Where an SMSF has bought property, the break-up of assets may be problematic during a Michael Hallinan writes.
Marriage and self-managed super funds (SMSFs) are supposed to be long-term structures with economic consequences for the partners involved.
Financial advisers have always faced issues around asset breakup when a client’s marriage/relationship ends.
Ordinarily, where easily traded assets like ASX 200 shares or cash are involved, the breakup of assets can be straightforward, but a lumpy asset like a property is more problematic.
It’s an even bigger problem if one of the parties has a need for that property to run their business – in fact, to stay in business.
This case study looks at a fictitious couple – Colin and Jane – who hold business real property in their SMSF and have now decided to divorce.
Colin runs his own business from this building and wants to keep the asset in his own SMSF and to continue operating from the building as a tenant.
We have assumed that it is an amicable breakup (whatever that means) and that the adviser and other parties are seeking to make this happen for Colin and also to ensure that Jane is properly paid out from the SMSF.
The Colin and Jane SMSF holds 100 per cent of the units issued in the C&J Property Trust. The sole asset of the Property Trust is the building from which Colin conducts his business.
Colin’s continued use of the building is vital to the continuation of his business.
Their SMSF has a cash balance of $200,000 and the building is worth $500,000 at the time of settling their personal affairs (no other properties or assets have to be considered).
Colin and Jane each have a 50 per cent interest in the SMSF: the current dollar value of their SMSF interests is $350,000.
Colin has been operating his business from the building. Jane simply wants her superannuation benefits to be paid out so that she can move on with her life.
Colin equally appreciates the need for Jane to have a clean break – not the least issue being that Colin does not want his former spouse to be his landlord.
How can Jane get paid out and how can Colin keep the building inside the SMSF?
While there are a number of outcomes possible, the best option seems to involve Colin paying out Jane in some form. The key issues for an adviser to consider in this kind of scenario are:
- Complying with the Family Court Order;
- Able to happen quickly enough to satisfy Jane;
- To be financially within Colin’s means.
The superannuation issues which the financial adviser needs to consider are relatively straightforward.
As the property trust is a “Reg 13.22C Unit trust”, the SMSF holding of units is not an in-house asset, and as the building is leased to Colin’s operating company used as his business premises, the building is not an in-house asset.
The adviser proposes that the SMSF buys the building directly from the property trust.
This purchase will not breach the Superannuation Industry (Supervision) Act 1993 (the SIS Act) as the building is business real property and the purchase price at its current market value (as shown by a recent valuation report).
Clearly, the SMSF does not have sufficient available funds to purchase the building.
Consequently, the SMSF will have to purchase the building on a geared basis.
The SMSF will borrow $400,000 from a third party lender. The SMSF uses $100,000 of its cash investments and $400,000 of the borrowed monies to pay the purchase price.
At settlement, the SMSF owns the building (albeit now held in a holding trust / security trust which is mortgaged to the lender).
The property trust has $500,000 in cash.
The property trust no longer has any purpose and is wound up, and the $500,000 in cash is paid to the SMSF upon redemption of the units.
The SMSF now has $600,000 in cash and the building (worth $500,000 and mortgaged) with a debt of $400,000.
The net position of the SMSF is $700,000. The SMSF now has sufficient cash to pay out Jane’s benefit of $350,000 and does so.
The SMSF position is now $250,000 in cash and the building worth $500,000 with a $400,000 debt.
Unfortunately, the SMSF will have to pay transfer duty on the purchase of the building.
Is there another way to pay out Jane?
The SMSF could have borrowed money in order to finance the payment of the benefit. In this case, the SMSF would need to have borrowed $150,000 (at a minimum).
Unfortunately, the borrowing exception for super benefits is subject to two restrictions which would preclude its use for Colin and Jane.
The first is that the amount borrowed cannot exceed 10 per cent of the value of the assets of the fund. The second is that the amount borrowed must be repaid within 90 days.
Must the borrowing be from a bank?
The short answer is no.
If Colin has access to other funding sources (such as the operating business) then the loan could be from his own company.
His operating company could lend to the SMSF for the purchase of the acquisition of the building.
The loan arrangement must still be fully documented and the lender, even though in-house, should still take a mortgage.
However, an adviser in this situation will have to carefully consider whether the loan from the company would be caught within Div 7A and therefore the interest rate be not less than the Div 7A rate.
Full documentation as you go along
The adviser should be aware that property transactions and family law settlements like any other issue around family law matters is happening under stress for both parties.
The adviser must document every discussion, every phone call in even greater detail than would normally be required to ensure that the adviser’s recollections of the decision-making processes occurring are recorded in the proper timeline.
In other words, what has been discussed above looks like a clean, clear process, but what if emotion and recrimination are clouding judgments?
The adviser has to be able to show that his involvement within discussions is properly recorded.
The solution works for Colin. Both Colin and the adviser must realise and understand that the solution cannot be implemented without the cooperation of Jane and her willingness to permit time for the solution to be implemented and the consequent delay in the payment of her benefit.
Divorce is a tricky issue for advisers with aggrieved parties now that SMSFs are coming of age, so to speak, and some are holding property which makes restructuring more difficult/complex.
The mix of assets, emotions and tax structures can turn this part of SMSF advice into a minefield for advisers.
Michael Hallinan is the special counsel at Townsends Business and Corporate Lawyers.
By Michael Hallinan