Peter Burgess

Peter Burgess examines the issue of SMSFs constructing buildings using goods and materials supplied by a party related to the fund.

At a recent meeting of the National Tax Liaison Group Superannuation Technical Sub-Group (NTLG), the ATO clarified the application of section 66 of the Superannuation Industry (Supervision) Act 1993 (the SIS Act) in situations where an SMSF constructs a property using goods and materials supplied by a related party.

Specifically, the question addressed by the ATO was whether an SMSF would breach the acquisition of related party asset rules in section 66 of the SIS Act if the SMSF owned land and it engaged a related party on commercial terms to construct a building using goods and materials supplied by a related party.

BACKGROUND

The construction of a building requires the performance of a service (in this case by a related party) and the use of goods and materials to construct the premises. As part of the professional services provided by a builder, it is common practice for builders to provide the goods and materials necessary to construct the premises. It would be unusual, and in most cases impractical, for the consumer (in this case the SMSF) to purchase the goods and materials required to construct the premises directly from the supplier.

In February 2010, the ATO released ruling SMSFR 2010/1 which explains when an asset is intentionally acquired by a trustee of an SMSF from a related party of the SMSF for the purposes of subsection 66(1) of the SIS Act. This ruling referred to situations where an SMSF enters into a contract with a related party entitling the SMSF to the performance of a service by the related party. Paragraphs 17 to 19 of this ruling state:

‘It would be the Commissioner’s view that there has been an acquisition of a related party’s assets (being the goods or materials)’

“In analysing whether there has been an acquisition of an asset by a trustee or investment manager, and the nature of that asset, the Commissioner takes a holistic approach to determine the substance of the transaction. If a trustee or investment manager enters into a contract with a related party entitling the SMSF to the performance of a service by the related party, the performance of that service is the substance of the transaction and not any rights that the SMSF might also acquire to have that service performed. Therefore, the acquisition of the performance of a service does not contravene subsection 66(1).”

The ruling went on to explain that in situations where the goods or materials are insignificant in value and function and are provided to an SMSF as part of a service, it would be the Commissioner’s view that it remains the performance of a service only. However, if goods or materials provided to the SMSF are not insignificant in value and function, it would be the Commissioner’s view that there has been an acquisition of a related party’s assets (being the goods or materials).

The Commissioner’s view is further explained in examples 5 and 6 of SMSFR 2010/1. Example 6 refers to a member of an SMSF who buys all the necessary building materials and builds a house on land owned by the SMSF. The member does some of the building work and also pays contractors to do some of the building work. A service is performed for the SMSF and assets are acquired from the member, as the building materials are not insignificant in value or function. Therefore, there has been a breach of subsection 66(1) of the SIS Act.

In order to avoid breaching section 66 of the SIS Act, the SMSF in this instance would be required to acquire the materials directly from the supplier and only engage the related entity for the actual performance of the service to construct the premises. This would be an unusual occurrence, as it is common practice (and sometimes there is a contractual obligation) for the provider of the service to also provide the necessary goods and materials to construct the premises. Also, from a practical perspective, this may increase the cost of construction for the fund, as trade discounts et cetera would not be available to the fund.

Unless the SMSF takes the unusual step of acquiring the goods and materials directly from the supplier, the requirement for the goods and materials to be insignificant in value and function means that in almost all cases the construction of a property on land owned by an SMSF will breach subsection 66(1) of the SIS Act.

Unfortunately SMSFR 2010/1 does not address situations where the SMSF trustees appoint the related party builder as their agent. Under this arrangement a contract would exist between the builder and the SMSF trustee such that the related party builder acquires the goods and services as an agent of the trustee. The related party builder would purchase the goods and materials directly from the supplier as an agent of the SMSF trustee and then seek reimbursement from the fund.

At the NTLG meeting, the Self-Managed Super Fund Professionals’ Association of Australia (SPAA) argued that a common sense approach requires some departure from a literal application of subsection 66(1) of the SIS Act.

Subject to the construction of the property being undertaken on an arm’s length basis, one possible approach would be to collectively consider the act of constructing a permanent structure on real property owned by the fund, and the goods and materials used in the construction of that structure, as the performance of a service. The acquisition of the performance of a service as defined above would not constitute a contravention of subsection 66(1) of the SIS Act.

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