SMSFs buying overseas property – tips & traps

Overseas property may appear as an attractive investment on the surface. However, when an SMSF is the purchaser there are several compliance traps for trustees to navigate.

SMSF trustees can purchase property either outright with SMSF funds or via a limited recourse borrowing arrangement (LRBA). To illustrate the potential risks involved, each of these types of investments will be considered in this article.

Investment with no borrowings

In short, while an SMSF trustee may be legally entitled to purchase a property overseas, there are many practical issues that can arise with such a purchase. Some of these are listed below.

• The sole purpose test

An SMSF must be maintained solely for the prescribed purposes (eg, to provide retirement benefits). In the Swiss Chalet Case (Case 43/95 [1995] ATC 374) a superannuation fund trustee invested in a unit trust, the assets of which included a Swiss chalet. The question in this matter was whether the fund met the then equivalent of the sole purpose test. The problem was not so much the investment itself, but that fund members and their friends stayed in the chalet without paying rent. The fund was held to have contravened the sole purpose test. Accordingly, it is important that an SMSF trustee only acquires real estate because it genuinely believes it is an appropriate way to achieve its core purpose of providing retirement benefits to members.

Moreover, some SMSF members also mistakenly believe the ATO will never know that they are using the property overseas. However, immigration, phone, credit card, GPS and other records can easily expose a person’s location. The ATO, relying on this type of information, have asked SMSF trustees/members to prove they did not use a property when the evidence trail places them at the location of the property.

• In-house assets

Australia and many overseas countries restrict property ownership to local residents. Thus, in many overseas countries, a resident company (in that country) is established to purchase the property. The SMSF trustee acquires shares in that overseas company. The share capital is then used by the overseas company to purchase the property.

If the SMSF members and their associates (as broadly defined) control or can exert sufficient influence in relation to the overseas company, the shares in the company can readily constitute in-house assets. If the company has, for instance, an overseas bank account (that does not qualify as an Approved Deposit Institution in Australia), it places a charge in relation to the property or the company conducts a business, the shares will not satisfy the exception in division 13.3A of the Superannuation Industry (Supervision) Regulations 1994 (Cth). If the shares are in-house assets and exceed 5% of the fund’s value, a contravention can occur.

A failure to comply with the in-house asset rules can potentially result in:

• significant administrative penalties;
• an SMSF being rendered non-complying with a significant tax liability; and
• the SMSF directors/trustees being rendered disqualified from ever being SMSF trustees/directors and SMSF members again.
• SMSF deed and investment strategy

An SMSF investment strategy is a plan for making, holding and realising assets consistent with the investment objectives adopted by the trustee. The acquisition must be authorised by the SMSF deed and consistent with the fund’s investment strategy. Formulating, reviewing regularly, and giving effect to an investment strategy is an operating standard (refer to reg 4.09(1)(a) of the SISR). Accordingly, an SMSF trustee/director who intentionally or recklessly does not maintain an investment strategy is guilty of an offence punishable on conviction by a significant fine.

Investment with borrowings

If the SMSF trustee were to borrow to acquire the property utilising an LRBA, additional risks also need to be considered:

• Will a bank lend to an SMSF for overseas property?

If a foreign company is intending to purchase the property, practically, the bank would be lending money to acquire a piece of paper (being shares in the foreign company). Our experience is that banks are reluctant to lend on this basis where the security is shares in a company or units in a unit trust, rather than obtaining security on the property.

• Loans to an SMSF must be limited recourse borrowing arrangement (LRBA)

Thus, borrowing to purchase an overseas property might prove problematic. Not many overseas banks provide documents that satisfy s 67A requirements in the Superannuation Industry (Supervision) Act 1993 (Cth).  In short, if an SMSF obtains a loan from an overseas country, it may give rise to a contravention.

• All dealings to be on arm’s length terms

If a related party were to lend instead of a bank, it may be difficult to ensure that the lending was on arm’s length terms as obtaining appropriate evidence of arm’s length practices may be difficult to obtain.

• More complexity

More complexity can result in dealing with overseas countries given different laws, tax systems and regulations. In short, there is a need to ensure that all legal matters satisfy the overseas and Australian rules as any contravention can prove very costly.

Conclusion

SMSF trustees can invest in overseas property. However, they must make sure to do so in full compliance with the rules here and overseas. We therefore strongly recommend that expert legal, accounting, tax, superannuation and related advice be obtained both here and in the overseas jurisdiction before an SMSF trustee considers buying an overseas property.

Related articles

• SMSFs, super & international issues
• International issues facing SMSFs today
• Transferring foreign superannuation fund amounts to an Australian resident

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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. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2001 (Cth).

Note: DBA Lawyers presents monthly online SMSF training. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.

By Daniel Butler, Director ([email protected]) and Cassandra Hurley ([email protected]).

DBA LAWYERS

6 March 2024