SMSFs and Property Development: Unpacking the ATO's Latest Regulatory Guidelines

In recent years, the landscape of property development as conducted by Self-Managed Super Funds (SMSFs) has experienced significant growth. Consequently, this has caught the attention of the Australian Taxation Office (ATO), the official regulator of SMSFs. The ATO has subsequently released regulatory guidance, with a focus on two key areas:

1. Diverting property development profits into an SMSF: Taxpayer Alert 2023/2, released on 15th June 2023
2. Compliance issues and potential risks associated with property development via SMSFs: SMSFRB 2020/1, released on 13th March 2020.

A Historical Perspective: SMSFs and Property Development

Property development activities that are performed in compliance with both superannuation and taxation rules should not cause any regulatory or taxation concern for the SMSF. Historically, the ATO has endorsed property development as a legitimate investment venture for SMSFs, granted it complies with super and tax regulations. However, the key point here is that all activities must function within the strict compliance regime to which all SMSF trustees are bound.

Focus on Profit Diversion: ATO's Recent Concerns

The ATO recently released a taxpayer alert in mid-June 2023, expressing its concerns regarding property development activities undertaken within SMSFs with the intention of diverting profits from those activities into the superannuation system. This concern arises from the fact that the tax rates applied to these activities within a superannuation environment are significantly lower than they would be if conducted through traditional entities like companies.

Unpacking Taxpayer Alert 2023/2

1. The intention to shift profits from property development activities from a related entity to an SMSF, where the profits are taxed concessionally.
2. The SMSF having either a direct or indirect ownership in a Special Purpose Vehicle (SPV) created for the development purpose.
3. The SPV subsequently engaging with other related parties controlled by the SMSF members or their associates to finish the development activities.
4. These services not being conducted on arm's-length terms.
5. The result being an increase in the profits generated from property development and these profits being shifted into the super's lower tax environment.

If such issues exist within an SMSF's arrangements, the ATO has stated that it will apply general anti-avoidance (Tax) rules, potentially resulting in additional tax and penalties imposed on the SMSF.

Compliance Considerations: Regular Superannuation Laws and Requirements

In addition to the tax and profit diversion issues, SMSF trustees must also adhere to regular superannuation laws and compliance requirements, many of which were addressed by the ATO in SMSFRB 2020/1, their regulatory bulletin on SMSF and property development.

Key Issues Outlined in the Taxpayer Alert 2023/2:

1. Related Party Involvement: It's crucial for all interactions between related parties or Part 8 associates of the SMSF to be conducted and maintained on an arm's-length basis.
2. Sole Purpose Test: The SMSF's involvement in a development must be solely for providing fund members with retirement benefits.
3. SMSF Trust Deed Rules: Trustees must ensure that the fund's activities and investments align with the rules set out in the fund's trust deed.
4. SMSF Investment Strategy: Consideration must be given to the fund's existing investment strategy and what it permits.

Conclusion: Careful Planning and Compliance are Key

For SMSF trustees considering property development within their fund,a clear understanding of the rules and restrictions they must adhere to is crucial. In instances where advice has been provided around the use of an interposed entity to carry out the development, a discussion with the relevant advisor is recommended, and potentially seeking a second opinion.

Maintaining and retaining clear, concise evidence on all activities and transactions, especially those involving a related party, is a vital part of this process. Ensuring compliance with all regulations will help SMSF trustees avoid any potential issues, maximize their benefits, and successfully navigate the complexities of property development within the superannuation landscape.

Source: https://www.superguide.com.au/smsfs/property-development-in-an-smsf-recent-ato-guidance