Paper for presentation at SPAA NC2011

1. Session 13B:
SMSFs & Real Property Applications
SPAA 2011 SMSF National Conference
Wed 23 February 2011 – Fri 25 February 2011
Stephen Heath
Partner, Wallmans Lawyers

2. DICTIONARY
Terms used in this paper:-
"ATO" means the Australian Taxation Office.
"ITAA" means the Income Tax Assessment Act 1997.
"ITAA 1936" means the Income Tax Assessment Act 1936.
"Regulations" means the Superannuation Industry (Supervision) Regulations 1994.
"SIS" means the Superannuation Industry (Supervision) Act 1993.
"SMSFR 2010/1" means Self Managed Superannuation Fund Ruling 2010/1.
"SMSFR 2009/1" means Self Managed Superannuation Fund Ruling 2009/1.
"SMSF/s" means self managed superannuation fund/s within the meaning of SIS.

3. SESSION 13B – SMSFs AND REAL PROPERTY APPLICATIONS
1. Introduction
Participants in the superannuation industry will be well aware of the rise to prominence of SMSFs
over the last 10 years. The rise to prominence has been a veritable revolution both in the
superannuation market (SMSFs represent an ever increasing percentage of total superannuation
funds assets under management) as well as in the broader market place (SMSFs representing
the preferred vehicle for private wealth creation).
The simplification of the taxation rules applicable to superannuation which took effect 1 July 2007
has had a big part to play in the SMSF rise to prominence. The main drivers have been the
abolition of the RBL regime, enhanced flexibility in benefit design options (pension income
streams) and a tax free regime for benefits for members having attained age 60.
The agenda of the ATO to change its interpretation of the Division 7A ITAA 1936 deemed
dividend rules in the context of unpaid past distributions, as spoken for by Taxation Ruling
TR 2010/3, is also considered to be a relevant factor.
1.1. Family Trust Model
The point can be made by reference to observing what the standard models to
structuring real property asset holdings has been and to compare that to current day and
emerging practice.
In the context of related party real property holding arrangements the standard model has
been as follows:
unpaid
distributions
Dump Company
P/L
owns Family Trust
rent
Other owns Trading Company
Investments P/L
Land lease
The common practice has been for a real property used in a business (a private company
being the vehicle of preference for this purpose) to be owned by a family trust, which
extracts rents from the trading company and makes distributions to a "dump company",
which distributions have usually been left unpaid. This has enabled amounts otherwise
representing profits to be extracted out of the trading company and to be retained by way
of a store of value in the trust entity. That in turn has usually meant that trust
distributions have not been paid and instead other investments have accumulated in the
family trust.
However, the ATO have taken an aggressive stance with family trusts in recent times as
follows:-
1) Trust cloning / splitting practices have been stamped out by amendments to CGT
Events E1 and E2 now providing that any attempt to create discrete shares under
a trust, often a desired succession objective, will carry adverse CGT
consequences;
2) Taxation Ruling TR 2010/3 expressing the view that when a trust makes an
unpaid distribution to a company the company's forbearance to demand payment
will constitute financial accommodation of the trust and therefore will be deemed
to be a loan. By virtue of being a deemed loan a deemed dividend (unfranked)
arises by virtue the operation of Division 7A ITAA 1936. Generally speaking
Division 7A has the effect of deeming loans by private companies to

4. -2-
shareholders / associates of shareholders to be dividends paid out of profits of
the company; and
3) Trusts being exposed to demanding trust loss tax rules and being required to
make "family trust elections" for a range of reasons.
A number of problems have therefore emerged with the trust ownership model as
follows:-
1) The risk of deemed dividends;
2) Even if the structure works the standard tax rate is 30% and possibly more tax on
ultimate distribution; and
3) There are succession problems with passing ownership of a trust to the next
generation as creating fixed interests is difficult.
1.2. Superannuation Model
It is now clear that the trust ownership model has been replaced by what might be
described as the "SMSF ownership model". This has seen many trusts dismantled and
the real property assets migrated to SMSFs. The challenge for planners has been to
surmount the limits on superannuation contributions applicable since 1 July 2007 and the
general prohibition on SMSFs borrowing and granting charges.
The SMSF ownership model might be described as follows:-
A SMSF Rent A Trading
Pension
Income Company P/L
Owns
Members A
Family Lease
Over Age 55
Land
Under this model a number of favourable outcomes are able to be locked in:-
1) A Trading Company P/L takes a taxation deduction for its rent expense and the
SMSF only pays 0% / 15% on that income, depending on whether it is in
accumulation or pension phase.
2) Private wealth accumulates in the SMSF without any need to distribute income
with the applicable tax rate on realised gains being limited to 0% / 10%: again
depending on upon whether assets are referrable to accumulation or current
pension liabilities. An effective tax rate of 10% applies when A SMSF derives
taxable capital gains on assets held for more than 12 months (Division 115
ITAA @ general discount for superannuation funds).
3) Once members attain age 55 / 60 pensions can be provided with the usual
outcome being that the proportion of the SMSF assets supporting the pensions
operates under the tax exemption for income referable to current pension
liabilities and with pension income in the hands of the members being tax
exempt / attracting taxation concessions.
4) Succession can also be achieved by next generation family members being
joined as members of the SMSF. In that event contributions by or in respect of
the next generation family members can acquire "equity" in the underlying
SMSF assets as their accumulation account balances grow and the pension
account balances of the elder generation ultimately diminish.

5. -3-
To date the ATO have not applied any "squeeze" on these sorts of practices and in light
of the ATO agenda with family trusts the SMSF model has become the preferred model.
This paper focuses on various real property applications which have emerged with
SMSFs over the last few years as well as seeking to define the range of practices which
are authorised by the superannuation and taxation legislation.
2. Business Real Property
It is common for SMSF trustees to look to acquire real property from related parties and/or to
enter into related party leasing arrangements. The acceptability of those practices depends in a
large degree as to whether or not the real property is "business real property".
There are a number of provisions in SIS which govern related party dealings.
Section 62 of SIS requires superannuation fund trustees to make and maintain their investments
for the sole purpose of funding member retirement benefits.
Section 109 of SIS requires dealings between superannuation funds and related parties to be
struck on terms which do not provide non arms length benefits to the non superannuation party.
Section 295-550 ITAA has similar effect in reverse by taxing income arising to a superannuation
fund from related party dealings, which is considered to be excessive (non arms length income),
at the highest personal marginal rate.
In practical terms the effect of section 109 SIS and section 295-50 ITAA is that all dealings
between SMSFs and related parties need to be struck on an arms length basis.
The most important provisions which relate to real property are section 66 of SIS (prohibition on
acquisitions from related parties) and section 71 of SIS (definition of in-house assets).
2.1. Section 66 SIS
Section 66 of SIS generally prohibits superannuation fund trustees from intentionally
acquiring assets from related parties. "Related party" is defined in section 10 SIS to
include members and employer sponsors in relation to a superannuation fund as well as
relatives and companies / trusts controlled by any combination of any group of such
persons.
An important exception to the general prohibition on related party acquisitions is
contained in section 66(2)(b). Subparagraph (b) applies where a superannuation fund
with less than 5 members acquires an asset which is "business real property of the
related property acquired at market value".
A number of the words and phrases used in section 66 warrant careful analysis and
consideration.
2.1.1 "Acquire" / "asset"
Section 66 only applies in the first instance where the superannuation fund
"acquire(s)" an asset from a related party. There can also be circumstances
where the existence of an "asset" also requires consideration.
The issue of whether there is a relevant acquisition is not always easily
determined. The general law interpretation of "acquire" is broad and includes
transfers for consideration, transfers in specie and property rights acquired by
the granting of rights by another (see Palinkas v Palinkas [2009] NSWSC 92
and Allina Pty Ltd v FCT (1991) 28 FCR 203). In any event as regards
contributions it should be noted that Cook v Benson (2003) 214 CLR 370
stands for the proposition that contributions to superannuation funds are for
consideration by virtue of the accretion to the member's interest in the
superannuation fund. A contribution in specie of real property does raise a
question of how or whether such an acquisition would be at market value. In
light of the limits on superannuation contributions it will be incumbent on the

6. -4-
superannuation fund trustee to record the "acquisition" / contribution by
reference to the market value of the property. The ATO accepts that an in
specie contribution can be at "market value" but that will require the dollar
value of the contribution to be accurately assessed at the contribution time.
2.1.2 Assignments of Contracts
Land acquisitions from unrelated parties will generally not give rise to any
issues. However, an issue does arise where a land contract is written in the
name of a related party of a superannuation fund and the benefit of the
contract is later assigned to the superannuation fund.
Acquires
Land B SMSF
Assigns
Owns contract
Third Party B
Writes contract for
sale of land
The issue is explained in the above diagram. "Asset" is defined in section 10
SIS to mean "any form of property and to avoid doubt includes money" though
"acquire an asset" is defined in section 66(5) as not including acceptance of
money. It should be noted that the SIS "asset" definition, in requiring the
existence of property is a narrower definition then the ITAA "CGT Asset"
definition which extends to contractual rights and other events which do not
require the existence of any property.
An assignment of a contract as described in the above diagram would seem
capable of being described as the acquisition of an asset. The issue arises of
whether rights under a land contact are in the nature of property so as to
qualify as an asset. In the absence of settlement and payment of the purchase
price the position at general law will be that a real property contract will be a
"chose in action" which is most likely "proprietary" though not necessarily an
interest in real property.
Therefore, it may be that the assignment of the land contract from B to
B SMSF in the above example will be an acquisition of an asset which will not
be "business real property" and consequently that would breach section 66.
Whether the ATO would take such a rigorous approach to the interpretation of
section 66 is uncertain. It should be noted that writing the contract as an
"and/or nominee" contract coupled with a contemporaneous letter of
nomination from the superannuation fund would avoid the issue altogether.
2.1.3 Granting of Rights
An issue which sometimes arises in the context of stamp duty and capital
gains tax is the question of the true characterisation of what happens when an
entity grants fresh rights to another party in respect of property. The most
common example of this is the granting of a lease. Other examples include
the granting of options, restrictive covenants and other property rights such as
easements. At general law a lease is not the disposal of a pre-existing asset
but rather the creation of rights by virtue of the grant of the lease. Whilst an
asset, in that context does not seem to be disposed of (see CSD v JV (Crows
Nest) Pty Ltd (1986) 7NSWLR529), it seems from the perspective of the
grantee that an asset will have been acquired "from" another party.

7. -5-
Certainly the general assumption about the operation of section 66 may be that
the granting of options / rights of use / lease in respect of an asset by an entity
to a related superannuation fund would not be considered to be a prohibited
acquisition though on a strict reading and by reference to the general law such
an assumption appears to be optimistic. Whilst it is rare to sight a real property
lease being granted to a superannuation fund the safest interpretation is to
conclude that the "lease" would need to be business real property to justify the
fund accepting the lease.
2.1.4 Market Value
The acquisition of an asset from a related party will not breach section 66 if the
asset is "business real property" immediately before the acquisition, subject to
the acquisition being at "market value". "Market Value" is defined in
section 10(1) of SIS to mean:-
"in relation to an asset, means the amount that a willing buyer of
the asset could reasonably be expected to pay to acquire the asset
from a willing seller if the following assumptions were made:
(a) that the buyer and the seller dealt with each other at
arm's length in relation to the sale;
(b) that the sale occurred after proper marketing of the asset;
(c) that the buyer and the seller acted knowledgeably and
prudentially in relation to the sale."
This definition does accord with the general law interpretation of the term.
Use of the words "the sale occurred after proper marketing of the asset" raises
a "double entendre", one interpretation being that the cost of a full marketing
campaign might need to be set off against the price. A different interpretation
is that an assumption needs to be made about "proper marketing" which
implies that all potential uses of the land need to be contemplated with an
"eye" to the best attainable price.
The classic example is the conundrum of primary production land which has
been rezoned to an authorised residential subdivision usage. There is also a
question about the assessment of market value of land which is likely to be,
but is not yet rezoned.
C Family Trust
Owns
$ Market Value
Farming Land C SMSF
Acquires land as
farming land
The above example demonstrates the point.
It may be that a valuer has provided a certified valuation for the land at say
$1M based on the SIS "market value" definition.
This appears, at least at a superficial level, to be uncontroversial.

8. -6-
The land may comprise 200 hectares and it may be readily determined that the
going price for land having those characteristics and for use in primary
production activities is around $5,000 per hectare.
Land valuation principles are likely to have regard to both existing usages as
well as all authorised usages; including most profitable usage. If residential
subdivision is an authorised usage of the land then there is a question of the
land "market value" if the going rate for subdivision land having those
characteristics is $500,000 per hectare.
It is questionable in those circumstances how a valuer could only assess a
$1M value.
The most difficult scenario is to assess a land acquisition where there is good
reason to believe that broad acre land zoning guidelines are likely to be
relaxed / changed. There is often advance notice of this sort of event since
consultation is usually held with stakeholders and developers are often "in the
know" about activity in certain regions; usually land bordering towns / cities.
In the above example the following course of events might transpire:-
(a) Land acquired by C SMSF for $1M being broad acre farm land of 200
hectares.
(b) Land is rezoned by State Government as rural living authorising
subdivision into 5 hectare allotments able to be improved by
construction of residential accommodation.
(c) A property developer who has been making overtures to C Family
Trust for over 12 months offers a contract to C SMSF for all the land
for a total price of $40M equating to $1M for each notional 5 hectare
allotment. The contract may well carry a long settlement, instalment
payments and may be conditional upon subdivision approval into 40
titles being obtained within say 12 months.
(d) C, the sole member of C SMSF turns age 55 the day before the
contract is written and C SMSF commences a transition to retirement
pension on the day the contract is written.
(e) C SMSF ultimately collects $35M as ultimate settlement of the contract
and after resolution of several contractual difficulties C SMSF records
the $34M capital gain as tax exempt income as being entirely
referrable to C SMSF's current pension liabilities.
(f) The week after collecting the final instalment payment C SMSF is
advised of an ATO audit.
There are obvious tensions with these sorts of scenarios where arguments can
be put supporting compliance with all SIS standards and yet the outcomes
leaving a professional advisor feeling somewhat uncomfortable. ATO audit
activity with respect to SMSFs conducting real property strategies is likely to
result in tensions but ultimately a better understanding of the demarcation
between acceptable and non acceptable practice.
2.1.5 Business Real Property
The most important aspect of section 66(2)(b) is the definition of "business real
property". The ATO provides a detailed exposé of its interpretation to the
"business real property" definition in SMSFR 2009/1.
"Business real property" is defined in section 66(5) as follows:-
"... means:

9. -7-
(a) any freehold or leasehold interest of the entity in real property;
or
(b) any interest of the entity in Crown land, other than a leasehold
interest, being an interest that is capable of assignment of
transfer; or
(c) if another class of interest in relation to real property is
prescribed by the regulations for the purposes of this
paragraph – any interest belonging to that class that is held by
the entity;
where the real property is used wholly and exclusively in one or
more businesses (whether carried by the entity or not), but does not
include any interest held in the capacity of beneficiary of a trust
estate."
A number of observations can be made about the definition as follows:-
(a) The definition clearly extends to freehold / leasehold and Crown land
interests in real property. The ATO notes in SMSFR 2009/1 that
freehold interest will encompass strata title / community title interests.
(b) To date no classes of other real property interest have been specified
in the regulations as anticipated by paragraph (c) of the definition.
(c) The real property must qualify as business real of the related party
immediately prior to the acquisition time. This requires the land to be
used in a relevant business at the time of the acquisition though the
business / businesses need not be conducted by the transferor related
party.
2.1.6 Existence of a Business
The existence of a business is not always easily determined. A transfer
subject to a commercial lease, which may attract the GST going concern
exemption, will usually meet the test since the lessee will conduct a business.
Where there can be difficulties is with land held as trading stock or as what
might be called a "revenue asset", where a lease may have recently terminated
or where land, which is fundamentally commercial in nature, is in the process
of being converted to an alternate usage.
The problem can sometimes be got around by the grant of a fresh lease
immediately before transfer.
The trading stock / revenue asset situation can produce difficulties. Land held
as trading stock, notwithstanding the lack of supporting jurisprudence, does
now seem to be accepted as a relatively common practice by property
developers. The definition of "trading stock" in section 70-10 ITAA merely
requires that an asset be held for the purpose of sale though that must be in
the "course of a business". For SIS purposes "Business" is defined in
section 66(5) as including:
"... any profession, trade, employment, vocation or calling carried on
for the purposes of profit, including;
(a) the carrying on of primary production; and
(b) the provision of professional services;
but does not include occupation as an employee."

10. -8-
This definition probably does not wavier significantly from the general law
meaning of the term.
One thing that may have been overlooked by the ATO in SMSFR 2009/1, or at
least perhaps not have attracted sufficient comment, is that land sales can give
rise to profits on revenue account, without the land being trading stock and/or
there being a relevant business. This seems to be a conclusion able to be
reached from CoFT v Whitfords Beach Pty Ltd 150 CLR 355 and its approval
of the reasoning in the old English decision in California Copper Syndicate v
Harris (1904) 5 Tax Cas 159. Whilst Whitfords Beach involved an extensive
subdivision of 1,584 acres the High Court held that the profits where taxable on
revenue account as ordinary income but did not feel the need to conclude
categorically that the company had conducted a business. The reasoning was
that an isolated transaction conducted in a business-like manner (an adventure
in the nature of trade) with a view to profit would not necessarily be a business
but could give rise to profits assessable on revenue account.
Care therefore does need to be exercised when determining when land is
business real property particularly where the land is considered to be the
subject matter of the relevant business. In SMSFR 2009/1 and 2010/1 the
ATO does accept that land can be held in connection with a land development
business conducted by the owner of the land.
2.1.7 Further Issues with Business Real Property
(a) The whole of the land must be used in a relevant business. Therefore,
if there are multiple tenancies and one is vacant at the transfer time
the definition may not be satisfied.
(b) Water rights as discrete items of property (that is water rights not
entrenched by definition in any associated real property interest) will
not be business real property.
(c) Other interests such as oyster leases / marina berths may be capable
of qualifying as business real property though that will require careful
analysis having regard to the legal characteristics of the rights in
question.
(d) Real property of a fundamental commercial nature will not be
precluded from being business real property because a tenant may be
a "not for profit" entity.
(e) Under the general law fixtures to land will be considered be part of the
land and therefore will not be considered as separate assets and will
pass with ownership of the land. Fixtures are to be contrasted with
items such as plant and equipment, lessee's fit out and items (usually
described as chattels) which may only rest upon the land by their own
weight.
(f) Demountables structures may be fixtures but that will depend upon the
degree of annexation; connection with electricity and water / sewerage
may support demountables as fixtures by virtue of having a permanent
annexation with the land.
(g) The definition of business real property provides that:-
"Business real property does not include an interest in real
property held in the capacity of beneficiary of a trust estate".
This qualification appears to be no more than an affirmation of units in
a real property holding unit trust not being included in the definition. It
is suggested the High Court decision in CPT Custodian Pty Ltd v CSR
(2005) 221ALR196 would compel this conclusion in any event. A unit
holder in a unit trust does not hold a fractional or beneficial interest in

11. -9-
the trust property and the same reasoning will apply to shares in a
company.
(h) Section 66(6) provides that primary production land can satisfy the
"business real property" definition notwithstanding that an area not
exceeding 2 hectares is used for private and domestic and purposes
subject to that usage not being the predominant usage of the real
property.
D Family
D Family $ Market Value Lease
Farming
Trust
Partnership
D SMSF
40 Hectare Acquires
lease of D Family
title farmhouse
½ Hectare
farmhouse
The above transaction will therefore not breach section 66 though it is
suggested that the entire property would need to be leased on
commercial terms. The rent paid by D Family for the farmhouse
should be at an arms length rate, absent which there is a risk of a
breach of section 109 SIS.
(i) Generally speaking residential property will not qualify as business real
property since there will not be a relevant connection with a business.
If a superannuation fund member owns a beach house which is in the
hands of a leasing agent the property will not have a sufficient nexus
with the leasing agent's business. The beach house is not used in the
leasing agent's business as such. The ATO in SMSFR 2009/1 does
accept that a residential property would be capable of comprising part
of an entity's property investment business. Care should be take with
this observation because it is often the case that the establishment of a
portfolio of rent producing properties (residential or commercial) is
more in the nature of a private wealth creation exercise as distinct from
the conduct of a business. Considerable scale and coordination of
operations would be required to enable a safe conclusion about the
existence of a business.
3. Tax Planning and Commercial Issues
Any transaction involving a disposal by a related party of business real property is likely to give
rise to issues of stamp duty, GST and capital gains tax. The convention with stamp duty is that
the purchaser pays and it is suggested that convention should be observed by superannuation
funds in related party dealings.
As regards GST whilst GST is not payable on the supply of second hand residential property
most supplies of business real property will be chargeable with GST. In some cases the supplier
will not be registered or required to be registered for GST or an application of the GST going
concern exemption will avoid the need for GST to be charged. For the going concern exemption
to be available the supply of the land must constitute the supply of the entire enterprise, both
parties must be registered for GST and agree in writing to the application of the going concern
exemption.
This does bring the question of the formalities needing to be attended to in the context of related
party land acquisitions. The temptation usually will be to proceed directly to execution of a land
transfer in registrable form. The striking of a formal contract and a settlement statement to adjust
the rates and taxes etc may be considered to be overly formal. Nevertheless there is no

12. - 10 -
detriment in proceeding in that way and that will ensure that the GST going concern exemption, if
applicable, is dealt with as a term of the contract. In some jurisdictions stamp duty is payable on
the land contract and in practical terms that may necessitate the production of a contract in any
event.
Capital gains tax liabilities can be a deal breaker for some related part transactions. The CGT
event which occurs can however often offer planning opportunities.
Where the desire has been to migrate real property from a related party to superannuation it is
common to seek to apply the Division 152 ITAA small business concessions. For individual and
trust transferor taxpayers the Division 115 ITAA 50% CGT general discount would also usually
apply. The issue sometimes arises as to the mechanics of the retirement exemption under
Division 152-D when the transfer of the property may be intended to qualify as the payment of a
CGT roll-over amount. The ATO issued ATO ID 2003/454 to provide that the transfer of the
asset, giving rise to the gain in the first instance, could also qualify as the making of the CGT roll-
over amount payment. That ATO ID has now been withdrawn as Division 152-D no longer
requires actual capital proceeds. However, the underlying principle remains unchanged that the
transfer of the asset which gives rise to the gain can itself constitute the payment for the
purposes of the retirement exemption. This can alleviate the need for the superannuation fund to
"pay" the entire purchase price.
Section 292-100 ITAA is a relatively new provision (effective 1 July 2007) which provides a
lifetime limit for each individual of $1M for certain capital gains amounts or proceeds to be
conveyed to superannuation. To date the section 292-100 contribution capability does not
appear to have been widely used in the market place.
In a related party transaction section 292-100 can be utilised to enable superannuation funds to
access and effect transactions which may otherwise may not be achievable.
(ii) Promissory Note $1M
E Family E Trading Co E SMSF
Trust Pty Ltd
Owns
Leased
Business Real
Property
(Market Value
$1M) Acquires (i)
E
(iii) Endorsed Promissory Note (iv) Section 292-100 contribution
On the above facts we assume that E Family Trust has owned Business Real Property for more
than 12 months and that the CGT cost base for the asset is $500,000.
A CGT event occurs by E Family Trust selling Business Real Property to E SMSF at its market
value of $1M. The consideration for the acquisition of the Business Real Property is evidenced
by E SMSF drawing a promissory note in favour of E Family Trust (that is, in the first instance
E SMSF does not have any money).
The small business 15 year exemption (subdivision 152-B ITAA) will apply in the following way
and subject to the following conditions:-
1) The small business CGT "basic conditions" must be satisfied. Basically these conditions
require E Family Trust to be a small business entity (group turnover less than $2M) or

13. - 11 -
satisfy the maximum net asset value test ($6M net assets) and satisfy the active assets
test with respect to the business real property.
2) E Family Trust must have owned the Business Real Property for at least the preceding
15 years.
3) In at least 15 years during E Family Trust's ownership period of the Business Real
Property there must have been a "significant individual".
A significant individual in relation to a discretionary trust must be a natural person who
has received distributions of at least 20% of any distributions of income or capital. A trust
will be taken to have had a significant individual in respect of any year of income in
respect of which distributions have not been made.
4) E (on our facts, the relevant person) must be a significant individual of E Family Trust for
the disposal year and the disposal of Business Real Property must be in connection with
E's retirement after age 55 or E's permanent incapacity.
5) E Family Trust must make a payment or payments to a CGT concession stakeholder
within 2 years after the CGT event. On our facts E Family Trust has made a payment to
E by endorsement of the promissory note (described in step (ii)). Notably the amount of
the payment is equivalent to the full amount of the capital proceeds.
The ITAA does not provide guidance on what the characteristics of the payment to be
made by E Family Trust might or should be. The trustee of E Family Trust will need to
find authority under the trust deed for the payment. It is suggested that it might be
described as a distribution of trust capital.
6) All the above conditions satisfied, E Family Trust can disregard the whole $500,000 gain
under the 15 year exemption and in doing so does not adopt the section 102-5 ITAA
method statement and therefore does not apply the CGT general discount (even if
applicable as it otherwise would be here).
7) Under section 152-125 the amount of E Family Trust's payment (in this case $1M to E)
can be disregarded by E Family Trust and E up to the amount calculated as
"Stakeholder's participation percentage x Exempt amount".
The exempt amount is a reference to the amount of the disregarded gain being $500,000
on our facts. The stakeholder's participation percentage, in the case of E Family Trust
(being a discretionary trust), is calculated by reference to the number of CGT concession
stakeholders in relation to E Family Trust for the disposal year. A CGT concession
stakeholder is a person who is a significant individual and a spouse of such a person
who receives any distribution from the trust for the disposal year.
If E is the only CGT concession stakeholder then his stakeholder's participation
percentage will be 100%. That being the case the full $500,000 disregarded gain of E
Family Trust is also disregarded in E's hands.
One might expect that would have been the case in any event without the need for
section 152-125. At least that appears to be the case with discretionary trusts whilst in
the case of unit trusts and companies deriving 15 year exempt gains ultimate
distributions to unitholders / shareholders pro rata to their holdings is required to avoid an
application of CGT Event E4 / dividend outcome.
8) Division 152-B provides a ready entree to an application of section 292-100 ITAA which
authorises contributions to superannuation up to $1M for individuals sourced out of
moneys referable to the Division 152-B concessions.
9) In the context of E Family Trust having made a $1M payment to E for Division 152-B
purposes section 292-100(4) will apply to enable E to make a special style of
superannuation contribution. Section 292-100(4) applies where a trust has disregarded a
capital gain under Division 152-B or where a trust could have disregarded a gain but for
an event not producing a capital gain (this enables an individual to access trust capital

14. - 12 -
proceeds to make a superannuation contribution even if this trust does not make a
capital gain).
10) If E was permanently incapacitated at the time of the CGT event it should be noted that
(for section 292-100 purposes at least) the condition requiring the asset to have been
held by E Family Trust for 15 years is not required to be satisfied. It is a precondition for
this rule that E not have been permanently incapacitated when the asset was acquired
(section 292-100(6)).
11) E must make a contribution to a superannuation fund within 30 days of receipt of the
payment from the trust. The payment is limited to the lesser of the contribution cap
(section 292-105: $1.1M for 2010 year), the payment received from E Family Trust and
the stakeholder's participation percentage applied to the capital proceeds.
12) The least of these amounts is $1M for E and therefore E is authorised to make a
contribution of up to $1M.
13) On our facts E makes the contribution to E SMSF by endorsing the promissory note. For
the contribution to qualify under section 292-100 E must make a choice in accordance
with section 292-100(9) which involves a choice in the approved form being provided to
the E SMSF trustee.
By way of modification of the facts if the Business Real Property was worth $2M and E's spouse
was also over age 55 and retiring then the entire property could still be acquired by E SMSF by
E Family Trust making payments of $1M to each of E and E's spouse and by ensuring that each
of them were CGT concession stakeholders for the disposal year.
This strategy is a powerful means of both migrating value to superannuation and enabling assets
carrying significant capital gains to be migrated to superannuation tax effectively.
In seeking to access this strategy the following circumstances in particular need to be present:-
i) an individual is, retiring / able to procure retirement having attained age 55; and
ii) a business asset must have been held under that individual's control for at least 15 years.
Whilst the conditions to satisfy section 292-100 can obviously only be met in very specific
circumstances it should be noted that this outcome can apply notwithstanding that:-
i) the business real property is a pre-CGT asset (section 292-100(5)); and
ii) even if the capital proceeds do not produce any capital gain the contribution able to be
made to superannuation is only limited by the contribution's stakeholder's participation
percentage and the amount of the capital proceeds and not the gross capital gain
(section 292-100(4)(a)).
4. Section 71: In-House Asset Definition
It is often desired that SMSFs make their real property assets available to related parties for their
use. There is an impediment to this provided by the in-house asset standard which includes in
the in-house asset definition:-
"an asset of the fund subject to a lease or lease arrangement between a trustee of the
fund and a related party of the fund...".
A superannuation fund will breach the in-house asset test if it makes an investment which is an
in-house asset, the value of which exceeds more than 5% of the total superannuation fund net
value.
"Lease arrangement" is broadly defined in section 10 of SIS to mean:-
"any agreement, arrangement or understanding in the nature of a lease (other than a
lease) between a trustee of a superannuation fund and another person, under which the

15. - 13 -
other person is to use, or control the use of, property owned by the fund, whether or not
the agreement, arrangement or understanding is enforceable, or intended to be
enforceable, by legal proceedings."
Therefore, prima facie, related party leasing arrangements (involving all styles of lease / making
available for arrangements) by SMSFs are all but prohibited as giving rise to in-house assets.
There are, however, some important exceptions to the in-house asset definition as follows:-
4.1. Section 71(1)(g) of SIS which applies to funds with less than 5 members. This provision
excludes from the in-house asset definition:-
"real property subject to a lease, or to a lease arrangement, enforceable by
legal proceedings, between a trustee of the fund and a related party of the
fund, if, throughout the term of the lease or lease arrangement, the property is
business real property of the fund (within the meaning of subsection 66(5))".
4.2. Section 71(1)(i) which excludes assets which are held on a tenancy in common basis
with a related party. Such an asset (not being business real property) will however be an
in-house asset if it is subject to a lease or lease arrangement with a related party.
4.3. Section 71(1)(j) which excludes "an asset included in a class of assets specified in the
regulations".
Division 13.3A of the Regulations specifies regulations for that purpose.
The effect of Division 13.3A is to exclude from the in-house definition investments by
SMSFs in related companies and trusts (generally that is any such entity which the SMSF
and/or its related parties control, usually evidenced by majority shareholding / unit
holding) subject to the company / trust balance sheet meeting SIS requirements as if that
entity was the superannuation entity.
Therefore, if a controlled company / trust merely owns a business real property which is
not mortgaged or acquired with borrowed moneys the shareholding / unit holding would
not be an in-house asset.
Owns
F P/L BRP
100% Shares
F SMSF
F P/L BALANCE SHEET $
Assets Liabilities & Equity
BRP 1,000,000
Accrued Rent 50,000
50,000 Retirement Earnings
1,000,000 Paid-up Capital (F SMSF)
Assuming F Pty Ltd's balance sheet is clear as above; that is, there are no borrowings or
investments which, if made by F SMSF direct might compromise compliance with SIS,
the F SMSF shareholding will not be an in-house asset. If F Pty Ltd had therefore

16. - 14 -
borrowed to support some of the purchase price Division 13.3A would not apply and the
F SMSF shareholding would be an in-house asset. It is not always clear why a
superannuation fund would want to hold a property in this way.
Returning to section 71(1)(g) if a related party lease is not to result in the underlying asset being
an in-house asset then it should be noted that
1) The lease needs to be enforceable by legal proceedings. This means that there must be
a written lease evidencing commercial terms of leasing though it should not be necessary
for the lease to be registered.
It is worth contemplating how the SMSF would / should act in the event of default of
payment of rent or if there is some other breach of the lease by the related party lessee.
2) The property must remain business real property throughout the term of the lease. If the
property ceases to be business real property the termination of the lease will suffice to
avoid the property becoming an in-house asset as there would not then be any related
party leasing arrangement.
3) Business real property only includes the land in question and fixtures to the land but not
otherwise any other asset / property held in connection with the land. Any associated
assets not being fixtures to the land will not be business real property.
5. Borrowings / Mortgages: Unit Trusts and Instalment Warrants
Superannuation funds are generally prohibited from borrowing (section 67 of SIS) and granting
mortgages / charges (Regulation 13.14 of SIS Regulations). This has been an area of tension in
planning going back beyond the advent of SIS. Prior to 11 August 1999 (when the in-house rule
was modified) it had been possible for superannuation funds to avoid making an in-house asset
investment by acquiring units in a controlled unit trust and then procuring the unit trust to borrow
and grant security. That never sat well with the Regulator and that exact structure was
challenged in Trevisan's Case (Trevisan v FCT (1991) 91 ATC 4416) where the Federal Court
held that units in a unit trust are not an investment in the trustee and in consequence of that the
units were not in-house assets under the definition which applied at the time.
On 11 August 1999 the in-house asset definition was reworded to provide a definition of "related
party" and "related trust", an investment in any such entity from that time by a superannuation
fund being an in-house asset. Since then there has no doubt been much thought given to how a
SMSF might invest in a controlled entity without making an in-house asset investment. The new
provisions appear to have been effective to achieve the intended outcome.
5.1. Investments in Unit Trusts
The SIS prohibitions on borrowings does raise a question of the circumstances in which a
superannuation can invest in another entity. This issue is determined by whether or not
such an entity is a "related party" or "related trust" of any investing superannuation fund.
The example below gives insight into investment arrangements which may be
acceptable.
Acquisition
G Unit Trust Land
unitholdings $
loan Mortgage
@ @ @
A B C Bank
SMSF SMSF SMSF

17. - 15 -
G Unit Trust will not be a related party / related trust of any of the SMSF unitholders
provided it does not contribute to any of those funds as a standard employer sponsor and
provided the members of the different funds are not relatives of each other or partners of
each other in a business. This assumes as outlined above that the unitholdings are @
each as between the unitholders (see further comment below about how G Unit Trust
might be controlled). If G Unit Trust was a related party / related trust of any of the
investing SMSFs then the referable unitholding would be an in-house asset and by
reference to the 5% authorised threshold for in-house assets, it could be expected that
the in-house asset standard would be breached.
Section 70E(2) of SIS provides that G Unit Trust will not be "controlled" (and hence not a
related trust / party) in relation to any of the investing superannuation funds unless a
group (any combination of associates in relation to that fund) hold fixed entitlements to
more than 50% of the units, controls the trustee or controls the appointment and removal
of trustee. One would ordinarily expect that in the context of @ unitholdings that no
unitholder, together with its associates, would control the trustee or the power of
appointment and removal of trustee.
Notwithstanding the borrowing by the G Unit Trust and the granting of a mortgage by it,
both actions will be actions of the G Unit Trust trustee and therefore cannot be attributed
to the unitholders.
There is an issue of personal guarantees which are sometimes required of proprietors /
natural person controllers of proprietors by financiers. This does raise a question of
whether the guarantees result in a need for a guarantee fee to be paid so that the
arrangement is able to be justified as being maintained on an entirely commercial basis.
Experience suggests that the Regulator has generally tolerated this though it may not be
a matter which "sits that comfortably".
One sometimes encounters a structure such as G Unit Trust operating as a hybrid trust.
Non-superannuation entities invest together with superannuation entities with the
different parties holding units carrying different rights. Non-superannuation entities may
borrow, be seeking a tax deduction for their interest expense and hold units which carry
preferential but limited income entitlements with only a right to return of capital on
winding up or redemption. The superannuation fund unitholders may hold units carrying
rights to all other income and capital. This style of structure does carry a risk of the
income flowing to the superannuation funds being deemed to be non arms length income
under section 295-550 ITAA by the ATO. This sort of strategy admittedly does carry
some intuitive appeal though more often than not results in disappointment (see Colonial
First State Investments Ltd v Commissioner of Taxation [2011] FCA 16)
5.2. Borrowings: Instalment Warrants
Section 67A of SIS authorises superannuation funds to borrow in specific circumstances.
This is a controversial provision which enables SMSFs to access real property
investments (and for that matter any other style of investment generally authorised)
otherwise not accessible to business proprietors or otherwise requiring a more
cumbersome ownership structure; tenancy in common for example. The diagram below
describes how an instalment warrant borrowing might proceed:-
Personal guarantee
Limited
recourse loan
H H SMSF Bank
Member
Nomination Mortgage
H Nominees P/L Land
Legal title

18. - 16 -
Borrowing is authorised under section 67A subject to:-
5.2.1 A split between legal and beneficial ownership as between H SMSF and
H Nominee P/L.
This does raise the question of whether the terms of bare trust are such as to
constitute a Division 6 ITAA 1936 trust estate. On the basis that the
superannuation fund is required to be the beneficial owner of the land it is
suggested that that would not be the case. The circumstances of a bare trust
relationship are more akin to H SMSF being absolutely entitled to the asset as
against H Nominees P/L in which case the "trust" would not be so much a
Division 6 ITAA 1936 trust as a section 106-50 ITAA style trust (where the
beneficiary is absolutely entitled as against the trustee in which case the trust
is disregarded for tax purposes);
5.2.2 The borrowed money being applied to the acquisition of a specific asset; and
5.2.3 Lender recourse against the borrower being limited to the asset which has
been acquired with the borrowed money.
This means generally speaking that the loan to valuation ratio limit will be conservative,
the loan will be principal and interest (with no capitalisation of interest) and the loan term
will be short, probably not exceeding 15 years. Some / most arms length lenders are
likely to require supporting personal guarantees. This has caused controversy by virtue
of the guarantor's right of subrogation, to the extent it may arise, resulting in
indebtedness of H SMSF to H which will be a SIS breach. Industry reaction to that has
been to document these arrangements by severing the right of subrogation thereby
avoiding any offending indebtedness ever arising. Whilst an effective response to the
problem it does suggest that any guarantee payment by H would be taken to be a
contribution to H SMSF which is in fact the view held by the ATO. There may be
consequences of that by virtue of the ITAA limits on superannuation contributions.
A vendor financed related party acquisition is capable of satisfying the section 67A
requirements though care should be taken to ensure that the terms of such an
arrangement are on an arms length basis.
Vendor finance converted to loan
I Family Trust I SMSF
Acquires land
$500K & $500K vendor finance
Owns Deed of
Nomination
BRP $1M Value Legal title
I Nominees P/L
Mortgage
There does not seem any reason on a literal reasoning of section 67A that related party
financing arrangements cannot occur. The instalment warrant borrowing concept within
superannuation is relatively new and it remains unclear whether the underlying policy will
continue to support these arrangements.
Matters requiring careful attention with instalment warrant borrowings supporting real
property acquisitions are as follows:-
1) Where the real property is intended to be developed / subject to capital works
expenditure after acquisition.

19. - 17 -
2) Where one borrowing is made with respect to a multiple title acquisition.
3) A longer term borrowing may result in tax losses accruing in the superannuation
fund if the borrowing remains on foot when the fund moves into pension phase.
4) Approach to be taken when the debt is ultimately repaid. It is not compulsory
that legal title be conveyed at that time and in fact there could be adverse stamp
duty ramifications.
5) Registration of the superannuation fund for GST purposes is likely to be required
and this will be best dealt with by the nominee acting as an undisclosed agent.
6. SMSFs which own Real Property and Pay Pensions
There is a question of whether SMSFs which may be top heavy in illiquid real property
investments will be capable of supporting long term pension liabilities.
rent @ 7%
property value
J SMSF J P/L
owns
pays
pension
income Business Real lease to
stream Property
J Member
Assumptions:
1. Pension payments are paid on the minimum pension for account based pensions under
Regulation 1.06(9A) of SIS Regulations.
Extracting from Schedule 7 of the Regulations the relevant age brackets and pension
factors for assessing the minimum pension payable are as follows:-
Age Brackets % Factor
65 – 74 5
75 – 79 6
80 – 84 7
85 – 89 9
90 – 94 11
The percentage factor is the percentage to be applied to the pension account balance at
the start of each year. For a pensioner aged 65 with a $100,000 account balance at the
start of a year, that would mean a minimum pension of $5,000 for that year.
2. Valuation of property at commencement $1M.

20. - 18 -
3. Pension is commenced for J at age 65.
4. Business real property is the only asset of J SMSF at commencement of pension.
5. CPI is 3% for each year during the term of the pension and rent / capital value of property
is assumed to increase at that same rate equally throughout the pension term.
6. Investments accruing from net rents yield at 6% per annum.
Issue: Capacity of J SMSF to support Pension
The issue to be assessed is the question of sensitivity of the illiquid business real property asset
and the supporting rents to the ability of J SMSF to satisfy minimum pension payment obligations
over the term of the pension.
Age of Account Balance at Year of Value of Business Value of Other Pension
J Commencement ($) Real Property ($) Investments ($) Payable ($)
65 1M 1M 0 50,000
70 1,267,538 1,159,274 108,264 63,377
75 1,583,205 1,343,916 239,289 94,992
80 1,869,015 1,557,967 311,048 130,831
85 2,101,417 1,806,110 295,307 189,127
90 2,166,449 2,093,796 72,653 238,309
91 Deficiency not
available to
support pension
Conclusion:
The illiquid investment does support the pension for many years (on these assumptions for 25
years) but that outcome is directly dependent upon sustained cash flow return exceeding 6%.
That of course assumes a consistent fund earning rate of 6% on other investments and 7% rent
yield on the property.
Once the pension rate (at ages 85 – 89 at 9%) escalates above the property yield / return on
other investments the superannuation fund soon becomes insolvent from a cash flow
perspective. The ATO does not accept that pension payments can be funded by in specie
distributions. At age 91 it would therefore be incumbent upon the trustee to take some action.
That might be any of the following actions:-
1. sale of the property;
2. termination of the pension and payment of superannuation lump sum commutation;
3. termination of the pension in whole or in part with the commuted amount reallocated to a
member's accumulation for J; or
4. admit cash contributions in respect of another member.
The investment returns of the fund are sensitive to:
1. no defaults on rent payments;
2. costs of running the fund not being excessive; and

21. - 19 -
3. land holding costs; capital improvements / repairs may be incurred. Land tax and other
landlord liability issues all involve unforseen cost for the landlord.
The outcome of this case study is not surprising. In short, cash returns on investments need to
roughly match the percentage factor under Schedule 7 of the Regulations. The modest
percentage factors up to age 85 are helpful in assisting superannuation fund trustees to proceed
with some confidence in ensuring that fund liabilities can be met as and when they arise.
The relaxed benefit design rules (ability to commute pension back to accumulations at any time
for example) which have applied since 1 July 2007 do provide assistance to funds with cash flow
issues.
7. Land Speculation in Superannuation
Land speculation in superannuation gives rise to many issues. There is interest in SMSFs
operating in this area as many SMSFs are cashed up and have funds available to fund
acquisitions / infrastructure works of real property. Also many land speculators are aware of the
potential "super profits" able to be extracted from speculative land activity and will be desirous of
accessing the concessional tax rates available to superannuation funds.
The role of superannuation and trusts has historically been to invest in relatively passive and risk
averse investments. Section 350 of SIS does specifically provide for the operation of trust law
generally and does provide for all applicable State and Federal law to apply to SMSFs.
As regards trust law the attitude to speculative investments is commented on in Jacobs: Law of
Trusts in Australia (7th Edition) at para [1806] as follows:-
"A discretion to invest, however wide, will not permit speculation by a trustee. Even if the
investment is authorised, the trustee must act prudently and must be satisfied that the
particular security is one which will protect the trust assets."
There is authority for this statement contained in Sidey v Huntly (1900) 21 LR (NSW) Eq 104.
Coupled with this fundamentally conservative position the statement is often made that
"superannuation funds cannot conduct businesses".
There is an issue then of the extent to which SMSFs might be justified in indulging in speculative
real property activities. Notwithstanding the above comment modern day practice involving most
trusts being managed and conducted by trustees for their own benefit and/or the benefit of their
family has blurred the obligation of trustees to act in such a strictured way. Rather the modern
day view seems to be more along the lines that beneficiaries do not require the assistance of
equity when they also act as trustee or perhaps put another way, members of a family group (at
least when harmony prevails) are not generally inclined to pursue actions for breach of trust.
7.1. Can SMSFs conduct property developments / subdivisions?
The ATO seems to accept the modern day view expressed above in SMSFR 2009/1 and
SMSFR 2010/1.
The issue is more a matter of "how" than "if".
Section 62 of SIS requires that superannuation fund trustees effect and maintain their
investments with the sole purpose of funding retirement benefits for the members. There
is an issue of the tension between that requirement and a land speculator seeking to use
their SMSF as a warehousing vehicle for taxable profits. To date there is little evidence
to suggest that the regulator is particularly concerned about this though the question of
where the "goal posts" stand may be a matter which is tested more rigorously over the
next four years.
The ATO however does touch on two issues in SMSFR 2009/1 and SMSFR 2010/1
which warrant consideration:

22. - 20 -
7.1.1 Lessee's Improvements
If a SMSF acquires vacant land and grants a head lease to a related party
authorising it to conduct capital works on the land to support a subletting
arrangement the ATO suggest that that will give rise to the acquisition of an
asset by the fund from that related party head lessee. The implication seems
to be that that asset will not be business real property and therefore will breach
section 66 of SIS.
Such a strategy might be explained in the following terms:
Head Lease
K SMSF Related Party
(Long term lease
around 40 years)
owns sub-leases
capital
works
Vacant Land Tenants
Under this model the following outcomes can arise:
(a) interest deductibility for expenses incurred by the Related Party in
borrowing to fund the capital works should be available;
(b) Division 43 ITAA capital works write off for Related Party at 2½% of its
expenditure spread over the 40 year term of the head lease;
(c) financial modelling of rents on head lease and sub leases to justify
commercial return to Related Party over the term of the lease. This
will require consideration to the cost of the capital works, the cost of
servicing any debt capital works expenditure and rent under the head
lease relative to the benefit of the Division 43 deductions, rents on the
sub leases and any benefit from a back end compensation payment;
(d) on termination of the head lease the Related Party may become
entitled to "sever and remove" the lessee's improvements and/or a
right to compensation from K SMSF for the value of the lessee's
improvements;
(e) K SMSF will own the land and all fixtures to the land; and
(f) rents from the head lease flow to K SMSF with any capital gain arising
to K SMSF on ultimate disposal and rents derived by the fund deriving
the taxation concessions applicable to superannuation funds.
The ATO suggests there may be an offending acquisition of an asset by
K SMSF from the related party by virtue of the capital works funded by the
Related Party passing for the benefit of K SMSF as the owner of the land.
That is in consequence of the general law position that an owner of land owns
everything which is affixed to the land.
What asset it is that is said to be acquired from the Related Party, and when it
is acquired, is not clear.
The ATO view may be correct though it is suggested that it strains the words to
suggest that anything is acquired "from" the Related Party and to suggest that

23. - 21 -
whatever might be acquired can be characterised as an asset which is not
business real property.
7.1.2 Building Contracts with Related Parties
The ATO contends for the view that benefit obtained under a building contract
with a related party will constitute the acquisition of an asset if "product" is
obtained under the contract as distinct from mere services.
Building Contract
Super Fund Related Party Builder
owns
Land Arrangement of infrastructure /
subdivision works
The above arrangement might be generally acceptable for superannuation law
purposes subject to the superannuation fund both acquiring the land and
striking the building contract on arms length terms.
However, the ATO contends that if the builder provides anything other than
services (that is "product" for infrastructure / building works) then that will be
the acquisition of an asset from the builder.
Again, the ATO could be correct, though it does strain the words to suggest,
when one strikes a building contract that involves the builder sourcing product,
that that involves the landholder acquiring an asset from the builder.
It may be that if the builder can proceed by acting merely as the agent for the
superannuation fund in the acquisition of all product, that the building contract
can be characterised as only a contract for the provision of services. This may
not be practical for builders accustomed to sourcing product through trade
discounts for all their building activities though acquiring as an undisclosed
agent may be the practical solution.
8. Conclusion
The SMSF revolution and the Australian appetite for real property investments means that the
superannuation model described in paragraph 1.2 above has come into mainstream use.
Further, other strategies have emerged and will continue to emerge if the existing legislative
framework remains in place. It is suggested that the underlying policy considerations will come to
be tested at some point and that, even if legislative change does not follow, the ATO will
ultimately come to test, more rigorously than it has to date at least, the boundaries of acceptable
practice.
Come what may, well considered real property strategies should continue to serve the interests of
SMSF members for the foreseeable future.
Stephen Heath
Wallmans Lawyers