Self-Managed Superannuation Funds for Small to Mid-Sized Business

Self-Managed Superannuation Funds for Small to Mid-Sized

Business Contributors: James Price, JPAbusiness Pty Ltd Michael Pisani, Chapman Eastway

http://www.jpabusiness.com.au

2 jpabusiness.com.au +61 2 6360 0360

Table of Contents

Introduction ........................................................................................................................ 3 SMSFs in practice .................................................................................................................................................................. 3 A SMSF success story ............................................................................................................................................................ 4 A word of warning ................................................................................................................................................................ 5 Meet our contributor ........................................................................................................................................................... 6

Chapter 1: Self-‐managed super – is it for me? ..................................................................... 7 1. As a small to mid-‐sized private business owner, how can I use my superannuation to build my wealth? ....................................................................................................................................................................................... 7 2. How do I know if a SMSF is for me? .......................................................................................................................... 8

Chapter 2: Using your SMSF to borrow for property investment – the risks, benefits and mechanics ......................................................................................................................... 10 1. I hear about business owners using their SMSF to buy a business premises or other investments using leveraging (borrowing). What’s the story? ................................................................................................. 10 2. What are the risks of borrowing within your SMSF? ...................................................................................... 11 3. What are the benefits of borrowing within your SMSF? ............................................................................... 12 4. What are the mechanics of borrowing within your SMSF? .......................................................................... 14

Chapter 3: Self-‐managed super FAQs ................................................................................ 17 1. Does a SMSF provide me with asset protection? ............................................................................................... 17 2. Can I use my SMSF as a family succession tool? ................................................................................................ 17 3. If my SMSF owns my business premises does it provide significant tax advantages over normal business deductible expenses if my business owns its business premises outright? Are there other implications? ......................................................................................................................................................................... 19 4. What happens if I want to sell my business premises? ................................................................................... 20 5. How can I transfer my business property into my SMSF? ............................................................................. 21

Disclaimer: The information contained in this eBook is general in nature and should not be taken as personal, professional advice. Readers should make their own inquiries and

obtain independent advice before making any decisions or taking any action.



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Introduction Comments by James Price JPAbusiness Pty Ltd

Many of our clients are looking to not only build the value of their operating business, but also build their wealth over time and extract some value along the way.

Often their business has a going concern aspect to it. It has clients, operations in different geographical areas, various products and staff, but it also has a business premises, or a range of premises.

The challenge is in how to treat those investments – the business investment and the real estate investment – separately. This is done because the investments have separate risk and return profiles, and also because there are extra wealth creation opportunities for the real estate investment within the current superannuation and taxation environment.

This eBook looks at some of these opportunities for value and wealth building, which are afforded by utilising Self-Managed Superannuation Funds.

SMSFs in practice

About one-third of Australia’s superannuation pool is held in self-managed super funds (SMSFs), with the number of funds rising by 35% since 2008.

Many business owners are aware SMSFs offer opportunities to control their super more closely and also utilise gearing to buy assets.




But sometimes creating a SMSF for these purposes is simply a bridge too far in terms of a lack of understanding of what’s available and how it can actually be done.

The purpose of this eBook is to bring that information to light and explain in practical terms:

• How to decide if a SMSF is for you; • How to borrow within your SMSF, and • The pros and cons of borrowing within your SMSF.

A SMSF success story

Self-managed superannuation is growing in prominence and that’s partly because – if done well – it can be a great vehicle for wealth creation.

For instance, I have clients – a husband and wife team – who own a family business in the heavy equipment industry.

They’ve been in business for more than 30 years and the business has solid earnings of 20% of turnover, with a turnover of between $10 and $20 million.




These clients have at least five commercial and industrial properties they have developed and now own as part of their SMSF.

Those properties are separate from their operating business, but one of the properties is the business’s premises and is leased by the business at a market rental.

When you look at their example, you see the business owners are driving a return from their investment in their business – from the engineering, construction and earthmoving industry – but they’re also drawing a return on a different risk profile in the commercial and industrial property market.

They’re getting a capital return from the properties they’ve developed, but they’re also leveraging their SMSF and enjoying the advantages that come from owning those properties separate from the business.

A word of warning

It’s important to note that borrowing to purchase an asset or investment within your SMSF is just like borrowing for any other investment. You must look carefully at the return and the risk.

If you’re making a commitment to a bank to borrow and repay funds, you need to be sure it’s a commitment you can meet, despite what fluctuations may occur in the business or the fund. Borrowing within your SMSF doesn’t make the risk any less.

Another point to keep in mind is you need to have both a short- and long-term view when choosing investments for your super fund. If you’re a business owner making a decision just for the short term, that approach may be fraught with danger.

A SMSF can give business owners flexibility and control over their retirement savings, but it’s not a silver bullet for wealth building. It has risks, complexities and issues that must be carefully considered, so make sure you get professional advice from a firm well versed in the rules and regulations applicable to SMSFs.




Meet our contributor

So just what does a SMSF offer and how can you tell if self-managed super is for you?

To answer these questions, and many more, we’ve called on a long-time accounting partner of ours, Chapman Eastway, a specialist firm we have known and worked with for more than 25 years.

Chapman Eastway is a family and business advisory firm based in Sydney, and one of the highly respected service providers in the JPAbusiness network.

Chapman Eastway Principal Michael Pisani has kindly agreed to share his expertise on this topic with us.

A chartered accountant and specialist tax advisor, Michael has a special interest in SMSFs, along with the provision of related taxation advice.

Michael has more than 10 years experience providing taxation and business advisory services to a diverse group of corporate and private clients. He has a strong technical background with experience in group restructuring, retirement and succession planning, ongoing taxation planning and family wealth preservation.



http://www.chapmaneastway.com.au

http://www.chapmaneastway.com.au/firm-profile/principals-and-advisors/michael-pisani/

http://www.chapmaneastway.com.au/firm-profile/principals-and-advisors/michael-pisani/


Chapter 1: Self-managed super – is it for me? Comments by Michael Pisani Chapman Eastway

1. As a small to mid-sized private business owner, how can I use my superannuation to build my wealth?

Many people who own or run small to mid-sized businesses have much of their wealth tied up in their business.

Building wealth through superannuation provides an avenue to diversify their wealth away from the day-to-day business activities and provides an environment that can be:

a) tax effective, and b) offers additional asset protection.

It is a great vehicle for building retirement wealth.

I see superannuation as providing a bit of a safety net for business owners, because it can be used as a source of wealth that sits outside their business.

Why choose self-managed super?

Business owners tend to like having the ability to control their own destiny.

For this reason self-managed superannuation funds (SMSF) are often attractive to small and mid-sized business owners; they offer a combination of flexibility and control of retirement investments.




What is a self-managed super fund (SMSF)?

Almost anyone can have a SMSF. Basically it is:

• A special trust; • Regulated by the Australian Taxation Office; • Run by members for their own benefit.

SMSFs growing in popularity

At the end of June 2013 the Australian Tax Office (ATO) reported:

• More than 500,000 SMSFs in Australia – a rise of about 35% since June 2008

• Approximately 960,000 members • $495 billion held by SMSFs – about one-third of all superannuation • At June 30 2012, 25.6% of SMSFs were valued $200k-$500k

2. How do I know if a SMSF is for me?

There are 3 key questions you should ask yourself before heading down the SMSF route:

1) Do I have the skills and knowledge required to make investment decisions for my own retirement?

A SMSF is basically do-it-yourself super. You have to have the skills and knowledge to make investment decisions and decisions about your own retirement.

You can and should take advice from professionals but, ultimately, the responsibility lies with you.




2) Am I prepared to accept the responsibility that comes with being a trustee?

All SMSF members must be a trustee or a director of a corporate trustee. You can be an individual trustee of your own SMSF, or a director of a corporate trustee.

Trustees are responsible for running the fund within the law and meeting audit and taxation obligations.

In December 2013 the government announced new penalties applying to SMSF trustees, including fines up to $10,200 for breaches of the Superannuation Industry Supervision (SIS) Act.

3) Do I have enough investments to make it worthwhile?

I’m often asked ‘how much do I need to set up my own SMSF?’ There’s no minimum amount in law, however there are some benchmarks published by ASIC and the ATO.

The ATO website features a number of publications and general information for people considering SMSF and, in their opinion, around $200,000 is an appropriate minimum benchmark.

As an indicative compliance cost associated with SMSF the ATO suggests you might be looking in the order of $2000 per year on $200,000. That represents 1%, which is comparable with a lot of the management expense ratios of public offer funds.

I’m happy to accept their guidelines, however I think you could consider having a fund with a balance of less than $200,000 if you set it up with the strategic view to grow the SMSF in the short to medium term, or if it was used to purchase a strategic asset.




Chapter 2: Using your SMSF to borrow for property investment – the risks, benefits and mechanics Comments by Michael Pisani Chapman Eastway

1. I hear about business owners using their SMSF to buy a business premises or other investments using leveraging (borrowing). What’s the story?

If we look at borrowing within super to buy real property, there has been a very large uptake of ‘limited recourse borrowing arrangements’ in the past few years.

Even five years ago, borrowing within super was considered a little ‘out there’ and many people were skeptical.

But in the last couple of years, in particular, the financial institutions, other lenders and a lot of the SMSF advisors have really taken to it, so it has become much more commonplace.

Some of that is to do with the promotion by the real estate industry, as well as lenders, banks and non-banks, who are looking at it as another product offering.

At a professional level this has caused some concern.

In response, the SMSF Professional Association of Australia has developed new industry guidelines on limited recourse borrowing arrangements. On July 30, 2014 the NAB became the first lender to sign up to the best practice guidelines.




2. What are the risks of borrowing within your SMSF?

Some of the risks on limited recourse borrowing arrangements are:

1) Incorrect documentation: You need professional help if you’re looking at borrowing in super – it’s not straightforward.

It’s a specific type of structure and specific type of loan, so it’s important to get it right from the beginning.

If you don’t document the arrangement correctly or the loan is not structured properly, it could lead to a breach of SIS (Superannuation Industry Supervision) Act, which could make your fund non-compliant, i.e. not conducted in accordance with the SMSF rules.

In extreme cases there are heavy penalties and taxes that apply to funds seen to be non-compliant.

Get proper professional advice to manage that risk.

2) Double stamp duty: If the limited recourse borrowing arrangement is not documented correctly from the beginning, it could lead to instances where stamp duty is paid twice on the same property.

3) Liquidity issues: If you have a very large asset within the SMSF, say you’ve borrowed to buy a piece of real property, you may have liquidity issues within your fund. For example, if one of the members wants to exit the fund or start a pension, you may find there is not enough liquid assets or cash to be able to do that and also meet borrowing commitments.




4) Inadequate insurance: Another risk when you have borrowed to purchase a large asset in the fund surrounds appropriate insurances.

If a member was to die and you needed to pay out their benefits in the form of a lump sum death benefit, you need to ensure there are appropriate insurances to provide liquidity.

For example, say you’ve got a mum and dad inside a super fund and one dies. You want to pay out the benefits but 90% of the fund consists of a piece of property.

You can’t sell half a property, so you may be forced to sell the whole property at a time that doesn’t suit.

If you have other investments, such as cash or listed equities, you have less liquidity issues.

5) Ability to service debt: Like any debt, you have to ensure you can service the debt and meet covenants, particularly with commercial property.

If a fund buys a piece of commercial property and there is an extended period of vacancy, it’s going to be very difficult for the fund to service the debt and, again, that could lead to an instance where you’re forced to sell the asset at an inopportune time.

3. What are the benefits of borrowing within your SMSF?

1) Strategic asset acquisition: The key benefit of this gearing strategy is that you’re able to buy an asset you may not have otherwise been able to buy. In other words, an asset that is greater than the value of the fund alone.

That may present great opportunities to buy strategic assets, in particular. For example, business owners may have the ability to buy a key piece of commercial property, such as the property the business is conducted out of, which they may not have been able to do without the gearing.




2) Capital growth: The power of gearing can increase the ability to access capital growth. Debt can be used to increase the asset base of the SMSF and if the assets appreciate in value, the capital growth can be accelerated. However, it also increases risk.




4. What are the mechanics of borrowing within your SMSF?

SMSF Borrowing Strategies – Chapman Eastway

As you can see from the diagram above, borrowing within your SMSF is not exactly straightforward.

A lot of Australians are very familiar with the concept of gearing – going out and buying an investment property in your own name. This is not that simple.

Let’s take a look at the diagram, starting with the lender.

The Lender: The lender doesn’t need to be a bank; it can be a non-bank and can even be a related party to the members of the super fund.

The definition of ‘related party’ can be a little complex, but generally it can be another entity that the members control. For example, if Mum and Dad are the members of a super fund, the lender could be ‘Mum and Dad Pty Ltd’ or ‘Mum and Dad Family Trust’.

The lender provides a Limited Recourse Loan to the SMSF.




Limited Recourse Loan: This is a special type of loan – it is not a typical mortgage arrangement. ‘Limited recourse’ means, in the case of a default, the recourse of the lender is limited to the asset being purchased – they can’t use any of the other assets in the fund to repay the debt.

In practice, that means the interest rates paid on a limited recourse loan are usually a bit higher than standard interest rates and the lending-to-value ratio (LVR) is generally a little lower than you could otherwise borrow.

The lender will be more cautious: they’ll lend less and the interest rate will be higher.

Holding Trust: The Holding Trust will own the asset being purchased – the title of the asset will not transfer to the SMSF itself until the debt is paid. This is because one of the rules under the SIS Act is that assets within a SMSF must be unencumbered; they can’t have a mortgage or charge over them.

The Holding Trust sits to the side and owns the asset, and it provides the mortgage or charge to the lender for security.

Declaration of Trust: This states that the ‘Holding Trust is holding this asset on behalf of the SMSF’. Some banks and lenders have specific requirements as to the form a holding trust must take or who can be the holding trust. There are some legislative requirements, but there is also some flexibility.




Beware stamp duty trap

At the end of the arrangement, when all the debt is paid off, the asset is transferred from the Holding Trust to the SMSF. This is the point where a double stamp duty trap can be found.

Normally, when you buy real estate, you pay stamp duty. In this case the Holding Trust pays stamp duty when it first buys the asset.

However, if the loan arrangement and Holding Trust wasn’t set up and documented properly at the beginning, the Holding Trust’s transfer of the property into the SMSF can trigger another round of stamp duty.

Be prepared for higher costs

Entering into one of these borrowing arrangements does add a layer of complication in the affairs of the super fund.

SMSF members should expect their compliance costs will also increase as a result.

Powerful strategy

The two issues mentioned above are cons of borrowing within your SMSF, but there are also some big positives.

When the lender is another entity within the family group, or borrowing allows you to purchase a strategic business or family asset, borrowing within your SMSF can be a very powerful tool.

It allows you to put a key asset inside super which you may not have been able to get in there without borrowing.

The asset is then in a low-tax environment with an additional layer of protection from creditors.




Chapter 3: Self-managed super FAQs Comments by Michael Pisani Chapman Eastway

1. Does a SMSF provide me with asset protection?

I can’t give legal advice, but generally assets held within a SMSF have an increased level of protection from business creditors, in the event of a business default or if there is litigation.

However, people should be aware commencing a pension within super may increase the exposure to creditors, and so increase the ability of creditors to access your retirement earnings.

If the member had provided a personal guarantee for the activities of the business – and small business owners are often required to do so – then that income stream could be attacked by a creditor in the event of a business default or personal bankruptcy.

2. Can I use my SMSF as a family succession tool?

Many people don’t consider a SMSF as a tool for succession planning, but it can actually be used really effectively.

The key reason is a SMSF doesn’t have a finite life.

A lot of key family assets are held in discretionary family trusts which all do have a finite life – generally about 80 years – but a SMSF doesn’t have a shelf life.

It can be used to transfer assets between generations without actually triggering capital gains tax (CGT) or stamp duty, which are the two major drawbacks when transferring assets between generations.




For example:

Mum and Dad have a SMSF which holds a farm.

You can have up to four members in a SMSF, so two of their children come in as members of the same SMSF.

They progressively build up their balance while Mum and Dad start taking pension payments as they move into retirement phase.

Eventually, Mum and Dad have taken their super monies as a retirement benefit while the next generation has effectively taken control of the asset by building their super balances.

That can be done over a couple of generations.




3. If my SMSF owns my business premises does it provide significant tax advantages over normal business deductible expenses if my business owns its business premises outright? Are there other implications?

Holding commercial property within a SMSF which is controlled by the owners of the business occupying those premises is a very powerful tool for building wealth and accessing some significant tax advantages.

Rent paid by a small to mid-sized business is a deductible outgoing business expense. So there could be a 30% tax benefit on rent paid, or 49% tax benefit when you think about funds flowing to individuals at the top marginal tax rate.

If that rent is being paid to your own SMSF, the income going into the fund is being taxed at a flat rate of 15% while the fund is in accumulation phase, or even 0% while the fund is in pension phase.

For example:

A small business operates as a company.

It receives a deduction of 30 cents in the dollar for rent paid to the super fund and, because the fund is in a pension phase (because it’s paying a Transition to Retirement pension or something similar) the income going in is taxed at 0%.

In order to access these benefits you must ensure the rent is paid on an ‘arm’s length basis’, i.e. a fair market rent.

However, even with a market rent this strategy is still a very powerful tool, particularly in recent times as the yield on commercial property has been relatively high, compared to residential property.




Planning strategy implications to consider

The planning opportunities increase as people approach retirement age.

As explained above, income generated within a SMSF is taxed at 0% when the fund is in a pension phase.

A SMSF can be in a pension phase if the members have commenced a Transition to Retirement Income Stream.

People aged between 55 and 65 may commence such a pension and still be actively involved in the business.

Even for members who are still in the accumulation phase of their super there is a flat rate of tax of 15% on income in super.

That is a lot less than taxes paid at the business level.

4. What happens if I want to sell my business premises?

If the premises are owned by the SMSF and have been held in the fund for more than one year, they are eligible for a Capital Gains Tax (CGT) discount when sold.

The discount brings the effective rate of tax to 10% on profits on the disposal of the asset.

However, if the fund is in pension phase and an asset is sold, the effective rate of tax on any capital gain is zero.




For example:

You’ve had a piece of property inside the SMSF for 10 years.

You start a pension in year 10 and a year later you sell the property.

You effectively escape paying CGT on that property even though you may have had 10 years of appreciation.

It requires careful planning, but it represents a huge retirement planning opportunity.

5. How can I transfer my business property into my SMSF?

There is a significant planning opportunity in NSW at the moment and that is the availability of stamp duty exemptions when SMSF members transfer assets from themselves into their fund.

If a member owns a piece of business real property there are avenues where they could transfer that piece of property into their SMSF without paying stamp duty on the transfer.

There may be some Capital Gains Tax (CGT) implications on transferring an asset from a member to their fund, but there may also be some opportunities to minimise or even totally remove those CGT implications through the Small Business CGT Concessions.



Date post:	13-Apr-2017
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