“While they consider it possible for SMSFs to undertake the property development or invest in a trust or company that undertakes development, funds may end up walking a very thin line between complying with and breaching the Superannuation Industry (Supervision) Act (SIS Act) and Regulations,” Mr Colley warned in an online article.

“When done correctly, property developments undertaken by an SMSF can be a legitimate investment, but the ATO’s concerns relate to developments which are not solely for genuine superannuation purposes.”

Some examples, he said, include SMSFs that use money to prop up a poor development, or where the SMSF is used to receive excessive income and capital gains into a low-tax environment. 

“Where the SMSF breaches the tax or super laws, any income — including capital gains from the development — may be taxed at 45 per cent. The fund could also lose its complying status and the trustees could be penalised or even disqualified,” he cautioned.

SMSFs, therefore, need to think very carefully about whether the development may be providing benefits to other parties which are not solely for superannuation purposes. Where this is the case, the development may compromise the SMSF complying with the SIS Act, he said.

The SMSF client will also need to consider whether the fund’s trust deed or other governing rules permit the fund to undertake property development.

The investment strategy, he said, also needs to allow the fund to be involved in property development and consider how the investment will support the provision of superannuation benefits for members and their dependents.

The client will also need to continue to meet the record-keeping requirements of the SIS Act and Regulations including market valuation of assets and ensure that fund assets are kept separate from members’ personal assets.

Another consideration, he said, is whether the development will involve making loans or providing financial assistance to members or their relatives.

“Does the development require the SMSF to borrow for purposes of a limited recourse borrowing arrangement? If so, have the compliance issues been considered, as it may result in a breach of the SIS Act,” he said.

They will also need to think about whether any of the arrangement may be considered in-house assets, he said.

“If they are, will the fund exceed its in-house asset level because of the investment, loan or lease at the time it was made or as at 30 June in the financial year?” Mr Colley said.

The SMSF trustee, he said, will also need to check that all aspects of the property development are being undertaken on an arm’s-length commercial basis so that no other parties are receiving a benefit which is to the detriment to the SMSF.

“In addition to the requirements of the SIS Act, any income and expenses in relation to the property development must be on an arm’s-length commercial basis. If they are not and the income received by the fund is greater than if the development had been on an arm’s-length commercial basis, it will be taxed at penalty rates,” he explained.

“Whether income is excessive includes situations where goods and services supplied for the development are provided at a discount or for no cost.”