By Mark Ellem
Thinking about SMSFs and property? How about something overseas?
Shares and property are always linked closely to SMSFs. Property is always a popular discussion topic, given that SMSFs can borrow to acquire property and how it’s alleged to affect capital city prices. However, SMSFs are not limited to Australian property and can opt for investing directly in property overseas. After the GFC, we saw increased interest in buying U.S. property due to a decline in housing prices and the strength of the AUD at that time.
So, can an SMSF acquire property overseas and, if so, what additional issues compared to Australian property should be considered?
The superannuation law governing fund investments is the same for property, whether acquired in Australia or overseas. Here are some discussion points to consider when contemplating buying property outside Australia.
Does the fund’s trust deed permit the purchase of assets outside Australia? Most deeds should not restrict assets to only those situated in Australia. However, it is always worthwhile confirming that it does in deed (pardon the pun) allow the SMSF to acquire overseas property.
The fund is required to formulate and give effect to an investment strategy which must allow for property, and particularly overseas property. A review of the investment strategy should be done and any amendment made. It will also need to consider the nature of the property investment, for example, the risks associated with overseas property and the liquidity issues of holding property. Refer to our previous blog article Our love affair with property – a liquidity risk?
Property acquired from a ‘related party’ must satisfy the requirement of ‘business real property’ (BRP). Further, only BRP can be leased or used by a ‘related party’ and market rate rent needs to be paid. Just because the property is situated overseas, don’t think you can get away with staying in it for a short period whilst in the neighbourhood. Staying in a property that does not meet the BRP definition, will cause the property to be treated as an ‘in-house asset’ (IHA), even where market rent is paid. In most funds, the value of the property will be more than 5% and consequently the IHA rules will have been contravened.
Unless the property is acquired under the specific limited recourse borrowing rules and good luck finding a lender who will provide finance that complies, there should be no charge over the property. For property situated overseas it can be difficult to ensure that this is the case, particularly where the country does not have an Australian style register of titles. Further, when attempting to confirm whether a charge exists, non-English-speaking countries can present challenges with communication and interpreting legal documents.
The superannuation law requires the trustee(s) of the SMSF to hold the legal title of the property, except where the specific limited recourse borrowing rules are being utilised or there is a custodial arrangement in place. It is common for a foreign country not to recognise a SMSF structure and consequently a local entity may need to be used. For example, in the USA a Limited Liability Corporation (‘LLC’) can be used to acquire US property, with the SMSF being the ‘shareholder’ of the LLC. This presents some superannuation compliance issues with the LLC needing to comply with the ‘non-geared entity’ rules under the superannuation law.
These provisions require the only assets of the LLC (being the non-geared entity) to be property and deposits with banks that are regulated by the Australian Prudential Regulation Authority (‘APRA’). A simple act of opening a US bank account (which is not regulated by APRA) in the LLC’s name, to deposit rents, can result in the structure not complying with the superannuation law.
In addition to compliance with Australian taxation requirements, there will also be the requirement to adhere to the local tax law and pay any relevant local charges. This will most likely require engagement of a local accountant to advise and attend to lodgement of relevant returns consequently increasing the costs associated with an overseas property investment.
Where a fund purchases an Australian property, it is common to engage a real estate agent to collect rents, attend to payment of expenses and liaise with the tenant regarding general property issues and maintenance. The same would apply for a property purchased overseas, however, given the greater distance involved there needs to be a higher level of confidence in the overseas agent in relation to the collection of all rents and payment of associated expenses. Don’t forget the fund will not get a tax deduction for the cost of the trustees visiting a residential property for an inspection. Further, an understanding of their costs for acting as agent and frequency of remittance of rents collected and statements should be confirmed.
All transactions in relation to the overseas property will need to be converted to Australian dollars. This could lead to increased fund administration costs.
Trustees need to consider the currency risk that comes with having overseas assets. On one hand, the value of the asset may be increasing, however, on the other the exchange rate is not favourable and consequently gains are reduced due to currency fluctuations.
Accounting for an overseas asset, together with correct tax treatment can lead to increased administrations costs, for example confirming treatment of taxes paid in the local tax jurisdiction under any Double Tax Agreement.
An overseas property can still be subject to a claim for depreciation and building allowance, however, there are some differences including the date from when a property needs to have been constructed in order to claim. There will also be the issue and cost of engaging a quantity surveyor to prepare a report on the property.
Further, given that the property is outside of Australia the fund’s auditor may not be able to satisfy themselves in relation to aspects of the property, including existence and market value. This could mean a qualified audit report and/or additional audit costs. Qualified audit reports can lead to further scrutiny by the regulator (Australian Taxation Office).
Consideration of dealing with a foreign government needs to be part of the investment decision. A government can change the law, as in Australia, that will make the investment no longer viable. In these circumstances what exit strategy is available to the fund?
Further, consideration should be given to the possibility of ownership of the property reverting to the foreign power with no compensation to foreign investors.
So that’s it in a nutshell. There’s a lot to think about if the fund is intending to purchase a property overseas and must consider whether it is a worthwhile investment.
