued by the regulator to the trustees or directors of the corporate trustee and they’d have to pay those penalties out of their own pocket,” she told delegates.
“Other penalties could include disqualification of the trustees and in extreme cases the fund could lose its compliance status. That’s a really big deal. So there’ll be a tax cost to that, a huge tax implication for a lot of funds and that would also have implications for the super of those members later on down the track.”
What is an in-house asset?
The SIS Act defines an in-house asset as an asset of the fund that is:
- A loan to, or an investment in, a related party of the fund
- An investment in a related trust of the fund
- An asset of the fund subject to a lease or lease arrangement between a trustee of the fund and a related party of the fund.
‘Related party’ also has a very specific definition under SIS law and is any of the below:
- (a) A member of the fund
- (b) A standard employer-sponsor of the fund
- (c) A Part 8 associate of an entity referred to in paragraph (a) or (b).
Part 8 associates include relatives, the other members of the fund, the directors of the corporate trustee or all individual trustees (if the SMSF is a single member fund). If a member is in a partnership then it also includes that partner (and their spouse or child) and the partnership itself. It also includes trusts, where the member and their Part 8 associates control the trust. The same applies to a company if a member and their Part 8 associates control the company.
Relative, under the SIS Act, refers to an individual’s parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the individual or of his or her spouse; and the spouses of the individual and the individuals mentioned above.
How it works
Mansel gave the following example to highlight some of the issues that trustees need to be aware of, in order not to fall foul of in-house asset regulations.
Gazza and Kath have an SMSF. The SMSF owns some machinery that used to be leased to an unrelated motor crash repair business.
Gazza’s parents (Das and Sal) own a motor crash and radiator repair business.
While looking for a new lessee, the machinery owned by the SMSF is kept at the premises of Das and Sal’s business (i.e. at a related party’s business premises) and is used by that business. There is no formal arrangement for the lease of the asset and no rent is paid.
Several factors point to the machinery being subject to a lease arrangement between the SMSF and Das and Sal’s business.
The machinery is physically located in Das and Sal’s business premises, giving them the right to control access to it and they use it in their business. Das and Sal have possession of the asset rather than mere custody of it. The nature of the arrangement is therefore similar to a lease, despite there being no rent payments or formal lease agreement.
The machinery is therefore an asset of Gazza and Kath’s SMSF that is subject to a lease arrangement while it is being used in Das and Sal’s business, and therefore is an in-house asset of the SMSF.
The issue of what constitutes a loan is also something SMSF trustees need to understand.
Another example from Mansell helps illustrate how a payment might not be considered a loan even if deferred.
Shazza is a member of an SMSF. The other members of the SMSF are Das and Sal (her parents) and Con (her husband).
Rent payable to the SMSF from Shazza’s nail and beauty business is due on the last day of each month.
Prior to COVID-19, the June 2019 rent payment was overlooked due to a clerical error. This was not discovered until the next payment was due in July 2019 and payment was received for both months at that time.
As the late payment was not part of an arrangement between the parties (i.e. the SMSF had not agreed/consented to Shazza’s business making the payment after it was due), it is not financial accommodation or provision of credit. Therefore the outstanding amount was not a ‘loan’ on 30 June 2019 and consequently was not required to be included in the in-house assets of the SMSF at that time.
Exceptions to the rule
While the easiest way to avoid an in-house asset contravention might appear to be not investing in any asset that has anything to do with a related party, thankfully there are some exceptions in recognition of the unique benefits investing in such assets can provide SMSFs.
The biggest exception is business real property. The SIS Act states that an in-house asset does not include real property subject to a lease, or to a lease arrangement enforceable by legal proceedings, between a trustee of the fund and a related party of the fund, if, throughout the term of the lease or lease arrangement, the property is business real property.
In another ruling (SMSFR 2009/1), the ATO clarified that business real property is real property that is used wholly and exclusively in one or more businesses (whether carried on by the entity or not), but does not include any interest held in the capacity of beneficiary of a trust estate.
However, in such cases trustees need to be mindful of the potential expiry of a lease. The ATO has said that if a lease expires and is not renewed and the original lease does not include a ‘continuation clause’ or other similar provision, the lease ceases to be legally binding and the leased asset could be considered to be an in-house asset of the SMSF.
The in-house asset limits are placed on SMSFs for good reason and responsible trustees would be well advised to keep them in mind when considering investments from related parties.