The recently released ATO taxpayer alert TA 2014/1 spells good news for SMSFs!
It should serve to remind us of a special exception that differentiates SMSFs from other types of trusts … and how this can save SMSFs extra tax in addition to the usual tax concessions that SMSFs are used to.
What taxpayer alert TA 2014/1 is all about
At the risk of oversimplifying, taxpayer alert TA 2014/1 describes an arrangement whereby a trustee of a trust undertakes property development activities. The developed property, which could be either commercial or residential in nature, is subsequently sold and the proceeds are treated for income tax purposes as being on capital account. More specifically, the trust self-assesses that it is entitled to the 50% capital gains discount.
Taxpayer alert TA 2014 questions the entitlement of the trust to treating the proceeds as falling under the CGT regime. Rather, the alert questions whether the proceeds would be more correctly treated as being fully taxable even if the real estate had been owned for more than 12 months. The alert even suggests that this could still be fully taxable even if the trust has only recently been set up (ie, no overt repetition).
Is this ground breaking stuff?
The position set out in taxpayer alert TA 2014/1 can seem like the ATO has ‘done a 180’ from the traditional position.
However, they haven’t. This has been the accepted position for many years now.
Recall cases like Myer Emporium considering whether profits on a seemingly isolated transaction are income. In light of this, the ATO released TR 92/3. Again, at the risk of oversimplifying, where a taxpayer acquires an asset with the objective intention of reselling it at a profit, that activity runs a strong risk of being taxed as ordinary income and therefore not eligible for any CGT discounts.
How does this impact SMSFs?
Naturally, SMSFs are trusts. Accordingly, on its face, taxpayer alert TA 2014/1 applies to SMSFs as much as it applies to any other type of trust.
However, there is a special exception that applies to SMSFs (or, more accurately, complying superannuation funds).
Recall that it wasn’t so long ago that the ATO was concerned that investors were incorrectly self-assessing themselves to be running a business. (See taxpayer alert TA 2009/12.) Naturally, this arose in the context of the GFC and resulted in taxpayers claiming losses on sales of assets as being business losses and therefore deductible against assessable income.
The government changed the law for SMSFs, which took effect from 10 May 2011 (ie, Budget night). The change was contained in the Tax Laws Amendment (2012 Measures No. 1) Act 2012 (Cth).
The relevant explanatory memorandum stated that:
This practice creates potential uncertainty regarding the appropriate tax treatment of gains and losses made from the sale of shares owned by complying superannuation entities. This has created the need to amend the law to reduce the present ambiguity around the application of the trading stock provisions.
Accordingly, the change introduced for SMSFs means that almost of their assets must be treated as being on capital account and therefore eligible for the CGT discount (33⅓%) if they had been acquired by the SMSF at least 12 months before the CGT event. This is the case even if the SMSFs is running a business.
In short, the changes introduced by the Tax and Superannuation Laws Amendment (2012 Measures No. 1) Act 2012 (Cth) were designed to counter one perceived tax mischief, namely, taxpayers treating assets as being on revenue account in a falling market. Taxpayer alert TA 2014/1 is designed to counter the exact opposite: taxpayers treating assets as being on capital account in a rising market.
Arguably, the legislative changes introduced by the Tax and Superannuation Laws Amendment (2012 Measures No. 1) Act 2012 (Cth) were therefore somewhat short-sighted. Regardless though, the key point is that taxpayer alert TA 2014/1 almost certainly does not apply to SMSFs. Rather, SMSFs are compelled to be taxed under the CGT regime, which can results in profits being taxed at 10% instead of the usual 15%. Naturally, this can be contrasted against other types of trusts where the ATO might warn real estate gains could give rise to ordinary income, even if the real estate had been acquired by the non-superannuation trust at least 12 months before the CGT event.
SMSFs running a business
This segues into the old chestnut: can an SMSF run a business? The introduction of the Tax and Superannuation Laws Amendment (2012 Measures No. 1) Act 2012 (Cth) can be seen as implicit acceptance that complying superannuation funds can run businesses. That is, it acknowledges that complying superannuation funds might have trading stock and thus are running a business.
The ATO have previously also acknowledged on their website that an SMSF can run a business. Their position has been as follows.
The fact that activities undertaken by an SMSF trustee are considered business activities for income tax purposes does not necessarily mean that the trustee contravenes the regulatory provisions. However, trustees should be aware that those activities may breach the sole purpose test or other regulatory provisions.
These comments suggest SMSFs running businesses might come under close ATO scrutiny. The ATO also highlights that in running a business, SMSFs should still ensure they meet the relevant prudential requirements.
One question is then whether it is possible for an SMSF running a business to comply with the sole purpose test. At the risk of over-simplifying, the 2008 High Court decision of Commissioner of Taxation v Word Investments Ltd (2008) 236 CLR 204 considered whether a company that ran a business met the charity equivalent of the sole purpose test. The company ran a funeral business charging clients a commercial margin of profit. Profits were then donated to another entity that clearly was a charity. Effectively this raised the question of whether the ends can justify the means. Four out of five judges answered in the affirmative, holding that the company’s activities were charitable because they were carried out in furtherance of a charitable purpose.
Although not expressly a superannuation case, Word does have implications for superannuation funds. Namely, it lends support for the view that superannuation funds running a business meet the sole purpose test if the business profits are retained in the fund to pay for things like retirement benefits.
Finally, the trust deed must be remembered. No trustee can run a business unless expressly empowered by the trust deed to do so (Kirkman v Booth (1848) 11 Beav 273, 280). As such, it is imperative that the SMSF’s trust deed authorises the trustee to carry on a business.
Taxpayer alert 2014/1 serves as a timely reminder for non-SMSF trusts that they might have to pay more tax on their real estate development activities. However, in this article, I have sought to remind that SMSFs almost certainly have to pay less!
Note: DBA Lawyers hold SMSF CPD training at venues all around Australia and online. For more details or to register, visit www.dbanetwork.com.au or call Marie on 03 9092 9400.
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.