One popular investment strategy employed by many small business owners is to have their business premises owned by their self-managed super fund.
There are three principal benefits of this strategy:
- An important business asset is held in a tax-effective structure.
- In the event of financial difficulty, creditors often find it more difficult to attack super fund investments (however, 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 an SMSF owns real estate it is common to want to lease it to a ‘related party’ of the fund. When this occurs, then the property must be considered ‘business real property’ (BRP).
In general, BRP is real property used wholly and exclusively in the running of a business. The definition of business real property is quite complex, and in 2009 the Australian Tax Office released a 70 page ruling – SMSFR 2009/1 – on this topic which contains 37 examples. If business real property is being acquired by the SMSF from a related party, then all the rules relating to related party transactions apply.
If the property is not BRP, then the asset will be considered an ‘in-house asset’. As discussed elsewhere, super funds with in-house assets need to make sure their fund’s total in house assets do not exceed 5% of the market value of its assets. Corrective action must be taken if there is a breach.
When business premises are leased by an SMSF to a business, it is important the transaction occurs at ‘arm’s length‘. To make matters simple, the fund should have a formal lease between it and the tenant. The terms of the lease should be independently verified by a recognised person, such as real estate agent involved in real estate in the property’s area.
As the trustee, you must be prepared to enforce the terms of the lease. Lease payments must be paid on time or the 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 homers.
The business is run by Jim and Mary, who have their eye on new, larger premises that have recently come on the market for $1 million. The problem is the business can only raise $500,000 for the purchase and therefore doesn’t quite have the financial muscle to buy the property.
Jim and Mary have their own SMSF, which has $600,000 in the fund. They decide that the business and the super fund should purchase the property as tenants in common.
To do this, the super fund must make sure the business does not use the property as security when borrowing to pay for its share of the asset. Once purchased, the business will need to pay rent to the SMSF, at arm’s length.
A benefit here is that a portion of the property is held in a more tax effective vehicle.