Dealing with compliance complexities impacting overseas SMSF property
An important part of a fund’s investment strategy is for trustees to consider diversification which can take place between investment classes but also within a particular investment class, according to the ATO, and this includes different types of residential and commercial property, not just in Australia but overseas.
In a recent technical update, SuperConcepts technical executive manager Graeme Colley said that while many SMSFs hold Australian real estate, some own overseas commercial and residential real estate which have a total value of $331 million (residential) and $137 million (commercial), respectively.
But he noted that while SMSFs can make the move to overseas markets considering rising prices domestically, there are various issues that need to be considered and will affect the compliance compared to purchasing property locally.
Setting up the overseas property
Setting up the fund’s trust deed is the starting point to see whether it permits the fund to purchase assets outside Australia.
Mr Colley said that most deeds do not restrict the trustee from making investments for assets situated in Australia, but it’s worthwhile confirming there are no restrictions on the SMSF acquiring overseas property.
“All super funds are required to formulate and give effect to an investment strategy which includes property, and particularly overseas property. A review should be made of the investment strategy to see that an overseas property investment can be made,” he said.
“If it’s not in the investment strategy, the trustees may need to amend it to be included. The strategy will also need to consider the nature of the property investment, for example, the risks associated with overseas property and the liquidity issues of holding property.”
When dealing with a related party, Mr Colley noted if the fund acquires an overseas property from a “related party”, such as a member of the fund or a close relative, the investment may be limited to “business real property” (BRP).
Further, this means only BRP can be leased or used by a related party and the trustees need to make sure a market-rate rent is paid, and just because the property is situated overseas, the trustees cannot stay in it even for a short time while they are on holiday.
“Staying in a property that does not meet the BRP definition — in other words, residential property — will result in it being treated as an ‘in-house asset’ (IHA), even where market rent is paid,” he explained.
“In most funds, it’s likely that the fund will contravene the legislation, as value of the property may be greater than the IHA limit equal to 5 per cent of the value of the fund.”
Meanwhile, SMSFs also must ensure no charge over the property, as the superannuation legislation prohibits the trustee from placing a charge over any fund assets.
“However, it is possible to put a limited recourse borrowing arrangement (LRBA) in place. An LRBA allows the fund to borrow to purchase an asset if it is held in trust for the fund and other conditions are met,” Mr Colley said.
“This can prove difficult for overseas property, as a lender may be difficult to find and the laws of a foreign country may not recognise the technical requirements for the fund to comply with the rules for LRBAs.”
The SMSF then needs to consider who holds the title of the property, as the superannuation law requires the trustee(s) of the SMSF to hold the legal title of the property, except for LRBAs or where a custodial arrangement for holding fund assets is in place, according to Mr Colley.
It is common that the foreign country may not recognise the SMSF structure and may require a local entity to be used.
“For example, in the USA a Limited Liability Corporation (LLC) can be used to acquire US property, with the SMSF being the ‘shareholder’ of the LLC,” Mr Colley said.
“This presents some superannuation compliance issues, with the LLC needing to comply with the ‘non-geared entity’ rules under the superannuation law.
“The Australian law applying to LRBAs is that the only assets of the LLC (being the non-geared entity) are property and deposits with banks that are regulated by the Australian Prudential Regulation Authority (APRA).
“A simple act of opening a US bank account (which is not regulated by APRA) in the LLC’s name to receive rent from the property and pay expenses can result in the structure not complying with our superannuation law.”
04 May 2021