Moving business real property into a self managed superannuation fund (SMSF) can have significant tax advantages. These include concessional tax treatment to the SMSF on rental income of 15%, and capital gains tax on the sale of the property at the rate of 10% (if the property is held for 12 months or more). While if the SMSF is in “pension phase”, the income tax and capital gains tax rates can drop to 0%. In addition, if the member is aged 60+ any payments from the SMSF to the member will be tax free.
Despite the significant potential of these tax advantages, there are often impediments to moving business real property into a SMSF, in the form of possible tax and duty consequences of the transfer, especially where the property is held in a unit trust or a discretionary trust and the limits imposed by the non-concessional caps.
In this article we will examine the ability to transfer Victorian business real property into an SMSF without triggering duty. This can include the transfer of a property from a unit trust to a unit holding discretionary trust, then from that discretionary trust to an individual beneficiary, and finally from an individual beneficiary to an SMSF as a contribution.
Although this article concentrates on the duty exemptions, it briefly examines some of the other considerations that need to be taken into account for such transfers.
It should be noted that the application of the duty exemptions discussed in this article are complex, and that the Victorian State Revenue Office (SRO) has strict evidentiary requirements in determining whether the exemptions apply. This article only provides a high level overview of the exemptions and only as they are relevant for the purpose of this article, that is moving business real property out of trusts into SMSFs. Advice should be sought before effecting any transfers referred to in this article.
Transfer of property from a unit trust to beneficiary unit holder who is a trustee of a discretionary trust
There are a number of exemptions that apply to transfers from a unit trust to a certain classes of unit holders without consideration (i.e. a capital distribution rather than a sale), including to unit holders who are individuals or trustees of SMSFs. One of the preconditions to obtaining the exemption is that, generally, when the unit trust initially acquired the property, the particular unit holder was a unit holder in the unit trust. In addition for SMSF unit holders, the members must also have been members of the SMSF when the unit trust acquired the property. If at the time of the distribution of the property the unit holder holds more units than it did when the unit trust acquired the property, then that unit holder will only receive a duty exemption to the extent it held units at the time the unit trust acquired the property.
The most common unit trust structure that we see is where the unit holder is a discretionary trust. If that is the case, the duty exemption can still apply for a distribution to a unit holding discretionary trust, although the application of the duty exemption in such circumstances is restricted. In particular, the terms of the discretionary trust must limit the beneficiaries of the discretionary trust to:
(a) Natural persons; or
(b) A corporation where all of the shareholders are natural persons who were shareholders of the corporation at the relevant time.
These natural persons or corporate beneficiaries of the discretionary trust must hold their rights or interests in the discretionary trust in their own right (i.e. they cannot hold these rights or interests as a trustee of another trust), and they must have been a beneficiary at the time the unit trust acquired the property. An exception from the latter requirement arises when individual beneficiaries subsequently become beneficiaries of the discretionary trust because they either marry, or become a child of, an existing beneficiary.
The typical discretionary trust will not satisfy these restricted beneficiary requirements. Therefore, the discretionary trust deed will need to be amended, prior to the distribution of the property, to exclude beneficiaries that do not fall within these requirements. In our experience the SRO will grant this exemption even if the discretionary trust deed is amended shortly before the distribution.
Transfer of property from a discretionary trust to an individual beneficiary
Again, like the unit trust exemption, there are a number of exemptions that apply for transfers from a discretionary trust to a beneficiary without consideration.
Although there are a number of beneficiaries to which the exemption will apply, the most common, and, for the purposes of making super contributions, the most important, is the exemption for transfers to individuals. There are a number of requirements in order to receive this exemption, including that the beneficiary must have been a beneficiary of the discretionary trust when the discretionary trust acquired the property. This is extended to certain beneficiaries who subsequently become beneficiaries by reason of becoming a spouse or domestic partner of an existing beneficiary or by being a lineal descendant, adopted child or step child of an existing beneficiary.
The transfer must be to an individual absolutely and there must be no consideration for the transfer. In relation to the latter point, there may be potential issues if loans or unpaid present entitlements (UPEs) exist between the discretionary trust and the relevant beneficiary, and those loans or UPEs are forgiven as a result of the transfer.
Contribution of property from an individual to their SMSF
The final exemption that we will examine in this article is the exemption for transfers from an individual to their SMSF.
In contrast to the requirements for the above the exemptions, the requirements for transfers from individuals to their SMSFs are relatively simple. The SMSF must either be a complying superannuation fund at the time of transfer, or will be a complying fund within 12 months after the transfer of the property. Other requirements include that the transfer must be made without monetary consideration (i.e. a contribution of the property rather than a sale) and that there is no change in the beneficial ownership of the property. For the latter requirement the SRO accepts that a contribution of property to a SMSF where the benefit of the property is allocated to the member account will not result in a change in beneficial ownership.
Aside from duty, other notable considerations in relation to the distribution and contribution of real property from trusts and to SMSFs include:
The distribution of property from trusts or the contribution of property to SMSFs will trigger tax consequences where, assuming the property is on capital account, the property’s market value exceeds its cost base. Where applicable, such tax consequences could be reduced using the small business tax concessions.
Where capital gains tax is payable, the cost of such a tax is a factor in making a cost benefit analysis of undertaking the transaction (especially in light of the concessional tax treatment for the property in the SMSF). That is, will the upfront cost of paying capital gains tax be offset over time by the tax savings of having the property in the SMSF?
Where the transferor of the property is registered for GST, then GST must be considered. Where the recipient is not registered for GST and the transfer is treated as a taxable supply, then 1/11th of the market value of the property will be payable to the ATO by the transferor as GST, while the unregistered recipient will not be able to claim it back. In such situations the GST will be a sunk cost of the transfer.
In scenarios like this, it should be considered whether the transferor can deregister (after taking into account any adjustments), or whether the recipient can register for GST. In cases involving the latter, the transfer may not be a taxable supply, or the going concern exemption may apply.
For the 2013/14 financial year, the non-concessional contributions cap is $150,000. As at 1 July 2014, the non-concessional contribution cap will increase, as a result of indexation, to $180,000. For individuals who are able to exercise the ‘bring forward rule’, they can bring forward three years’ worth of contributions in the one year. For example, they could make non-concessional contributions of $540,000 for the 2014/15 year (meaning they could not make any further non-concessional contributions for the 2014/15 to 2016/17 years).
Although members aged over 65 are unable to use the bring forward rule, its operation can be triggered in the financial year in which the member turns 65.
Therefore, a member can effectively stagger the contribution of a property over the 2013/14 and 2014/15 financial years (i.e. make a $150,000 non-concessional contribution prior to/on 30 June 2014 and a $540,000 non-concessional contribution on or after 1 July 2014), which will allow for total non-concessional contribution transfers of the property worth up to $690,000 for an individual, or $1,380,000 for a couple.
If the value of the property is more than $690,000 (or, where couples are making the contributions, $1,380,000), the SMSF could buy the excess amount from the member(s) (noting that any part of the property purchased will be subject to duty).
In addition, the member may be able to utilise the small business tax concession contribution caps allowing the member to make further contributions of up to $1,315,000 (or $1,355,000 for the 2014/15 year).
Acceptance of contributions
Contributions can only be accepted by an SMSF if permitted under the Superannuation Industry (Supervision) Regulations 1994. Those regulations restrict the acceptance of contributions by members aged 65+. For members aged between 65 to 75, non-concessional contributions can only be accepted if they satisfy the “work test”; that is, during the financial year, members in that age group must work for 40 hours during a 30 day period. Members aged 75 cannot make non-concessional contributions.
Trust deed requirements
It is important to ensure that the trust deeds and SMSF deeds have the necessary provisions and powers in order to make the capital distributions and accept transfers of property as contributions. This includes that the relevant persons are beneficiaries of the trust, that the trust has the necessary power to make capital distributions and transfer of assets and that the discretionary trust satisfies the unit trust duty exemption requirement (if applicable, as discussed above).
Before any changes are made to the trust deeds, any resettlement consequences should be considered. In addition, the effect these changes may have to the administration of the trust in the future ought to be contemplated (for example, if the classes of beneficiaries of the discretionary trust are reduced).
Will the distribution put the trust into deficit?
As a practical consideration, the distribution of property from a trust will often put that trust into a technical (if not a real) deficit. It is therefore important to consider how this can be rectified, especially in light of the SRO’s view that a transfer made in conjunction with the payment/forgiveness of a UPE may be consideration (and, therefore, the duty exemption may not apply).
This article has briefly considered the potential to transfer properties from trusts to SMSFs without duty. However, such transfers involve a number of complex considerations. It is important that anyone contemplating such a transfer reviews all the relevant issues and requirements before effecting such a transaction.
Download a PDF version of this article: Transferring property from trusts to SMSFs without duty
For further Information please contact:
+61 3 9611 0161