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Property and SMSFs: loosening the rules
If your SMSF has borrowed money (or thinking of borrowing money) to acquire ‘bricks and mortar’ property then there are a few things you need to know.
A new ATO ruling released last month helps to clarify what you can and can’t do with property that is under a limited recourse borrowing arrangement (LRBA).
The ruling addresses three key areas:
· Under the borrowing rules in the Superannuation Industry and Supervision (SIS) Act, the borrowing must be used to acquire a “single acquirable asset.” The ruling seeks to define what constitutes a single asset.
· The borrowing rules allow an asset that is held under a borrowing arrangement to be improved, however, the trustees cannot use borrowed funds to make the improvements. There is a fine line between what is a repair or improvement and the ruling attempts to clarify how the ATO assess the difference between these terms.
· Also, if you do improve the property, any improvement must not result in the asset becoming a different asset. The ruling looks at the factors the ATO considers, and what your SMSF auditor needs to consider, when they assess whether a property has been changed to such an extent that it is no longer the same asset.
If a fund falls outside of these rules, the fund must sell the asset. Imagine having to sell a property your fund recently acquired, leaving your fund with the stamp duty, legal and agent’s fees (or perhaps making a loss because the market conditions were not as good as they were when you purchased the property).
Is the property a single asset?
Assuming the fund is able to purchase the asset, the borrowing rules require that the money is used to acquire a single asset. For example, if the fund purchased a block of units, is the block considered to be one asset or are each of the units inside the block individual assets?
In the ruling the ATO concedes that “it may be possible … that the trustee is acquiring a single object of property notwithstanding that it is comprised of two or more proprietary rights. However, this will only be so where … the separate proprietary rights is distinctly identifiable as a single asset.” The bottom line is that if the rights can be dealt with separately, then they are not a single asset regardless of how the trustee wants to treat them.
Common examples include:
· where the fund acquires a property and the car park is held on a separate title but laws do not allow separation of ownership then there is a single acquirable asset.
· where a warehouse is constructed on multiple titles, then there may be a single acquirable asset.
Maintenance, repair or improvement?
There has been confusion in this area as ‘maintaining’ ‘repairing’ and ‘improving’ are common terms and not defined in the legislation. In the ruling, the ATO states:
· Maintaining generally means work done (or in anticipation) to prevent defects, damage or deterioration of an asset provided that it merely ensures the functional efficiency of the asset is maintained in its present state.
· Repairing generally means remedying or making good defects in, damage to, or deterioration of, an asset and contemplates the continued existence of the asset. The ATO goes on to state that “an asset may be acquired in a state in which a part of the asset is defective, damaged or suffering some deterioration of what would be considered to be its normal level of functional efficiency. Restoration of that part of the asset to its functional efficiency would be a repair for LRBA purposes.”
The ruling seems to suggest that the repair needs to bring the item back to its original condition but not go beyond that. The cost of the repair in the context of the overall asset is also likely to be a factor in the ATOs assessment of whether or not what has occurred is repair, maintenance or an improvement.
Defining improvement remains a grey area as it is a matter interpretation whether something is merely repaired or maintained or has been improved.
Can you improve a property?
Trustees can use money provisioned under a borrowing arrangement to maintain or repair the property but not improve it. If the trustees use money from other sources outside of the borrowing, they can improve the property as long as the improvements do not turn it into a different asset. For example, if the fund borrows money to acquire a vacant block of land and then builds a block of units on it, the asset would be fundamentally changed and considered to be a different asset.
If the fund does not have to borrow money to acquire the property, then the property can be improved as long as the investment decisions are in line with the funds investment strategy (don’t forget to minute key decisions) and all other SIS requirements are met – note there are some traps when using related parties to carry out the improvements.
Property and natural disasters
Trustees can now take some comfort in knowing that they can rebuild an asset that has been destroyed by flood or fire and not breach the borrowing rule. Using an insurance pay-out in these cases to rebuild what is essentially the same asset that existed prior to the event seems to be allowed.
Get advice!
Despite the clarifications offered by the ruling, the borrowing rules remain complex and rely on subjective decision making. Trustees should ensure that they seek advice before purchasing, renovating or changing any property held by their fund.
What’s the difference between price and value?
You are looking to buy a small business. You see something you are interested in: right industry, right location but is it the right price? In today’s market everyone is looking for a bargain. The difficulty in assessing the price of a small business is that there may not be a lot of ready comparisons available in the market. If you are looking to buy a business where there is a large and active market - like a newsagency, pharmacy or coffee lounge - then comparisons will be available. And, there are industry models that typically set the pricing for these types of business. However, if you are looking at a more unique business where there is not a lot of public information, the going can get tougher.
If you need an opinion on price, be careful and make sure you get the information you are really after.
When you value a small business it is not unusual for the valuation to come in under the asking price. A normal reaction to this is that the business must be overpriced. While this is sometimes true it is not automatically the case. In a perfect market, price and value are the same thing - but we don’t operate in a perfect market. As a result, this causes price to trade at either a premium or a discount to value. Over the past decade in Australia, price has traded at a premium of up to 30% on value for good quality businesses. To test the price of a business, you need to understand both its value and also any information on the price that businesses of the type you are looking at have traded for in the market.
When you ask for a valuation of a prospective business, the real question you might be seeking an answer to is should I buy this business? This is a very different question to one about valuation. Should I buy this business is about a range of both financial and non-financial indicators. It is as much about whether the business suits your lifestyle expectations and core capabilities as it is about the financial performance. If the business is a growth business and needs lots of marketing push, then it will not suit you unless you like the marketing aspect and have the time to dedicate to it. To assess all of this you need to understand the business and the business model in operation. You then need to compare the model to your expectations and also your business strengths. None of us are good everything. You need a business that matches your strengths.
You don’t want to pay too much for the business but equally you don’t want to miss out on the right business because the asking price is a bit more than you expected or what someone has told you it’s worth. Whether or not you are prepared to pay a premium to value will depend on how much you want the business and what growth you can see in it. Good quality businesses with good growth prospects will almost always command a premium as there are always buyers for these types of businesses. Understanding the true value of a business, is understanding what it is worth now and also what value you can add to it. Once you know both these numbers you should be ready to negotiate on price.
Quote of the month
“A genuine leader is not a searcher for consensus but a moulder of consensus.” Martin Luther King, Jr.
The material and contents provided in this publication are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.
September 2011 Newsletter
Juggling tax losses
We are often asked whether it’s possible to offset a loss in one company against the profit in another.
The answer is that there is no automatic way of offsetting losses and profits between your companies.
Most people try to manage a situation like this by putting through charges between the companies after year end (for example, a charge from the profit making company to the loss making company for ‘management fees’). This is not an effective strategy and creates a risk position for you.
Each company is an independent entity for tax purposes and needs to account for its tax position separately. This could result in one of your companies having a tax liability and the other having a tax loss which will be carried forward. In this case, the carry forward loss will continue to be available for a future year in which your company derives a taxable income. Providing there is a continuing majority of ownership of the loss company in both the loss year and the year in which you make a profit and seek to claim the loss, then there is no time limit on carrying forward the losses.
In the event that your loss company never made a profit in future years, then it is possible that the losses would be foregone.
One option available for you is to tax consolidate the two companies. Under a tax consolidation the two companies are dealt with as one for tax purposes. This allows you to offset profits and losses between the companies. To tax consolidate the two companies there must be a head company and a subsidiary. The fact that they are commonly owned by the same shareholders is not enough – you need to have a head company in place. If this is your situation then you can elect to tax consolidate the two companies for the 2011 year. If the shareholders are private individuals or held through family trusts then you may need to complete a restructure of ownership first. In this case, tax consolidation will only be available in a future year.
The decision to tax consolidate brings with it a range of requirements; it is not simply a matter of saying that you are tax consolidated. The fact that your accounts may be consolidated for accounting purposes does not mean that you are tax consolidated. Tax consolidation is a specific process that you need to go through and will include the resetting of your cost base for tax purposes.
Tax consolidation makes sense in some situations but is not appropriate for everyone. It comes with an initial set up cost and will place ongoing requirements on you. It does, however, provide a number of benefits. If this sounds like your situation, let us advise you on the implications of tax consolidation and determine whether it is advantageous for you.
Paid leave for Dads
If the Government holds on to power, Dads will qualify for two weeks paid parental leave from 1 January 2013.
Like the existing paid parental leave scheme, the ‘Dads and Partner Pay’ is paid at the minimum wage - currently $589.40. The payment applies to Dads and partners sharing the care of a new born (including adopting parents and same sex couples).
The payment is likely to be administered by the Family Assistance Office rather than through the employer.
The payment will be available in addition to any employer-funded paid leave but cannot be taken at the same time the employee is taking paid leave.
Employees are able to take three weeks unpaid parental leave at the same time as their partner after the birth of the child. It appears that while the payments to Dads can be taken at the same time as the existing paid parental leave payments for the primary carer – the total payments to the parents cannot exceed the existing 18 weeks.
Unlike the existing paid parental leave scheme, Dads will not be able to work while receiving the benefit and they cannot transfer any unused payment entitlement.
The scheme is means tested and the payments cut out once the individual earns $150,000.
Paid parental leave for Dads was initially scheduled for 1 July 2011 then postponed during the global financial crisis.
The full details are yet to be finalised and the Government is seeking consultation into the scheme. You can find the details at http://www.fahcsia.gov.au.
What does the new R&D tax credit offer you?
Australia has progressively fallen behind in the Global Innovation Index for the last few years. Last year alone, Australia slipped three places from 18 to 21 (Switzerland, Sweden and Singapore were the top performing countries).
Boosting innovation is a question that has plagued the Government for some time and the restructuring of the research and development incentives is an attempt to better target and encourage true innovation. For many years the criticism has been that R&D funding is too narrowly applied to make a difference and generally relates to product development rather than innovation – so, activities that a business would generally undertake rather than innovation. In addition, small business has been vastly under represented because in many cases the owners are simply unaware that what they are doing could qualify for the incentives available or because it appears complex and the amount of paperwork required to apply and sustain the funding may not be worth it. The irony is that in many cases SMEs are funding their own development whereas larger companies, that have a larger capacity to manage the cost of the risk of innovation, are capitalising on the concessions available.
The new R&D tax incentive tightens the definitions for R&D funding in an attempt to give the Government a bigger bang for its innovation buck, and provides additional incentives for businesses under $20 million.
For small companies with an aggregated turnover of less than $20 million, the R&D tax incentive provides a 45% tax offset for eligible R&D activities. The offset is refundable so the company will receive a cash refund even if they are in a tax loss position. Until 2014, the offset is processed through the company tax return. After 2014, small business will be able to access the R&D offset quarterly. So, for a small company with a turnover of say $4 million with eligible R&D expenditure in 2010/2011 of $500,000, the company would be entitled to a refundable tax offset of $225,000 when it lodges its tax return for the year.
For larger companies, a 40% offset is available for eligible R&D activities. The offset is non-refundable so if a company is in a tax loss position they will not be able to utilise the offset in that year but can carry forward unused offset amounts in future years.
Eligible R&D activities are now categorised as either ‘core’ or ‘supporting’ R&D activities. Core R&D activities are experimental activities where the outcome is unknown. The primary purpose of core activities is to create new knowledge (that might result in a product). Supporting R&D activities are activities that support core R&D activities. The test for supporting R&D activities is tighter than previous definitions and companies that currently claim R&D tax offsets will need to ensure that their activities still qualify.
The changes also expand access to the R&D tax credit to foreign companies that undertake R&D in Australia and to companies that hold their intellectual property offshore.
For small business in particular, the R&D tax incentive provides a way of funding investment that they often already make.
The R&D tax incentive applies from 1 July 2011. Companies wanting to access the incentive will need to register with Innovation Australia.
The restructuring of the R&D scheme has been in progress since 2009 before the enabling legislation was finally passed by both houses of Parliament last month.
Speak to us today about identifying whether or not your company can access the R&D tax credit.
Quote of the month
“Your present circumstances don't determine where you can go; they merely determine where you start.” Nido Qubein
The material and contents provided in this publication are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.
