The strategy of transferring ownership of a commercial property to the business owner’s self managed superannuation fund (SMSF) has, at first glance, several advantages for both the business concerned and also for the members of the SMSF.
For starters, all lease payments made by the business don’t end up in the pocket of a third-party landlord, but are investment earnings in the hands of the SMSF (and as such are taxed at 15%). Also any capital growth in the value of the business premises is realised much more tax-effectively.
There is also the possibility, depending on the state or territory in which the property is located, to transfer “business real property” into an SMSF with concessional stamp duty. As well, the business premises can be acquired by the SMSF using a limited recourse borrowing arrangement where the loan is supplied by a related party (subject to the arrangement being made at market rates and conditions).
But many SMSF trustees, and indeed their advisers, can sometimes fail to recognise that however tempting the benefits may seem for SMSF ownership of business premises, there are also potential pitfalls that can sometimes, especially after the passage of time, loom unexpectedly on the horizon.
Financial difficulty and a Catch 22
The fortunes of business life are never assured, and while most Australians running a business will be doing so diligently and with competence, there is more to securing financial success than merely having an ABN. That one’s SMSF owns the premises from which the business is run has little to do with making profits or losses.
Were the business to run into financial difficulties and faced problems finding rent money, then as trustee of the property-owning SMSF one is expected to take recovery action. The fact is that one very real option here would be to evict one’s own business from the premises.
And should severe difficulties arise, a business can fall into insolvency. While the assets held by an SMSF generally have a level of protection from debt recovery proceedings, a bankrupt person is prohibited from acting as a trustee of the fund, and their account may be, in effect, frozen. The results can be catastrophic for the continued viability of the SMSF, and under these circumstances the fund may have to be wound up.
CGT and the cessation of an income stream
The Tax Office confirmed in a draft ruling that a superannuation income stream, or pension, ends when there is no longer automatically a member who is entitled to it — that is, the pension ends when the life of the member ends. Where there is no “reversionary beneficiary” who may be automatically entitled to keep receiving the income stream, the fund reverts to accumulation phase. As such, any sale or transfer of assets may be subject to capital gains tax (CGT), and in the case of a sizeable asset in terms of value such as the commercial property, especially if it has been held for a number of years, a capital gain has the potential to be quite large.
Many members of an SMSF may have at the time of their death financially independent adult children. One result of the distribution of benefits (the payment of which is typically taxable at 16.5% to the deceased member’s adult offspring) could be a huge tax bill payable by the beneficiaries. The added possibility is that cash in the fund will also be scarce as the main asset to be distributed is the commercial property. In some cases this could also necessitate the sale of the premises to raise the necessary cash to pay out beneficiaries.
Succession planning undone
Family businesses may intend for the next generation to take up the baton, but having the business premises owned by the previous generation’s super fund may put an unintentional pothole in an otherwise smooth succession plan. In addition to the tax issues of transferring the property to the next business operator, mentioned above, there are potential issues that will possibly be given oxygen through a change to the business property’s ownership.
One is that the “next generation” may indeed be comprised of additional family members who may not intend, or want, to follow in the last generation’s footsteps — but still expect, and be entitled to, a share of the wealth that has been built. A forced sale of the business premises in question may also be initiated by relationship breakdowns, the risk of business creditors, disputes between beneficiaries or a large tax liability to be paid.
So while there are indeed benefits to be had through having business premises owned by one’s SMSF, the fact is that there are other potential issues that may have to be eventually dealt with — and that may be able to be ironed out with appropriate strategies. Forewarned is forearmed.