By Mark Ellem
At the recent SMSF Association (formerly SPAA) National Conference in Melbourne I presented a session on the issues concerning the transfer of business assets to an SMSF when a business owner transitions from business life to retirement. There are a number of issues to consider, including allowable assets, GST issues, stamp duty and tax consequences as well as the effect on a client’s estate planning.
There are a number of small business owners transitioning to retirement. The 2006 Australian Bureau of Statistics Character of Small Business survey showed that 33% of all Australian Small Business Owners were of age 50 or over. As part of this transition to retirement, they will turn their mind to the sale of their business, whether that is to a third party, family member or senior employee. In addition to determining the price to ask for the business, consideration should also be given to the actual assets that will be included as part of the sale. Where the purchase of business assets are not required for the new owner to continue the business, then this gives a greater chance for the deal to be done, as this will require less capital outlay by the prospective purchaser.
The prime example of a business asset that could be retained and not actually sold, to a prospective buyer, is of course the property from which the business is conducted. This asset can be retained and leased to the new business owner, assuming that they keep the business at the same location. The amount of capital required to purchase a property can be a substantial part of the total business purchase price. Removing it from the equation and replacing with a more manageable periodic rental payment may be the one thing that seals the deal for the sale of the business.
Where the property is retained and not already held by an SMSF, moving it to an SMSF is an obvious consideration, given the many advantages of property being held within superannuation. Focusing on business property, as the main asset that can be transferred from a related party to an SMSF, let’s consider some of the issues with such a transfer.
If the asset is being transferred from an entity, like a company or a trust, then firstly you need to ascertain whether the transfer will be treated as a contribution or as a sale and purchase. Focusing on the contribution option, then a simple transfer (of the property from the company or trust to the SMSF) would be at risk of being treated as an assessable contribution and taxed at the fund’s tax rate and also being assessed against the concessional contribution cap, as generally non-assessable contributions and contributions that are assessed against the non-concessional contribution cap are made by an individual.
Options would include firstly transferring the property from the entity to the member, where there is a sufficient size credit loan or beneficiary account, and then the member transferring to the SMSF. Alternatively, a direct transfer from the entity to the SMSF could be effected, again where there is a sufficient size credit loan or beneficiary account, where the relevant documentation is put in place to show that the transfer of the property from the entity to the SMSF is in satisfaction of a repayment of the member’s credit loan or beneficiary account.
Contribution caps of course need to be considered and the value of the property may determine whether it can be transferred wholly as a contribution in specie in one income year or staggered over a number of income years or whether there may be the use of the borrowing rules (whilst they’re around). Just keep in mind that when utilising the borrowing rules in a transfer in specie that section 67(A) requires there to be a borrowing of money and that vendor finance does not qualify.
If the entity, disposing of the asset, is registered for GST you will need to consider the GST impact of the transfer. Will the SMSF be required to be registered for GST? If not required, should the SMSF voluntarily register for GST? What is the impact on other SMSF transactions if it does register for GST?
The transfer of the asset is a disposal for CGT purposes. Consideration needs to be given to whether the CGT Small Business Concessions can be utilised. Whilst I am not going to go into an analysis of these rules in this article, one thing to keep in mind is that where the property being transferred does qualify for the CGT Small Business Concessions, that where the CGT Retirement Exemption is chosen and the person is under age 55, that there is a question as to whether the value of the property transferred to the SMSF can be used to satisfy the requirement to contribute the amount claimed under the CGT Retirement Exemption to a complying superannuation fund. This has been considered in ATO 2010/217, where the ATO stated that the retirement exemption can be satisfied by a transfer of (permitted) real property into a complying superannuation fund. However, at the June 2011 National Tax Liaison Group (NTLG) Losses and CGT Sub-Committee meeting, the ATO outlined their concerns with this type of transaction, specifically in relation to the timing of the in-specie transfer, the capital gain arising from the transfer, and the choice to use the CGT Retirement exemption. Whilst addressed in ATO ID 2010/217, it does not contemplate the CGT retirement exemption being claimed simultaneously with the actual in-specie transfer. The ATO view appears to be that all these events cannot occur simultaneously under the law. This is despite there being existing private binding rulings that allows such, examples being:
https://www.ato.gov.au/rba/content/?ffi=/misc/rba/content/1012469335533.htm
https://www.ato.gov.au/rba/content/?ffi=/misc/rba/content/1012503008540.htm
The SMSF Association (formerly SPAA) believes that an outcome where the retirement exemption is denied to an individual making an in-specie transfer to their SMSF is an unintended consequence of the law. They have made a submission to the Tax Issues Entry System (TIES), which allows organisations and individuals to make submissions to the ATO and Treasury requesting a law change which may be needed to correct technical or drafting defects, remove anomaly or address an unintended outcome. However, to date, I understand that there has been no response. Consequently, on this type of transaction it would be prudent to consider applying for a Private Binding Ruling.
Also, you, as the Adviser can have some influence over the timing of the sale of the business and asset transfer. For example, if restructuring within a family group or disposing of assets to precipitate a capital gain and contributing the CGT exempt amount to superannuation before the relevant person attains age 75. Further, the actual timing of the transfer of business real property could be delayed to take advantage of the more generous CGT 15 year rule that exempts the entire amount of the capital gain. For example, the entity has owned the eligible active asset for 14 years. Delaying the transfer to the SMSF for 12 months may allow the taxpayer to utilise the more generous 15 year exemption.
Now not being a lawyer, I am not going to endeavour to cover the stamp duty issues across all of the various jurisdictions, however, my non-lawyer understanding is that whilst there does exist concessions across states and territories, that they are restrictive and mainly apply to where the real property is being transferred from an individual to the SMSF, rather than from an entity to the SMSF.
Where you are able to transfer from the entity to the SMSF, within contribution caps and have sufficient credit loan or beneficiary accounts, as the case may be, then the transfer will most likely be subject to ad valorem duty.
Where you have to transfer the real property from the entity to the individual and then to the SMSF, depending on the state or territory, there may be some concessions, for example, for distributions from a trust to a beneficiary. Again, these are quite restrictive and require a particular set of facts. You may then be able to utilise the concessions for a transfer from an individual(s) to an SMSF.
Of course, stamp duty is one aspect of this type of transaction that as an advisor you should seek specialist advice.
However, one strategy that I have seen used is where real property, situated in Queensland, has been held by a company and rather than transferring the real property to the SMSF, the shares in the company, held by the member, were transferred to the SMSF. In this scenario, the following is required:
Looking at SISR non-geared entity rules, even where the company does not satisfy regulation 13.22C, for example it has a loan, there is the opportunity to “clean up” the company so that it does satisfy regulation 13.22C prior to the shares being transferred to the SMSF.
Once the company complies with regulation 13.22C, then the SMSF can acquire the shares in that company from the member, at market value, which maybe by way of a contribution in-specie (section 66(2A)(a)(iv) – subsection 71(1)(j) refers to assets included in a class of assets specified in the regulations not to be in-house assets, which includes a unit trust or company under SIS regulation 13.22C). Again, contribution caps need to be considered.
As the SMSF is acquiring shares, these are exempt from stamp duty, provided it is not caught under the Landholder rules. So, for Queensland, provided the land holding was valued at less than $2m, let’s say it was $1.9m, that’s a Queensland stamp duty saving of $89,775.
A further advantage of using the 13.22C rule, is that the property owned by the company, does not have to be “business real property”, it can be residential property, again provided the company satisfies the requirements of SIS regulation 13.22C, for example it’s not rented to a related party.
Some issues for the SMSF are around risk and whether the fund should own the property directly or via another entity, for example a non-geared unit trust or company that complies with Regulation 13.22C of the SIS regulations.
I am sure that you are familiar with the case of Giovenco v Dick (2010) NSW DC 4. In this case, Mr Dick owned a residential property in Darlington, NSW. He engaged a Mr Stephens, a plumber, to decommission a solar hot water system on the roof and replace it with a new gas system, situated at ground level at the rear of the property. In carrying out this work, the plumber did not arrange for the disconnection of the electricity to the old system, nor did he advise Mr Dick that this needed to be done. Three years later, a handyman, Mr Harley, was fatally electrocuted while working on the old system on the roof.
The court awarded $350,000 in damages to the de facto partner of the deceased. Of this amount, Mr Dick was ordered to pay 20 per cent and the plumber, Mr Stephens, to pay 80 per cent, or $280,000. The plumber was held 80 per cent liable primarily because he failed to notify Dick that he should have arranged for a licensed electrician to disconnect the electricity when the plumber decommissioned the old system.
(Note: on appeal, Mr Stephens (plumber) was found not to owe Mr Harley (deceased handyman) a duty of care and consequently his liability for damages was reduced to nil. Whilst Mr Dick (property owner) was found to owe Mr Harley a duty of care, there was an 80% deduction for Mr Harley’s contributory negligence, resulting in the total damages being reduced from $350,000 to $70,000, all payable by Mr Dick (note that this amount equates to Mr Dick’s liability originally, 20% of $350,000.)
Where this property was owned by an SMSF there is the potential for other fund assets to be at risk. The use of a 13.22C entity can limit this exposure to risk, where the damages awarded are greater than the value of the property. Also, where the property was acquired via an LRBA, upon payout of the limited recourse loan, it may be prudent to retain the property in the bare trust structure to limit risk. Due to changes to the relevant law in 2014, a property can be retained in the bare trust structure, after the fund’s limited recourse loan has been fully extinguished and not be treated as an in house asset.
Other considerations for the SMSF holding the business property include:
Finally and appropriately, at the end, any transfer of assets from one entity to another will most likely require a change to the client’s Estate Plan (assuming they have one). The effect of any asset transfer on the client’s estate plan should be addressed at the start, rather than the end. Assets may be held by certain entities or persons for particular purposes or reasons and any transfer could have significant consequences on detailed plans previously put in place, most likely by another family advisor. So best to ascertain from the client if there are any specific estate planning reasons for why assets are held as they are at the outset – you should also probably ask these questions of the client’s advisors as well, as advisors have been known to know more about reasons why things have been structured a certain way than their clients. Again, Estate or succession planning advice can be another great value add service you can provide to your client.
Also, this review of the client’s whole structure may result with entities being wound up. This can make the client’s Estate Plan easier to draft, implement and understand, particularly by the client themselves. Eliminating entities will also make any application for Social Security benefits easier.
So there are a number of issues for consideration when transferring business real property to an SMSF. It provides an opportunity for you as advisors to provide valuable advice to business owners in their transition from business life to retirement.
