Consequences of staying in SMSF farm land

Article published on: 08-02-2024

My client’s SMSF owns a farm which is rented to a third party who carries on a cattle business on the property. There is a vacant house on the farm which sits on less than 2 hectares. The clients plan to install new fences on the property. Can they live in the vacant house while doing the fencing? 

ANSWER

It’s not advisable for the client to live in the SMSF property to install fencing. Fencing materials cannot be supplied by the client, but must be purchased by the SMSF directly from a third party (eg a hardware store). 

There are certain considerations depending on whether the client is a fencer by profession or not. If the client is not a professional fencer, they cannot charge the SMSF for their services. The installation of fencing will increase the value of the SMSF property and the capital of the SMSF. The increase in value is a contribution to the fund. If the client is a fencer by profession, they can charge the SMSF for fencing services. A third-party provider of fencing will charge the SMSF commercial rates, which may include any accommodation expenses incurred while installing the fencing. Where the client has free accommodation, service fees charged to the SMSF could be less than commercial rates where no accommodation expenses was incurred. This will be a non-arms’ length expense for the SMSF. 

Non-arms’ length expenses trigger the non-arms’ length provisions, where related income (including a capital gain relating to the asset) can be taxed at the highest marginal rate. 

Explanation

Fencing materials must be purchased from a third party

A super fund is prohibited from acquiring assets from its members and related parties. There are certain exceptions, such as business real property and listed securities. Fencing materials are not an exception to the rule.

Improvement is a contribution - where client is not a fencer by profession

Tax ruling TR 2010/1 explains the meaning of a contribution as ‘anything of value that increases the capital of a superannuation fund provided by a person whose purpose is to benefit one or more particular members of the fund or all of the members in general.’ One way of increasing the value of an SMSF asset such as land or building where ownership of the improvement passes to the SMSF, could include the addition of infrastructure such as fencing.

Fees charged to the SMSF must be at commercial rates

If the client is a professional fencer, they can provide services only to the SMSF. Fencing materials must be purchased by the SMSF directly from a third party. It cannot be supplied by the client because the SMSF is prohibited from acquiring assets from its members and related parties. Alternatively, the SMSF could enter into a formal agency agreement, however, this would generally require well considered legal advice.

If the client stays on the SMSF property, they will not incur accommodation expenses. On the other hand, a third-party supplier may incur accommodation expenses while installing the fencing and incorporate the cost in their services fees. This means the cost of fencing services can be higher if supplied by a third party compared to if the client did the work. If the SMSF incurs a non-arm’s length expense, it can trigger the application of non-arms’ length income (NALI) rules. 

Under the NALI rules, income including any assessable capital gain relating to the asset is taxable at 45% where:

• the super fund’s income is more than might be expected where the SMSF has transactions with related parties, and/or
• an SMSF expense is less than what would be expected from an arm’s length dealing. 

The ATO site discusses NALI and NALE. There is also a Bill currently with the Senate that will further support these measures, which is explained in our article Legislation to support changes to non-arm’s length expenses.

Personal use of property is prohibited

While personal use of up to two hectares of property used for the carrying on of primary production business is not prohibited, the clients are not the ones carrying on a primary production business on the farm. The stay in the SMSF property may result in a lease arrangement  and the property may become an in-house asset. The value of in-house assets held by an SMSF is limited to 5% of the value of SMSF assets, and the SMSF will have to dispose of the property by a certain time.

A lease arrangement is discussed in SMSFR 2009/4 as ‘any agreement, arrangement or understanding in the nature of a lease (other than a lease) between a trustee of a superannuation fund and another person, under which the other person is to use, or control the use of, property owned by the fund, whether or not the agreement, arrangement or understanding is enforceable, or intended to be enforceable, by legal proceedings.’

Sole purpose test

The sole purpose test requires that the super fund’s investments are solely for the purpose of providing retirement benefits and death benefits for the member’s beneficiaries. The stay on the farm which is not related to carrying on a primary production business is a present-day benefit rather than a retirement benefit. The SMSFR 2008/2 explains sole purpose test. Free accommodation may also be seen as providing financial assistance to a member, which is also prohibited under super law. 

Given the significant issues that may arise, a few nights stay in the farm house is not worth it.