- SMSF property investing is under the spotlight
- You can’t afford to be sloppy
- If you’ve made one of these mistakes, you need to act now
Tax-effective investing has a golden rule; the more popular the strategy, the greater the chance the taxman will scrutinize it, with a view to shutting it down. The revenue at stake almost demands that position.
This is the Australian Taxation Office (ATO) approach: First, go after the easy cases, the poorly conceived or implemented versions of the strategy. Next, challenge those with a weak technical case in court. Finally, for those with a strong case and perfect execution, change the law.
If you’re investing in property through your SMSF, especially if you’re borrowing through it, the ATO is now at stage one and has you firmly in its sights, as a recent Taxpayer Alert (TA 2012/7) makes clear.
The Taxpayer Alert regime was introduced to enable the ATO to issue early warnings to investors about schemes it wasn’t happy with. It followed the 'mass marketed tax schemes' debacle of the late 1990s. The aim of a Taxpayer Alerts is to put investors on notice that they’re on thin ice.
The latest alert says to SMSF property investors ‘you’ve been warned’. It’s rather vague, a warning in itself that ATO concerns about SMSF property investing are broad, not specific. It identifies three principal areas of concern:
Poor execution of property borrowing arrangements. For example, having the wrong name on the property title or loan, or entering into a contract to buy a property before establishing the bare trust required to own it.
Breaches of basic borrowing arrangement rules. Like acquiring multiple land titles under one arrangement or SMSFs buying property from related parties, or SMSFs buying vacant land for development. All will attract scrutiny.
- Use of unit trusts to avoid restrictions. For instance, a SMSF investing in a unit trust that buys residential property with borrowed money and then leases it to members, thus circumventing the restrictions on use of fund property by members and the prohibition on SMSFs giving security over its assets.
On point 3, a general word of warning. Whilst there may be areas of your affairs where you might be able to push the envelope a little, self-managed super is not one of them. The spotlight on super and SMSFs is too bright.
Using tricky structures to circumvent the intended operation of the SIS Act or other super regulations is an invitation to the taxman to do battle.
The first lesson from the ATO announcement is that SMSF investors need to comply, and be seen to comply, with every detail of the super regime. You can’t afford to be sloppy.
For SMSF property investors, especially those borrowing, this risk is acute. You and your adviser need to go through every aspect of your strategy with a fine-tooth comb. It's an unfortunate cost of the strategy.
In Which assets should I put in my SMSF?, we mentioned the practical difficulties of investing in illiquid assets like property and art. The ATO announcement highlights three principal risks; the risk of messing up the execution; the cost associated with avoiding it; and the ATO not agreeing with you, taking you to court, and winning.
Are you a target?
If you think you’ve made one of these mistakes, or invested in a unit trust arrangement, you should seek independent legal or tax advice now. You may not be able to make the problem go away but you might minimise the damage.
If you’ve invested in one of the SMSF property investment arrangements through an accountant or adviser associated with a real estate developer, you should consider having it checked out, even if you’re not aware of any specific mistakes.
The cost of getting it wrong can be horrendous. Note 4 from the Taxpayer Alert spells it out:
Contravention of SISA provisions may result in an SMSF becoming a non-complying superannuation fund for tax purposes. Where this occurs the SMSF is subject to the 45% tax rate which is applied to its income and the market value of its assets (other than undeducted contributions) measured at the start of the income year in which the fund becomes non-complying. In certain circumstances, the fund's trustee may also be liable to civil penalties or face criminal charges.
Source: ATO Taxpayer Alert TA 2012/7
And there could be tax payable by the individual members, with penalties, on top.
If you’re not a SMSF property investor, the lesson is simply to make sure your SMSF is being run and administered properly.
But if the recent Taxpayer Alert might apply to you, be warned that the ‘scrutinise and shut down’ process has begun and you need to take action, quickly.