Head of Education & Content
My client’s SMSF owns units in a non-geared related unit trust which owns property. The trust recently entered into a contract to sell the property to an unrelated party on vendor finance terms over a three year period. Is such a transaction permitted under the superannuation laws?
In short, no.
Self managed superannuation funds (SMSFs) are not permitted to hold more than 5% of their assets in “in-house assets”. In-house assets generally include loans to, investments in and assets leased to related parties, and investments in related trusts. There are however a number of exemptions.
One such exemption is units or shares in a non-geared entity (often also called a Reg 13.22C entity). A non-geared related entity is a trust or company controlled by the SMSF and/or related parties of the SMSF with the entity meeting very strict rules. The most well-known of these rules is that the entity must not borrow (hence the entity’s name) however there are actually a number of other conditions these entities must meet and a number of events which can cause these entities to no longer meet those conditions.
Of relevance here is the requirement that the trust not lend money to other entities, whether related parties of the SMSF or not [SIS Reg 13.22D(1)(b)]. The definition of a “loan” for this purpose is very wide.
The underlying transactions of a vendor finance contract is a loan by the trust to the purchaser and the use of those monies by the purchaser to acquire the property.
Even though no money changed hands, the trust has lent monies to another entity (ie the purchaser). (Interestingly there is no similar definition of “borrow” which is why an SMSF can acquire things on vendor finance terms in the right circumstances and why money needs to change hands when an SMSF wishes to use vendor finance to borrow under an LRBA).
This loan means the trust failed the non-geared entity rules and the fund’s investment in the trust has become an in-house asset. If the value of the fund’s units in the trust was more than 5% of the market value of the fund’s total assets at the next 30 June (eg 30 June 2020 if the vendor finance transaction was executed today), the fund will be required to develop and implement a written plan by which the fund will dispose of its units by the next 30 June (eg 30 June 2021). If this plan is not implemented and the units sold by 30 June 2021, the fund will breach the in-house asset rules.
It may be that your client intends to wind up the trust after the sale of the property (ie the fund may be planning to redeem its units anyway). However the three year term of the vendor finance arrangement will not allow the loan to be repaid and the fund’s units redeemed in the required timeframe. In this case it may be appropriate for the trustee to make voluntary disclosure of the situation to the ATO and request the Commissioner’s discretion for a longer time period to dispose of the in-house asset. There is no guarantee the Commissioner will exercise its discretion, particularly given the relatively long timeframe for rectification. However, the inadvertent nature of your client’s breach, the current economic environment and the ATO compliance concessions already offered for in-house asset breaches will be factors in their favour.