"Business real property" explained.
One popular strategy employed by many small and medium business owners is to have their business premises owned by their self-managed superannuation fund (SMSF).
There are three principal benefits of this strategy:
An important business asset is held in a tax-effective structure (super is generally more tax-effective than other investment vehicles).
In the event of financial difficulty, creditors often find it more difficult to attack super fund investments (although there are mechanisms for creditors to unwind transactions involving super funds).
By using the capital held in a super fund, a business can more efficiently make use of its own balance sheet.
When a super fund owns real estate, it’s common to want to lease it to a related party of the fund. When this occurs, the property must be business real property (BRP).
Related parties of your fund include all its members, all their relatives and entities that those members and relatives control, or are deemed to control.
Business real property
In general, BRP is real property used wholly and exclusively in the running of a business.
If the property is not BRP, then the asset will be considered an in-house asset. Super funds with in-house assets need to make sure that their fund’s total in-house assets do not exceed 5 per cent of the market value of all the super fund’s assets. If there is a breach, then corrective action must be taken.
The BRP rules apply when a person or business wants to sell business premises to a super fund.
The official definition of BRP is quite complex. In fact, in 2009, the Australian Taxation Office released a 70-page ruling – SMSFR 2009/1 – on this topic, which contains 37 examples. As you might gather, the definition of business real property also includes many farms which contain a maximum area for housing.
When business premises are leased to a business, it’s important that the transaction occurs at “arm’s length”.
To make matters simple, it’s best that the super fund has a formal lease between it and the tenant. The terms of the lease should be independently verifiable. This verification could be obtained from a recognised professional, such as a property or real estate agent involved in real estate in the property’s area.
The super fund’s trustee must be prepared to enforce the terms of the lease. Lease payments must be paid on time or various penalty clauses must be enforced as they would for a third-party lease.
Jim the Hardwareman is your local specialist store specialising in hard-to-find heritage items for renovators of older homes.
Jim and Mary run the business and have their eye on new, larger premises that have recently come on the market for A$1 million. The problem is that the business doesn’t quite have the financial muscle to purchase the property. The most they could raise is A$500,000.
They have their own SMSF which has A$600,000 in the fund.
Jim and Mary decide that the business and the super fund should purchase the property as tenants in common.
The super fund must make sure that the property is not used as security for any borrowings that the business needs to enter into to purchase its share of the purchase price.
Also, an arm’s length rent needs to be paid from the business to the SMSF.
A benefit here is that a portion of the property is held in a more tax-effective vehicle.
Transferring your business premises into your SMSF
Suppose you personally own, or your business owns, commercial property. Also suppose you have a reasonable sum of money in your super fund. If circumstances allow, you might be interested in putting this property into your super fund.
If the commercial property is in the right state, you might be entitled to stamp duty exemptions or concessions. New South Wales (NSW)Queensland, South Australia and Victoria all have stamp duty concessions when a commercial property is transferred into a super fund.
The concession is different in each state, however. In South Australia, for example, it only applies to rural land. In Victoria it only applies if the property is transferred for nil consideration – that is, it has to be an in-specie contribution.
In all states you should obtain specialist legal advice so you’re sure you can claim it and obtain it in the correct way.
One important consideration that needs to be factored into these transactions is Capital Gains Tax (CGT), which would be paid by the current owner. As the asset is moving from one owner to another, CGT will be payable. This will apply even when an in specie contribution is made. It may be that you’re eligible for small business CGT concessions, which would reduce or even remove the amount of CGT owing.
Again, you should receive specialist advice about these rules because they’re some of the most complex tax laws around.
In NSW, using the available stamp duty concessions and limited recourse borrowing arrangements (aka “super gearing”) is beginning to become very popular when an investor, or their business, owns the commercial property unencumbered.
One feature of super gearing is that anyone can loan money to the super fund. As a result, many small business property owners are using these provisions to loan money to their super fund so it can purchase the commercial property.
There are a number of essential steps in these transactions, such as the need to make sure the terms of the loan – for example, the interest rate charged – are based on similar arm’s length arrangements.
Using super gearing is particularly popular when the super fund doesn’t have sufficient money to purchase the property outright.
Before this type of transaction is contemplated, it’s essential to consider your super fund’s investment strategy. For example, what are the cash flow impacts on the super fund if the property remains vacant for an extended period of time?
Also, normally it’s essential to hold real estate for a medium to long term and this must be a key part of your consideration.