SMSFs and related party transactions
Related party transactions continue to represent a challenging issue for SMSF trustees.
In the December 2011 National Tax and Liaison Group (NTLG) Superannuation Technical Sub-Group meeting, the Australian Taxation Office (ATO) was asked two key questions regarding SMSFs and related party builders, and the application of section 66 of the Superannuation Industry Supervision (SIS) Act.
Ordinarily, SMSFs are prohibited from intentionally acquiring assets from related parties.
The ATO confirmed this in the December 2010 NTLG Superannuation Technical Sub-Group meeting, saying in cases where an SMSF engaged a related party to construct a building on land owned by the SMSF, it must be clear the related party provides building services only, and not any materials if a section 66 breach is to be avoided.
During the December 2010 meeting, the question was raised whether the supply of goods and materials from a related party agent would avoid a breach of section 66.
The appointment of an agent would typically involve the SMSF trustees appointing the related party as their agent by a variation to the building contract or under a deed of agency agreement.
The agent would acquire the goods and materials then invoice the trustee for the cost of the purchase either on a progressive basis or once the work has been completed.
The cost of services provided may be invoiced separately or together with the cost of goods and materials.
The invoiced cost of the goods and materials may be increased by a profit margin charged by the related party builder.
As an alternative, a new bank account could be opened in the name of the builder and the builder executes a deed of bare trust, confirming that it holds the bank account on bare trust for the SMSF trustee and that all things purchased with the bank account proceeds belong to the SMSF.
Funds are then transferred from the SMSF to the bank account and neither the builder nor any other entity puts any money in the bank account.
The builder buys building supplies using the bank account as directed by the SMSF trustee and those supplies are then affixed to the SMSF land.
The questions put to the ATO in the December 2011 meeting were:
- Will the trustees of an SMSF breach section 66 of the SIS Act if the trustees appoint as their agent, a related party to purchase the goods and materials on behalf of the trustee and those goods and materials are used in the construction of a building on land owned by the SMSF?
- Will the trustees of an SMSF breach section 66 of the SIS Act if the trustees execute a deed of bare trust to finance the purchase of goods and materials used by a related party in the construction of a building on land owned by the SMSF?
In response to the first question, the ATO stated that where a related party only acts as an agent, arranging for the acquisition of building materials on behalf of the SMSF trustee from an unrelated vendor and the related party at no times holds legal title to the building materials, the SMSF trustees have acquired the materials from that vendor, not the related party.
Therefore section 66 of the SIS Act would not apply to the acquisitions.
On the second question, the ATO said they did not believe that payment for the building materials out of a bank account which is held by the related party on bare trust for the SMSF will, of itself, cause a contravention of section 66 in respect of the acquisition of those materials.
As discussed in question 1 above, the application of section 66 will depend on whether the building materials are acquired by the SMSF trustee from the original suppliers, with the related party only acting as an agent, or whether the related party acquires the building materials in their own right which are then supplied to the SMSF trustee.
The above scenarios also apply to a property subject to a limited recourse borrowing arrangement where the SMSF trustee engages a related party to improve a property with the fund's own assets.
Example 1
The Smith Superannuation Fund enters into a limited recourse borrowing arrangement to purchase a property.
The trustees decide to use the fund's own resources to improve the property in line with Draft Ruling SMSFR 2011/D1.
The fund engages the services of one of the trustees - Richard - who is a qualified builder.
Richard uses his trade account to purchase the supplies required to undertake the improvements so the fund can utilise his trade discount.
The fund then reimburses Richard for the cost of these materials.
Subsection 66(1) of the SIS Act is contravened in the above circumstance, as the fund has acquired assets from a related party (Richard).
Example 2
Assume the same facts as example 1, but now the SMSF trustees appoint Richard as their agent, and Richard purchases the goods and materials on behalf of the SMSF trustee to improve the property.
The items are purchased in the name of the trustees of the SMSF from the SMSF bank account and at no time does Richard hold legal title to the building materials.
Richard does not use his trade account; therefore the fund does not receive any trade discount.
The SMSF trustees have acquired the materials direct from the vendor, not the related party.
Therefore section 66 of the SIS Act would not apply to the acquisitions.
Nicholas Ali is a Super Concepts Technical Services Specialist.
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