More SME owners will focus much more closely in coming months on the pros and cons of buying and gearing their businesses premises through their self-managed super funds.
Specialists in superannuation, investment and business advice expect SME owners to consider accelerating any existing plans to gear their business premises through their self-managed super funds. This follows renewed debate about whether to bar future gearing.
The interim report of the Australian government’s inquiry into the financial system calls for views about whether superannuation gearing should be prospectively prohibited because it “may create vulnerabilities for the superannuation and financial systems”.
Here are 10 critical points to consider when deciding whether your SMSF should acquire business premises, typically through gearing, to rent to your family business:
1. Family businesses may make excellent tenants
Sue Prestney, a partner at PwC Private Clients, says that in her experience, family businesses tend to make “excellent” tenants for their SMSF-owned business premises.
Again speaking in regard to her own clients, Prestney says their family businesses typically pay their rent on time to their SMSF. “They look after the premises like it was their own.”
Martin Murden, a director of SMSF consulting and auditing with the Partners Wealth Group, says family businesses make “great” tenants provided the business is successful.
And Murden says dealings between a family SMSF as landlord and a family business as tenant can be smoother – regarding such things as rent reviews – than with an arm’s-length tenant.
2. Exception for business property
Business real estate is one of the limited types of assets that SMSFs are allowed to acquire from related parties including members.
And business real estate is one of the few types of assets that SMSFs can lease to related parties, including the members’ businesses, without a limit on its value under the in-house asset rules in superannuation law.
3. Concessional tax treatment
During an SMSF’s accumulation or saving phase, rents are taxed at 15% within the fund while capital gains are taxed at an effective 10% if the property is held for more than 12 months.
And once the business premises are backing the payment of a superannuation pension, fund income and capital gains are tax-free. This means that the SMSF may eventually be able to sell a property in the pension phase without paying CGT on any profits.
SMSFs in the accumulation phase can claim the same types of tax deductions as individual investors who buy properties in their own names including negative-gearing deductions for the shortfall between the deductible expenses, including interest payments, and rental income.
4. Business succession and estate planning
SMSF trustees aim to keep the premises of their family businesses in their super fund through generations, with the aim of gaining greater security of tenure for the business as well as business succession and estate-planning benefits.
Under this strategy, an SMSF will need sufficient other assets to pay member superannuation benefits when necessary for older members such as a business’s founders.
5. Asset protection
Business premises held in an SMSF are generally out of the reach of creditors if individual fund members are declared bankrupt – subject to claw-back provisions in the Bankruptcy Act.
6. Potential conflicts if family business struggles to pay rent
While the principals of a troubled family business may need the premises to keep trading, the family SMSF’s trustees – who are often the same people – must maintain the fund for the core or sole purpose of paying member benefits.
Additionally, funds are prohibited from providing financial assistance to members, says Murden. This includes giving rent relief to family businesses in financial difficulties.
7. High-cost business premises can dominate an SMSF’s portfolio
This can make it to diversify a fund’s portfolio to spread investment risks and opportunities.
When preparing their mandatory investment strategies, SMSF trustees must consider such factors as investment risk, portfolio diversification, liquidity of investments, ability to pay member benefits and the members’ circumstances.
Peter Crump, superannuation strategist for ipac South Australia, says that super funds are not legally required to diversify their investments but emphasises that trustees must consider diversification when preparing their investment strategies.
Indeed, some fund trustees specifically decide to have SMSF portfolios dominated by a single property asset, such as the premises of their businesses, perhaps after considering the diversification of their other super and non-super investments.
8. It may be more tax-effective to gear business premises outside super
Much will depend on the circumstances.
First, the superannuation tax rate is much lower than most personal marginal tax rates, thus providing potentially lower tax deductions for negative gearing. Second, lenders usually require a much higher deposit for SMSF gearing, which means a property is likely to remain negatively-geared for a relatively short period – if at all.
As well, SMSF trustees should be cautious about relying too much on the possibility that the business premises will eventually be sold when the asset is backing the payment of a pension and thus becomes exempt from CGT.
Crump suggests that trustees recognise that the fund may well sell the property before it becomes exempt from CGT.
9. Potential costly traps in conditions for super gearing
SMSFs should gain quality professional advice to ensure compliance with the strict conditions allowing funds to borrow. Mistakes can be costly.
SMSF Trustees must enter a limited recourse borrowing arrangement and a geared asset must be held in a separate trust until the load is repaid. Lenders cannot make a claim against any other assets of the super fund in the event of a default on the loan.
10. SMSF could face severe financial setback following loan default
Despite the requirement for a limited recourse loan, an SMSF that defaults on a loan to buy business premises could lose its sizeable deposit plus capital repayments and payments of interests and costs.
Upon a property’s forced sale, a defaulting fund would be paid whatever is left after the lender recovers any outstanding amounts including the cost of a forced sale and the discharge of the mortgage.