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Self Managed Super Fund (SMSF) Article
Best business at arm's length
By Tony Negline.
This article may be out of date.
26th August 2009
Can a super fund run a land development business?
This question often pops up when a super fund trustee either owns land or wants to buy land that it wants to develop for a profit.
The answer to this question can be quite complicated.
In a superseded publication Roles and Responsibilities of Trustees the ATO said, “if a superannuation fund is conducting a business, [the super fund] is not administered for the sole purpose of providing benefits for the members and beneficiaries of the fund.”
However Bryce Figot of DBA Butler lawyers points to minutes of an October 2005 meeting of the National Tax Liaison Group Superannuation Sub-committee which said, "CPA Australia questioned whether the ATO would provide further guidance on whether a fund can carry a business. The Tax Office indicated that there is nothing in the legislation to prevent it. However, there are potentially a number of issues in carrying on a business that might lead to a contravention of the [super laws] … As each case must be assessed on its merits, the Tax Office cannot give a more definitive answer."
The ATO in Interpretative Decision 2003/524 say that a super fund cannot claim a tax deduction for some expenses incurred is setting up a business structure if the business is designed to earn income subject to tax. Effectively the ATO believes that even if a super fund could run a business, it would be denied tax concessions available to other taxpayers.
Figot points to two important Federal Court tax cases which provide guidance on when activities to subdivide or develop land might amount to running a business or a profit-making undertaking or scheme.
The first case was decided in 1988 and involved the deceased estate of a man who died in 1980 and farm land near Kingaroy in Queensland. The deceased man had acquired the land from his deceased father's estate in 1970. In 1976 he sold about one third of the land to his sister and brother-in-law and about another third to an unknown party.
Just prior to his death the deceased man, his sister and brother in law decided to sub-divide their combined land however the Kingaroy Shire Council didn't receive the first application for sub-division until several months after his death.
Between 1980 and 1986 the farm land was progressively subdivided. In the end all the land had been sold.
Once the shire council approved a subdivision application it undertook all necessary subdivisional work (roads, earthworks, sewerage and electricity).
The second case involved a Tasmanian farmer who first purchased land from his father in 1955. Between 1975 and 1993 the farm land was subdivided eight times into multiple allotments.
Professional engineers and surveyors who worked in association with the farmer's solicitor designed all work to subdivide the land. Together these professionals sought Council approval for the subdivision. The consulting engineers supervised all necessary construction work to implement the subdivisions.
In both cases the owners did not participate in selling the subdivided land. Instead they relied upon their agents.
The tax office failed in both cases to show that a business was being run and the Courts decided that the gain was a realisation of a capital asset not ordinary income of a business.
In Figot's view the key points which determine if a taxpayer has begun to conduct a property development business or is completing mere isolated transactions include the following:
- there is a change in purpose for which the land is held
- whether there is repetition and regularity of the activities
- whether the activities are of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business
- the size, scale and permanency of the activity
A super fund that wants to run a business needs to make sure that:
- their investment strategy allows for this
- no trustee receives any remuneration from the super fund for any function they perform in relation to the fund
- it doesn't provide any financial assistance to fund members or their relatives
- no charge is given over any fund asset
- all dealings with any other party are conducted on an arm's length basis
- their trust deed allows the trustee to run a business
One key question for Self Managed Super Funds is how to fund any property development especially if the fund doesn't have adequate resources to fully complete a project.
Most property development activities involve some form of borrowing. Ordinarily a super fund is not allowed to borrow money except for very short periods of time.
A super fund might be tempted to use the Instalment Warrant provisions which allow super funds to borrow under strict conditions.
Under these rules the borrowings can be used to purchase an asset but not for any other purpose such as paying subdivision or development costs.
Figot proposes three potential solutions:
- Borrow to buy the land and the super fund money funds the development – finding a funding source for this solution may be difficult
- Purchase one clear contract (which would be an asset) and that contract covers all development work needed – this option works in theory but probably not in practice
- Borrow to buy units in a unit trust. Unit trust trustee purchases land and conducts development. Great care must be taken with option because it is easy to breach the super laws
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