Can My SMSF Buy And Lease Plant And Equipment To My Business


ID-100210503

Plant or Equipment in an SMSF?

I get this question on Plant and Equipment financing regularly from business clients with an SMSF. The technical answer is yes subject to complying with the regulatory provisions of SIS Act. In reality for most businesses the answer is most likely NO as there are so many ways you can breach one or more of the rules governing this area. Let’s look at some of those rules.

Firstly it is a requirement that a SMSF and any assets it considers purchasing must meet the Sole Purpose Test.

Sole purpose test

• Section 62: trustee must ensure fund is maintained solely for core purposes, such as benefits to members upon retirement and ancillary purposes

Other relevant issues include:

Formulating Investment Strategy

Section 52: trustee must formulate and give effect to investment strategy that has regard to whole of circumstances including:

• risk involved in making, holding and realising, and likely return from investments having regard to objectives and expected cash flow requirements

Lending to members, relatives and financial assistance:

Section 65: A trustee must not lend fund money or provide financial assistance to:
• member of fund OR relative of a member

• ‘Financial assistance’ has no technical meaning and their frame of reference is language of ordinary commerce … one must examine commercial realities of transaction and decide whether it can properly be described as giving of financial assistance (Charterhouse Investment Trust Ltd v Tempest Diesels Ltd [1986] BCLC 1, 10)

In-house asset rules:

An In-house asset is:
• loan to ‘related party’
• investment in ‘related party’
• investment in a ‘related trust’
• asset subject to lease between trustee and a related party (this is the one that matters in your case)

However a SMSF can have up to 5% of fund’s assets in invested “in-house” assets without breaching the rule so if the equipment’s value were less than 5% of the funds total value then you would not be in breach of this rule….but remember the other rules hold equal importance. Also it is important that this rule is met on an ongoing basis so if stock markets drop or cash is taken out of the fund for pensions you need to revisit the value of the in-house asset.

Arm’s length requirements:

Section 109(1): A trustee must not invest unless:

• the trustee and the other party are dealing with each other at arm’s length OR
the terms and conditions are no more favourable to the other party than if they were at arm’s length
• Section 109(1A): If trustee invests and is required to deal with investment with another party not at arm’s length, must deal as if were at arm’s length

• The term ‘at arm’s length’ is not defined in the SIS Act so open to interpretation

• implies dealing that is carried out on commercial terms again subject to interpretation

• useful test to apply is whether prudent person, acting with due regard to own commercial interests, would have made the investment (APRA v Derstepanian (2005) 60 ATR 518, 524)

So example of how this works:

Let’s say you have $600,000 in your SMSF and you want to purchase an excavator for $25,000 to lease to your own business.

  1. The SMSF Trustees do their research and minuted how they calculate a lease rate that takes into account market return on their investments, allows for the depreciation of the asset and insists on the insurance of the vehicle with its interest noted on the policy to protect its investment. They are satisfied that this provides a decent return for the fund not correlated to the other assets of the funds invested in shares and term deposits. Sole Purpose, S62 and S52 satisfied.
  2. They amend the SMSF Investment Strategy to include this type of asset with the target allocation to “Other Assets” or specifically have an allocation to “Plant & Equipment”

  3. They ascertain that the business could be approved to obtain finance for the excavator from a third-party on similar terms. Section 65 met as clear finance available elsewhere and that this is not the reason why the arrangement is being entered into.

  4. As the value of the excavator ($25k) is less than 5% of the fund ($30K) it does not breach the In house asset rule. This needs to be monitored annually.

  5. They arrange for a written commercial lease agreement comparable with the standard lease available in the market to be entered into by all parties. S109(1) satisfied

So in summary, yes it can be done but in reality there are so many ways you can trip up that it is really not worth the hassle and raising the eye of the ATO or challenging your Auditor’s patience. Your first step is to engage your Accountant and a SMSF Specialist before considering these types of strategies. I would be interested to receive comments from people who have implemented these strategies.

Why not checkout my article ” What can my SMSF invest in?” as a good place to start.

As always please contact me if you want to look at your own options. We have offices in Castle Hill and Windsor but can meet clients anywhere in Sydney or online via Skype.

Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser 

 Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

Verante Financial Planning

Tel: 02 98941844, Mobile: 0413 936 299

PO Box 6002 BHBC, Baulkham Hills NSW 2153

5/15 Terminus St. Castle Hill NSW 2154

Corporate Authorised Representative of Magnitude Group Pty Ltd ABN 54 086 266 202, AFSL 221557

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

Image courtesy of Supertrooper at FreeDigitalPhotos.net

ASIC Releases CHECKLIST for those giving SMSF Advice


The latest ASIC REPORT 337: SMSFs: Improving the quality of advice given to investors includes a useful checklist for those dealing with SMSF advice to the normal person in the street or in technical terms “retail clients”. It also includes some useful examples. Here is the Checklist and I would suggest all those  including Licensed Accountants, Financial Planners, Lawyers, Mortgage Brokers, Property Developers and Share Brokers be prepared to ensure your clients have considered all 32 issues raised or you leave yourself open for scrutiny and litigation if you have been involved in the recommendation of the structure.

Have you considered a SMSF and sought advice? Did your “adviser” mention these issues?

Appendix: Tips for advice providers

Table 6: Some tips for advice providers giving advice to retail clients on SMSFs

Issue: Role and obligations of SMSF trustees

What you should do or consider

C1      The ATO regulates SMSFs and provides a number of useful publications on its website about the obligations and duties of trustees in managing an SMSF. As good practice, you should:

(a)  direct investors to the relevant pages on the ATO website; or

(b)  provide investors with a copy of key ATO publications with their SOA to ensure investors understand their obligations.

C2      You should explain to investors that, by law, each trustee has duties and obligations to:

(a)    act honestly in all matters concerning the SMSF;

(b)    exercise skill, care and diligence in managing the SMSF;

(c)     act in the best interests of all SMSF members;

(d)    take appropriate action to protect SMSF assets and manage them separately from the trustee’s own affairs;

(e)    comply with the SMSF trust deed and review and update it as required;

(f)     be responsible for and control the SMSF, even where the trustees outsource the required expertise or one trustee is more actively involved in the day-to-day running of the SMSF;

(g)    have a documented investment strategy that considers all the circumstances of the fund, and review and update the investment strategy as the members’ financial situation, needs and objectives require;

(h)    consider insurance for fund members as part of the fund’s investment strategy;

(i)      understand which investments are restricted and that SMSF investments must be made solely to pay retirement benefits to members or the members’ dependants if a member dies;

(j)     accept and document contributions in accordance with the superannuation laws;

(k)    ensure the SMSF’s money is invested appropriately (even if the trustee outsources the investment to an advice provider);

(l)      keep proper and accurate tax and superannuation records (e.g. minutes of all investment decisions) and allow members to have access to such information and records;

(m)   comply with the superannuation and tax laws (and the Corporations Act for corporate trustees);

(n)    value the fund’s assets at market value for the purposes of preparing financial accounts and statements;

(o)    have the SMSF audited annually by an independently approved auditor;

(p)    comply with the reporting obligations to the ATO (e.g. report contributions from members, lodge annual returns, report on any changes to trustees, directors or members of the SMSF; lodge a business activity statement if the SMSF is registered for Goods and Services Tax (GST));

(q)   pay the supervisory levy and the SMSF’s income tax liability when due;

(r)    refrain from entering into contracts or behaving in a way that hinders trustees from performing or exercising functions or powers;

(s)   refrain from entering into transactions that circumvent restrictions on the payment of benefits; and

(t)    ensure that the money in the SMSF is only accessed by members when the trust deed and law allow it.

C3      You should explain to investors that, within 21 days of becoming an SMSF trustee, they will need to complete the ATO’s trustee declaration.

C4      You should walk investors through the ATO’s trustee declaration, explain each obligation and duty, and allow investors to ask any questions about their obligations.

C5      If you do not adequately understand the role and obligations of SMSF trustees, it is inappropriate for you to advise investors about SMSFs.

ISSUE: Suitability of an SMSF structure

What you should do or consider

 C6      You should discuss the investor’s fund balance size and whether it is likely to be cost-effective for the investor to set up an SMSF. Cost is just one factor to  consider and does not mean by itself that an SMSF will be appropriate or   inappropriate for the investor.

C7      You should discuss the likely costs associated with running an SMSF, including the costs of establishment, ongoing investment management, compliance and advice,

and explain these costs to the investor before making a recommendation to  establish an SMSF.

C8      Before recommending an SMSF, you should consider the investor’s ability and

willingness to manage the fund and meet their trustee obligations on an ongoing basis.

C9      Be aware of ‘red flag’ indicators that may suggest an SMSF will not be suitable for an investor, including, but not limited to:

(a) a low fund balance where the members have a limited ability to make future contributions;

(b) the investor wants a simple, low-touch superannuation solution;

(c) the investor wants to delegate decision-making to someone else;

(d) the investor does not have a lot of time to devote to managing their financial affairs;

(e) the investor has little investment decision-making experience;

(f) the investor, or suggested trustee, is an undischarged bankrupt or has been convicted of an offence involving dishonesty (as such, persons are prohibited from acting as a trustee); and

(g) the investor has a low level of financial literacy.

C10     You should explain to investors approaching the pension phase that there may be a point at which the SMSF may cease to be cost-effective because fixed costs will remain constant or increase while the balance of the fund diminishes.

C11     Where appropriate, you should discuss SMSF succession planning issues with investors (this will be more relevant for older investors). Some key questions to discuss include:

(a) For investors who are individual trustees, what will happen if one of the     trustees dies?

(b) If one trustee (the controlling trustee) is more actively involved in the day-to-day management of the SMSF, what will the less active trustee do if the  controlling trustee is unable to manage the SMSF?

ISSUE: Risks of an SMSF structure

What you should do or consider

 C12     You should warn investors looking to set up an SMSF about the lack of Government compensation available to SMSFs. This information will help investors properly weigh up whether an SMSF structure is right for them.

C13     You should warn investors that SMSF trustees and members do not have access to the Superannuation Complaints Tribunal (SCT) to resolve complaints.

C14     You should explain the advantages and disadvantages of establishing an SMSF with a corporate trustee versus individual trustees, and provide investors with relevant ATO publications via hard copy or web-links.

C15     If the investor’s proposed membership structure of an SMSF is unusual, you may need to spend more time discussing the duties and obligations of trustees, the risks associated with the membership structure, and the importance of having a    well documented, specific investment strategy and a trust deed that contains  dispute resolution clauses.

C16     You should reiterate the role and responsibilities of trustees, and explain that, even if one trustee is less actively involved, they are equally liable for the SMSF’s compliance with the superannuation and tax laws.

C17     When you recommend an SMSF to an investor, you will need to discuss their insurance needs. This will often involve discussing:

(a) their existing insurance coverage;

(b) the level of insurance coverage they will need in future;

(c) the cost and options for maintaining, increasing or decreasing (as appropriate)

their existing insurance coverage through an SMSF;

(d) whether the investor has any health issues that may affect their ability to get

insurance coverage;

(e) the advantages and disadvantages of retaining a portion of their APRA- regulated superannuation for insurance purposes (if considered appropriate); and

(f) the impact of the insurance recommendation on the investor’s SMSF balance.

C18     If you identify an investor needs advice on insurance, you must consider and   advise the investor on their insurance needs before recommending an SMSF be established. If you do not have the necessary expertise to provide insurance   advice, you should notify the investor and refer the investor to an advice provider who has the expertise to provide the advice.

Issue Investment strategy

What you should do or consider

C19     You should explain to investors the sole purpose test and the requirement for investments to be made and maintained on an arm’s length basis.

C20     When you are advising investors on their SMSF investment strategy, you should explain the benefits of asset diversification and investing across a number of   asset classes (e.g. shares, real property and fixed interest products) in a long-term investment strategy.

C21     You should explain to investors that some investments are restricted and that it is the trustee’s obligation to ensure that the SMSF does not make restricted Investments: see tip C2(i).

C22     You should explain to trustees that they are required to regularly review the    fund’s documented investment strategy to ensure that it suits the needs of fund members.

C23     If you are recommending that an SMSF be established to invest in a single asset, you should ensure that the SOA adequately documents the basis for the advice in

light of the investor’s financial situation, needs and objectives. In particular, you should set out why the investment is appropriate, rather than a diversified investment portfolio, and whether the investment will generate a sufficient return      to fund the investor’s retirement needs and, if not, what the exit strategy is and any costs or risks associated with this exit strategy.

C24     You should explain to investors that the SMSF investment strategy is likely to change as members approach the retirement phase and their needs and circumstances change.

C25     If an investor has a preference towards a real property investment, you should consider whether the real property investment is appropriate.

C26     If you are recommending a real property investment, you should discuss with the investor:

(a) the needs and circumstances of the fund members (e.g. their age and retirement needs);

(b) if the recommendation involves an investment loan, how long it will take for the investor to repay the loan;

(c) the investor’s ability to repay the loan if an unexpected event occurs (e.g. the investor becomes unemployed for a period);

(d) how the investor’s retirement will be funded by the real property investment (i.e. through the sale of property or through rental income);

(e) how likely the property can be sold quickly (i.e. whether it is in a high-demand area); and

(f) what the investor will do if the property is not rented for a period.

Note: If the investment property is not the SMSF’s sole asset, you may need to spend less time discussing the above issues.

Issue: Switching from an APRA-regulated superannuation fund

What you should do or consider

C27     When recommending an SMSF, you will need to explain the charges and significant consequences the investor will, or may, incur as a result of changing (fully or partially) from an APRA-regulated fund to an SMSF.

C28     When discussing the consequences of a switch, you will need to use language and concepts that the investor will understand.

C29     If you assess an investor has a low level of financial literacy; an SMSF will not be an appropriate retirement savings vehicle for the investor.

Issue: Alternatives to an SMSF structure

What you should do or consider

C30     Before recommending an SMSF to an investor, you should consider whether an APRA-regulated fund will meet the financial situation, needs and objectives of the investor. Many APRA-regulated funds now offer a DIY investment option.

C31     APRA-regulated funds may be more cost-effective for investors than an SMSF, depending on the size of the investor’s superannuation balance, and the extent to which the SMSF trustee(s) would engage external professionals to undertake administrative and other functions.

C32     Setting up an SMSF, which then invests through an investment platform, may not be as cost-effective for investors as becoming a member of a public offer investment

 Thoughts:

As a licensed Financial Planner and Accredited SMSF Specialist Advisor™ I can and do assess these 32 points with my clients and under my license I am required to put the recommendations in writing after considering and high lighting the above points.

There is therefore less chance of me recommending a SMSF to a person not suited to running one but if that should happen they may have recourse to my Professional Indemnity Insurance. However if they have received the advice to set up a SMSF from an unlicensed person then they may have no recourse to PI as that person’s cover would most likely exclude such claims.

As always please contact me if you want to look at your own options. We have offices in Castle Hill and Windsor but can meet clients anywhere in Sydney or online via Skype.

Liam Shorte B.Bus SSA™ AdvDipFS

Financial Planner & SMSF Specialist Advisor™

Verante Financial Planning

 Follow SMSFCoach on Twitter  Liam Shorte on Linkedin  NextGen Wealth on Facebook 

Tel: 02 8853 6833,  Mobile: 0413 936 299

liam@nextgenwealth.com.au

PO Box 6002 BHBC, Baulkham Hills NSW 2153

 Liam Shorte is a partner in NextGen Wealth Solutions, Corporate Authorised Representative of Genesys Wealth Advisers Limited, Licence No 232686, Genesys Wealth Advisers Limited ABN 20 060 778 216 • AFSL No.232686

Important information :

The information in this article is provided for illustrative purposes only and does not take into consideration your personal circumstances. You are encouraged to seek financial advice suitable to your circumstances to avoid a decision that is not appropriate. Any reference to your actual circumstances is coincidental. Genesys and its representatives receive fees and brokerage from the provision of financial advice or placement of financial products.

SMSF Borrowing: What Can I Do With An Investment Property Within The Rules.


We constantly have people contacting us with ideas of what they want to do with an investment property once they have borrowed to purchase one in their SMSF. Some are sensible but some show no grasp of the regulations at all and include moving the whole family in to save on their home mortgage or knocking it down to build a multi-storey unit development. If you run a self managed superannuation fund, you have the ability to invest in residential property or commercial property and under certain circumstances a farm. (Note: ability to do something does not mean you should).

Repairs v Improvements

Repairs v Improvements

Borrowing to purchase a property in an SMSF or in the industry jargon a “limited recourse borrowing arrangement (LRBA)” has been legal since 2007 and is becoming increasingly popular with SMSF owners seeking to leverage their funds.

In May 2012, the ATO released a ruling SMSFR 2012/1, “Self Managed Superannuation Funds: limited recourse borrowing arrangements – application of key concepts.” To clarify its understanding of the legislation.

It should be noted that the ATO focused on borrowing to invest in property as it saw this as the most likely area people would encounter problem scenarios. They key issues that the ruling addresses are:

–   defining a single acquirable asset

–   property development and off-the-plan purchases.

–   distinguishing between improvements vs repairs or maintenance.

–   improving an asset to the extent if becomes a replacement asset.

In this article I will concentrate on the latter 2 issues as it is ok to use borrowed funds for most repairs or maintenance but you can’t use borrowed money to finance improvements. You can use your other funds in your SMSF to fund improvements so it is a matter of getting the strategy right.

The ATO has given specific meanings to the following words:

‘Maintaining’ an asset typically involves work done to prevent or anticipate defects, damage or deterioration (in a mechanical or physical sense). For example, repainting a timber house to prevent deterioration is typically maintenance

‘Repair’ ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired and contemplates the continued existence of the property.  A repair replaces a part of something or corrects something that is already there and that is damaged, has become worn out or dilapidated or has deteriorated. Repair may be necessitated through ordinary wear and tear, accidental or deliberate damage or by the operation of natural causes (whether expected or unexpected) during the passage of time.

‘Improvement’ the guidance is that they mean work that:

  • provides something new
  • generally furthers the income-producing ability or expected life of the property
  • generally changes the character of the item you have improved
  • goes beyond just restoring the efficient functioning of the property

So what can you do and what can’t you do?

The following scenarios outline when an existing LRBA will continue to apply to an asset, based on the ATO’s SMSF ruling.

1. Using Borrowed Money : Repairs and Maintenance (Yes You Can) v Improvement (No You Can’t)

Work to be carried out Repair or maintenance (Yes you Can under an LRBA) Improvement (No you Can’t under an LRBA)
Residential property
A fire damages part of the kitchen (cooktop, benches, walls and ceiling). Restoring the damaged part of kitchen, including addition of a dishwasher, even if there wasn’t one there before (considered minor). Yes you can If as well as restoring the damaged part of the internal kitchen (a repair) a new external kitchen was added to the entertainment area of the house the external kitchen would be an improvement. No you can’t
Replace guttering Yes you can
Replace fence Yes you can
Replace house destroyed by fire Rebuild comparable house. Yes you can Rebuild house not comparable (although if built from insurance proceeds does not affect LRBA) No you can’t
A pergola is built to create an outdoor entertaining area. No you can’t
The addition of a swimming pool or a garage. No you can’t
A house extension to add another bathroom. No you can’t
Cyclone damage to a roof Replace roof: Yes you can Add a second storey at the same time as replacing roof.  No you can’t

Source: ATO SMSFR 2012/1

 

2. Development while under a LRBA: Retains Same Attributes (Yes You Can) v Creates a different asset (No You Can’t)

Asset and Action Result
1.  Vacant block of land on single title. A vacant block of land is subsequently subdivided resulting in multiple titles. One asset has been replaced by several different assets as a result of the subdivision.  Different asset created No You Can’t
2. Vacant block of land on single title. A residential house is built on vacant land which is on a single title. The character of the asset has fundamentally changed from vacant land to residential premises. This is a different asset. Different asset created No You Can’t
3. Residential house and land. A house is demolished following a fire and is replaced by three strata titled units. The character of the asset has fundamentally changed along with the underlying proprietary rights. This has created three different assets. Different asset created No You Can’t
4. Residential house and land. A residential house is converted into a restaurant by renovations which include fitting out a fully functioning commercial kitchen. As a result of the renovation the character of the asset has fundamentally changed from residential premises to restaurant premises. This is a different asset. Different asset created No You Can’t
5. Residential house and land. One bedroom of a residential house is converted to a home office. This would not ordinarily result in a change in the overall character of the asset as a residential house. The conversion of the bedroom into an office does not result in a different asset.  Same asset – Yes You Can
6. Residential house and land. A fire destroys a four bedroom house and a new superior residential house is constructed on that land using both insurance proceeds and additional SMSF funds. Rebuilding another residential house (whether of the same size or larger) does not fundamentally change the character of the asset held under the LRBA. The addition of a garage, for example, would also not change the character of the asset. Same asset – Yes You Can
7. Residential house and land. While each of the following changes would be improvements each (or all) of the changes would not result in a different asset:

  • · an extension to add two bedrooms;
  • · the addition of a swimming pool;
  • · an extension consisting of an outdoor entertainment area;
  • · the addition of a garage shed and driveway;
  • · the addition of a garden shed.
Same asset – Yes You Can
8. Residential house and land. To allow a road to be widened, a local government authority undertakes the compulsory resumption of a minor portion of the frontage of a property which has a residence on it. While the resumption results in the existing property title being replaced, the minor extent of the resumption is such that the fundamental character of the asset, taking account of not only the proprietary rights but also the object of those proprietary rights, remains that of being the residential property. Same asset – Yes You Can
9. Residential house and land. A ‘granny flat’ is to be constructed in the backyard of a property which already has a four bedroom residence established on it. The granny flat will have two bedrooms, a family room, a kitchen and a bathroom and will be connected to utilities such as electricity, water and sewage. The character of the asset would remain residential premises and thus the construction of the granny flat would not result in there being a different asset. Same asset – Yes You Can

Source: ATO SMSFR 2012/1

Conclusion

There is no doubt that this ATO ruling and the examples given are good news, and much appreciated by the SMSF industry who have to deal with enquiries every day. It provides a substantial amount of clarity around many issues that had previously been quite unclear. The common sense and commercial approach by the ATO has also been welcomed and was somewhat unexpected.

I always suggest that SMSF Trustees keep sufficient cash flow in the SMSF to finance repairs and maintenance or any expected improvements rather than using borrowed funds and risk running foul of the rules.

You should however carefully consider any strategy in the light of these rules and make sure you get a second opinion as often if you are too close to a project you can be blinded to its faults. That’s where a good team of advisors comes to the fore.

Checkout : Can I borrow to buy a house and land package off the plan in my SMSF?

As always please contact me if you want to look at your own options. We have offices in Castle Hill and Windsor but can meet clients anywhere in Sydney or online via Skype.

Liam Shorte B.Bus SSA™ AFP®

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser Follow SMSFCoach on Twitter  Liam Shorte on Linkedin  NextGen Wealth on Facebook  

Verante Financial Planning

Tel: 02 8853 6833,  Mobile: 0413 936 299

liam@verante.com.au

PO Box 6002 BHBC, Baulkham Hills NSW 2153

Corporate Authorised Representative of Magnitude Group Pty Ltd ABN 54 086 266 202, AFSL 221557

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

%d bloggers like this: