Overseas property can easily appear an attractive investment. Who wouldn’t want an apartment in Paris, a Balinese beachfront villa or perhaps a ski chalet in Colorado?
However, when an SMSF is the purchaser, there are a number of traps to navigate – regardless of whether the trustees are buying the property outright or are using a limited recourse borrowing arrangement (LRBA).
Investment with no borrowings
An SMSF trustee can purchase an overseas property outright, but they face many compliance hurdles,
The sole purpose test
This test asks whether the SMSF is being maintained solely for the prescribed purposes (eg to provide retirement benefits).
In the famous Swiss Chalet 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. Because fund members and their friends stayed in the chalet without paying rent, the fund was held to have failed the sole purpose test.
This case confirms that an SMSF trustee should only acquire real estate because it genuinely believes it is an appropriate way to achieve its core purpose of providing retirement benefits,
If an SMSF member believes the ATO will never know about the distant indulgence, they should recall that, these days, immigration, phone, credit card, GPS and other record: can readily pin someone to the ‘scene of the crime. We’ve represented clients who were asked by the ATO to prove they did not use the overseas property owned by their SMSF or related structure.
SMSF deed and investment strategy
The acquisition must be authorised by the deed and be consistent with the fund’s investment strategy.
In-house assets
The in-house assets rule provides perhaps the most common constraint on overseas investment by SMSF trustees. Some overseas jurisdictions require that a company or similar vehicle in the foreign country must hold the property. This means that a company uses its capital to buy the property, while the SMSF trustee acquires shares in the company.
In some Asian countries, SMSF trustees pay a local native to hold the title on their behalf. I have questioned previously whether this arrangement will hold up under the foreign country’s laws.
Exceptions to the in-house asset rule are outlined in 13,22C asset rule are outlined in 13,220 (Supervision) Regulations 1994 (Cth) – the SISR. But among other issues, the exceptions will not apply if the company being acquired establishes a bank account with an overseas bank.
Unfortunately, many SMSF trustees are ‘lambs to the slaughter’. Smooth real estate agents tell them they are buying real estate – but when the deal is done and the advisers get involved, the detailed requirements of the local jurisdiction’s law become apparent and a company or similar structure may be needed. – This results in many falling into this compliance trap, with great downside risk and substantial costs to unwind the transaction.
Investment with borrowings
If the SMSF trustee acquires property by using a limited recourse borrowing arrangement, new risks appear.
Firstly, if the property being acquired has to be held via a m costs in sourcing the property foreign company, we question whether a bank would be willing to lend; their security is merely shares in a company or units in a unit trust. Moreover, we have found few overseas banks that provide documents that are consistent with s67A requirements. Thus, the LRBA may not be limited recourse or may otherwise contravene the law.
As an alternative or supplement to taking security over the shares of the foreign company, the bank may seek to take security over the overseas property itself. If it were to do so (and the property was held via a foreign company), this would contravene the requirements of reg 13.22C of the SISR. As such, the SMSF trustee’s investment in the foreign company would be an in-house asset again, with numerous potential penalties and downside risk.
If a related party lends instead of a bank, it is questionable whether that lending will be at arm’s length, unless evidence can be gathered that the friendly-party LRBA terms and conditions are consistent with arm’s length practices.
Our experience has also proven that dealings with jurisdictions can result in complicated legal analysis to ensure everything is properly bedded down.
Increased costs
In addition to the compliance aspects outlined, there are often inflated costs for the transaction that must be taken into account. These may include:
. costs in sourcing the property (such as a buyer’s agent or advocate in the foreign country);
. having maintenance and repairs undertaken;
. costs for the lawyers and advisers overseas to complete the conveyance and provide ongoing advice;
. costs of creating and maintaining.a structure, such as a company,, in the jurisdiction;
. overseas tax compliance;
. documentation to allow fund borrowings, if required;
. overseas land and wealth taxes;
. costs associated with dealing with tenants (evicting a tenant may not be a straightforward process in overseas jurisdictions); and
. and a range of other reporting and other obligations.
Clients need to consider all of these factors, plus the compliance challenges, before embarking whether on overseas property investment. I strongly recommend expert legal, accounting and related advice before SMSF trustees buy overseas property.
The overseas property challenge: keypoints
. SMSF trustees can invest in overseas property.
. Either with or without compliance requirements
. Compliance costs and a wide range of other costs may make the investment less attractive.
