SMSFs buying overseas property
Overseas property investment sounds exotic and exciting. Investors are buying properties in Paris, Bali, and the US where properties seem unbelievably cheap compared to WA. There appears to be a misconception that these properties must be a good investment for an SMSF. However, SMSF purchasers must address a number of compliance issue which add huge administrative burdens and costs on the trustee.
Adding to the concept of value is the idea of potentially combining the purchase with a Limited Recourse Borrowing Arrangement (LRBA) rather than simply purchasing outright.
An SMSF trustee must satisfy the following compliance issues – this maybe problematic due to the prevailing governing rules where the property is located.
- Sole purpose test — don’t mention the Swiss Chalet Case! – If member’s or relatives stay in the property, then satisfying this test becomes most unlikely. Although the assumption might be that the ATO would not find out, they can gather evidence from immigration, phone, credit card, GPS and other records, that may pose a “please explain”.
- In-house assets — the SMSF would be categorized as a foreign investor and in some countries only companies are able to purchase properties. The SMSF must then become a shareholder of a foreign company. This in itself is a complicated issue for which trustees should definitely seek advice before putting pen to paper. This is one of the most common mistakes made by trustees and may result in a costly “unwinding” of the investment.
- SMSF deed and Investment strategy — the purchase must be authorised by the deed and consistent with the fund investment strategy.
Investment with borrowings
Although entering into LRBA is a complicated process, it is becoming popular in the SMSF Arena.
If the property being purchased has to be held via a foreign company, it is unlikely that a bank would be willing to lend, as the bank would essentially be lending money to purchase a piece of paper (being shares in the foreign company). Additionally, overseas banks are not fully aware of the compliance requirements of the SIS Act and the result might be that the LRBA does not technically exist. If the bank was to seek security over the property held by the foreign company the arrangement would be in breach. As such, the SMSF investment in the foreign company would be an in-house asset, again exposing the trustees to the current ATO penalty regime.
If a related party were to lend instead of a bank, onus is on the trustees to provide evidence that terms are consistent with arm’s length rules.
There is no doubt that purchases in overseas countries requires legal analysis to ensure, for example, that the trust relationship is recognized. Additionally in some countries the legal system makes it extremely difficult and costly to obtain details of ownership required for auditing purposes.
The challenge is in making sure that both the overseas and SIS requirements can work together.
Not only do the complications above suggest higher administration costs, there are often inflated costs for the purchase, with property promoters wanting their slice of the pie.
Optima Partner’s suggestion to you is – proceed with caution and ensure you contact us for quality advice before signing up for the bargain of a lifetime in the city of your dreams!
This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.