This question comes up regularly so let’s split it into two parts before answering it.
Transfer of the property
At first glance, the SMSF would not be able to acquire the property from the member because they are a related party of the SMSF. However, section 66 of the SIS Act does contain a relevant exception to the general prohibition on related party acquisition.
The exception allows the fund to buy what is called ‘business real property’ provided it is transferred at market value. Figuring out whether the property constitutes ‘business real property’ can be straightforward or a little more complex, depending on the type and use of the property, so it’s always best to speak to a professional before proceeding. Basically, it’s property which is wholly and solely used for business purposes.
Both the ATO and the local Duties Office will generally require a valuation to be presented as evidence that the property is being acquired at market value. Ideally, this should be obtained from an independent, qualified valuer to avoid any complications.
Provided the above requirements are met, the SMSF would be able to acquire the property from the member by cash (including borrowing) and/or in-specie contribution. In some states, the transaction is even eligible for concessional stamp duty (e.g. NSW, Victoria or WA).
Transfer of the shares in the private company
Here again, the prohibition would apply but another exception is available. Generally, an SMSF can acquire from a related party an asset even if the investment would be an in-house asset of the SMSF.
The asset must be acquired at market value, which must be less than 5 per cent of the total market value of the fund (this is colloquially called the ‘5 per cent rule’).
As the acquisition of shares in a related private company (i.e. unlisted shares) falls within the definition of an in-house asset, the SMSF is able to buy the unlisted shares from the member (keeping the 5 per cent rule in mind).
However, this investment comes with ongoing obligations as the trustee needs to ensure the market value of the unlisted shares (and any other in-house assets of the SMSF) is carefully monitored each year.
Should the value of the SMSF’s in-house assets go over 5 per cent of the overall asset value of the SMSF, the trustee must either sell some of the shares, sell some other in-house assets or otherwise increase the total value of the assets of the fund to get back below the threshold before the end of the financial year.
Other points to remember:
- The investment must be conducted at arms length to comply with s109 of the SIS Act and avoid non-arms length income consequences;
- The investment strategy of the SMSF must be considered prior to entering into the transaction; and
- The ‘sole purpose’ test must be taken into account.
Michael Hallinan is a special counsel at Townsends Business & Corporate Lawyers.