Buying your business property inside your SMSF
Normally, the purchase of assets from related parties is not allowed within an SMSF, however under section 66 of the Superannuation Industry (Supervision) Act 1993 (the SIS Act) ‘business real property’ (generally, land and buildings used wholly and exclusively in a business) is an exception. The asset must be acquired by the SMSF at ‘market value’ and it is generally advisable for a valuation to be done by a qualified third-party to ensure this requirement is satisfied.
Importantly, once ‘business real property’ has been acquired by an SMSF, it can then be leased back to a related party for business use without the normal 5% limit on ‘in house’ assets applying.
Many small businesses are attracted to owning their own premises because it provides the security of being their own landlord as well as gains seen historically from strong commercial property returns. This strategy may impact the business cash flow as well as potentially not being the best tax outcome.
One of super’s biggest advantages is its taxation.
Under a superannuation structure, any income earned is taxed at 15%. Any capital gains realised on assets held for 12 months or more are effectively taxed at 10%. Both of these rates are most likely lower than both the individual and company tax rates. The rent paid to the SMSF is generally tax-deductible by the business at the full marginal rate and 30% for a company. For the SMSF, any negative gearing benefit can be used to reduce tax payable on the fund’s other assessable income (which would otherwise be taxed at 15%).
But the real advantages come when you sell the property, if you’re in the pension phase in your SMSF, gains made on assets that are backing pensions2 are taxed at 0%. Income made on investments in pension phase are also taxed at 0%.
Opportunities with six-member funds
When buying business property, a six-person super fund opens up the possibility of real scale. With alignment between the members' investment strategies being focussed on the acquisition of the business property, there is greater scope for a cash deposit and loan repayments through combined concessional contributions and rental payments by the business. The SMSF could be formed from family members or a combination of family and key business stakeholders, although genuine alignment is probably easier with just family in the fund.
To bring other business partners into the purchase, non-family members could bring additional SMSFs into play using a unit trust structure.
However, assuming a single family-based SMSF is used as the acquisition vehicle for the business premises of the firm, with six members the total possible concessional contribution inflow could be $150,000 a year as against the current $100,000 a year with only four members.
A six-person SMSF would also potentially allow each person to contribute a set amount to the single SMSF, rather than their entire existing superannuation balance. This could then position the SMSF as the "business premises" SMSF. If the collective amounts were large enough, they could also look at options that didn't involve adding the additional complexity and costs of a limited recourse borrowing arrangement.
Before deciding on a course of action, it’s worth considering the potential downsides or risks in managing larger SMSFs:
1. Best Interests. With more members there could be a greater challenge to manage the fund in all of their best interests. Having different generations, in possibly different superannuation stages (early accumulation as against retirement stage) may give rise to different priorities as to investment strategies. Different investment priorities may have to be accommodated in the fund by having two (or more) investment strategies – one appropriate for early accumulation stage and a second strategy appropriate for retirement stage.
2. Increased administrative complexity. With a six-member fund, there is the potential for more frequent changes in fund membership, with more members leaving or joining the fund over time. This underlines the importance of appointing a corporate trustee for an SMSF to avoid having to make changes every time a membership change occurs - the advantages of having a corporate trustee are discussed further in our article here. The addition of more members may increase costs to the point where no cost benefits apply.
3. Control. Any decisions made by the fund could impact on a larger pool of members. It could mean up to six individual trustees or six directors of the corporate trustee would be making decisions about the future of the fund. An increase in the number of members may also mean that the fund is more susceptible to the members abusing their position in the fund by improperly and without authorisation removing money from the fund’s bank account for other reasons. In other cases, members could align to out-vote other members. For example, children may try to out-vote the parents in order to achieve their interests at the expense of their parents’ interests.
4. Potentially, there might be additional succession and estate planning complexities, particularly if certain members of the wider family are not included.
Many of the risks above, to a large extent, may already be dealt with on a day-to-day basis within the family business. Collaborative strategies like the six-member SMSF should really only be implemented if the family members are already focussed on working together and operating a successful family enterprise. The SMSF is just another method to achieve long-term wealth.
The one thing that doesn’t change is the constraints on passing on wealth within the SMSF. When the older generation passes away, they can’t just pass their balances onto the next generation. That’s because death is a compulsory cashing condition, and in the case of adult children beneficiaries, any death benefits must generally be paid out of the SMSF as a lump sum. Potentially, that's a liquidity issue that needs to be managed, especially for large assets such as business premises. On the death of a member, you need to be able to liquidate enough assets to be able to pay that benefit out of the fund.
A well thought out investment strategy and careful estate planning can provide the tool to retain those assets inside an SMSF across generations by ensuring the fund maintains sufficient liquidity to pay out those death benefits.
While already a well-known and utilised strategy, buying business real property within an SMSF may soon have potential additional flexibility with six members and a greater investable pool. With careful planning, the ability for different member generations to hold onto the property while paying out retired and or deceased members is enhanced.