The allure of business real property in SMSFs
The business real property (BRP) strategy for SMSFs has a reputation for being complicated to design and execute. This needn’t be the case and people should not be afraid to look into it.
The ‘BRP strategy’ is where an SMSF acquires business real property and then leases that property to a related party who runs a business from there. It comes with no real tax law or super law risk. In fact, the law has been written specifically to encourage the use of a BRP strategy. It is a rare situation where SMSF members who are also business people are significantly advantaged by having an SMSF.
The garden variety is clear and no one thinking about a BRP strategy should fear it. It’s a doctor whose SMSF owns the property where the surgery is. The tradie who has a workshop. No private use. It’s just a workspace. A retail operator who wants to own the shop the business operates from.
In such circumstances, a BRP strategy within an SMSF can work well. The BRP strategy has become even more attractive after recent super reforms, and SMSF members and trustees might consider revisiting it.
A qualification is that, at the margins, it can be complicated. Can a residential building, for example, be business real property? Maybe. Maybe not. People should tread carefully going into such BRP grey areas.
The current law and attraction for businesses
Generally, transactions between an SMSF and a related party are totally out of the question. An SMSF can’t buy things from a member although an SMSF can sell things to a member for full market value. An SMSF can’t make loans and can’t lease things to a member. It’s mostly in a set of rules generally referred to as the ‘in-house asset test’. But BRP is exempt from all that. Critically, this means an SMSF can own BRP and then lease it to a related party.
From a business perspective, it can be very useful to have an SMSF own the BRP. It provides the business with long-term security. The business tenant doesn’t have to worry about being kicked out if the property is sold or the landlord changes direction. Having to move business premises is expensive and disruptive. It’s also a great asset protection strategy for the BRP owner, the SMSF.
The SMSF can be well protected from the various risks of the business.
The super reforms
The government’s objective from the super reforms was to achieve some kind of ‘reigning in’ of super. A big part of this was to limit how much people will be able to put into super due to contribution limits. So:
1. The concessional contributions cap went from a maximum of $35,000 to a maximum of $25,000 per annum
2. The non-concessional contributions (NCC) cap went from $180,000 to 100,000 per annum
3. Once a member has a total superannuation balance of more than $1.6 million, they cannot make any more non-concessional contributions.
What does that have to do with BRP?
Paying rent to an SMSF is not a contribution to super. Consider this example.
Mark is a 55-year-old designer with $2 million in his super fund. He operates a successful design business through a company. He would like to get as much into super as possible. The lowest tax rate on his business profits is the small business tax rate of 27.5%. He knows about a commercial space that he could purchase for $1 million that is currently rented out for $80,000 a year. It would perfectly fit the requirements for his business workshop. He currently rents workshop space.
If he employs a BRP strategy via an SMSF then he will pay that rent from his business to his SMSF which effectively transfers $80,000 per year from a 27.5% tax environment into a 15% tax environment. It’s still his money. He saves $10,000 in tax a year and compounds that for several years in a low tax environment. He obliterates the concessional contributions cap of $25,000 (which he could also put in from his business) because the business entity will get a tax deduction for the rent of a workshop space.
He has just grabbed back everything the government took by reducing the NCC from $180,000 to $100,000. The full NCC cap of $100,000 for the year remains intact if he happens to have some spare after-tax cash. He can keep using this BRP strategy even though he has a total superannuation balance of over $1.6 million. Any capital gain on the property will also be derived in a very friendly capital gains tax environment.
The main obligation going forward is the idea that the investment must be maintained on an arm’s length basis. Mark’s business will have to make sure that it pays an arm’s length rent, calculated using well-known principles. That rule is designed to make sure that the SMSF doesn’t let the related business only pay nominal rent which would clearly be providing Mark a present-day benefit. However, Mark is actually trying to do the exact opposite.
In fact, Mark is probably wanting to push the envelope in the other direction to get more into his SMSF. Perhaps Mark’s property could get a rent of $100,000 as determined by a valuer and signed off by an auditor. It’s hard to see how that would violate the arm’s length rule in super. It would be more likely to potentially violate the anti-avoidance rule in tax law. What is happening here is a transfer pricing type of exercise: Possibly overcharging on the yield from an asset to get tax deductions in a high tax environment, and assessable income in a low tax environment, whilst keeping control of the cash.
The super reforms limited what people can put into super. The use of a BRP strategy eases some of those limitations for small business owners.
Stephen Lawrence is a Chartered Accountant, CA SMSF Specialist, TEP and Member of the International Tax Planning Association. These views are considered an accurate interpretation of regulations at the time of writing but are not made in the context of any investor’s personal circumstances.