In-house asset - section 83 says “acquire”

As most people are aware, section 83 of the SISA states that a fund trustee must not acquire an in-house asset if the market value ratio of the fund's in-house assets already exceeds 5%, or would exceed 5% due to the acquisition. 

Often it is assumed that if an asset becomes an in-house asset during the year and the in-house asset is greater than 5% of the assets of the fund then there is a breach of section 83 in that year.  However the word "acquire" which appears in sub-sections 83(2) and 83(3) should not be overlooked and to help us focus on that term, sub-section 83(4) states:

For the avoidance of doubt, a reference in this section to acquiring an in-house asset includes a reference to making an investment or loan, or entering into a lease or lease arrangement, if the resulting loan or investment, or the asset subject to the lease arrangement, would be an in-house asset.

Therefore, if you have an asset or lease agreement which has already been "acquired" prior to it becoming an in-house asset, then section 83 will not apply.  Recently we have come across two scenarios in which this distinction has been important:

1. An SMSF has an investment in a related trust which is not an in-house asset due to the requirements of regulations 13.22C and 13.22D of the Superannuation Industry (Supervision) Regulations 1994 (SISR) being met.  However on 1 July 2016, the unit trust allows a charge to be placed over the property it owns, the result of which is that 13.22C can no longer exclude the trust from being an in-house asset due to the application of 13.22D(1)(c)(ii).

As the units in the related trust were acquired prior to them becoming in-house assets, section 83 of the SISA does not apply.  However, assuming the SMSF still holds the investment in the unit trust as at 30 June 2017, what the auditor will need to do is assess the level of in-house assets on hand as at that date with section 82 of the SISA telling us that if the market value ratio of the fund's in-house assets as at 30 June 2017 exceeds 5% then the trustee(s) must prepare a written plan which specifies the following:

• The excess amount (i.e. the dollar value of the amount over 5%); and
• The steps the trustee(s) proposes to take to dispose of one or more in-house assets equal to, or more, than the excess amount during the next following year of income.

Importantly the plan must be prepared before the end of the next following financial year and the trustee(s) must ensure the plan is executed.

Therefore, despite the SMSF having an in-house asset since 1 July 2016, it has until 30 June 2018 to rectify the situation without there being a breach of the SISA.  Whilst this might seem like a long time frame, often the situation only presents itself when the auditor performs the audit for the year ended 30 June 2017 which might be as late as May or June 2018.  This would then leave approximately one month to dispose of one of the SMSF's in-house assets.         

2. An SMSF owned a property which it began to lease to the parents of the girlfriend of a member of the fund in August 2015.  As the parents of the girlfriend of the member were not related parties of the fund, the property was not an in-house asset of the SMSF.  Five months after the lease commenced, the girlfriend of the member moved in with him and there was enough evidence to suggest the two of them were in a de facto relationship from that time.  Do we now have a related party and in-house asset issue?

A related party of the SMSF is a Part 8 associate of the members of the fund.  Section 70B of the SISA outlines the part 8 associates of a member of an SMSF and we note that at section 70B(1) a relative of the member is a part 8 associate and therefore a related party of the SMSF.

Relative is defined in section 10 of the SISA to be a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the individual or of his or her spouse.  The inclusion of spouse is relevant because once the girlfriend moves in with the member and a de facto relationship is established, she is considered his spouse.  At that point, her parents become related parties of the member of the fund.

Again we have a scenario where an asset was not an in-house asset when "acquired" but subsequently becomes one.  Assuming the parents of the girlfriend continue to rent the property from the SMSF as at 30 June 2016 and the value of the property is greater than 5% of the market value of the assets of the SMSF, then the trustee(s) of the SMSF will have until 30 June 2017 to prepare a written plan and then carry out the steps in that plan to dispose of the excess amount in-house asset.  Interestingly, despite section 82 of the SISA requiring a disposal of the excess in-house assets, the Australian Taxation Office is normally happy for the related party to simply move out of the property.