Related party builders and section 66 of the Superannuation Industry (Supervision) Act 1993
Issues raised
- Will the trustees of a SMSF breach section66 of the SIS Act if the trustees appoint as their agent, a related party to purchase the goods and materials on behalf of the trustee and those goods and material are used in the construction of a building on land owned by the SMSF?
- Will the trustees of a SMSF breach section 66of the SIS Act if the trustees execute a deed of bare trust and transfer funds from the SMSF to the bare trust to finance the purchase of goods and materials used by a related party in the construction of a building on land owned by the SMSF?
Background information provided by member
The construction of a building requires the performance of a service (in this case by a related party) and the use of goods and materials to construct the premises. As part of the professional services provided by a builder, it is common practice for builders to provide the goods and materials necessary to construct the premise. It would be unusual, and in most cases impractical, for the consumer (in this case the SMSF) to purchase the goods and materials required to construct the premise directly from the supplier. In deed, given trade discounts, it would be to financial disadvantage of the SMSF if it did purchase goods and materials directly.
Paragraphs 17 to 19 of SMSFR 2010/1, state:
'In analysing whether there has been an acquisition of an asset by a trustee or investment manager, and the nature of that asset, the Commissioner takes a holistic approach to determine the substance of the transaction.'
'If a trustee or investment manager enters into a contract with a related party entitling the SMSF to the performance of a service by the related party, the performance of that service is the substance of the transaction and not any rights that the SMSF might also acquire to have that service performed. Therefore, the acquisition of the performance of a service does not contravene subsection66(1)'
'If goods or materials that are insignificant in value and function are provided to an SMSF as part of a service it is the Commissioner's view that it remains the performance of a service only. If, however, goods or materials are provided to the SMSF that are not insignificant in value and function there is an acquisition of assets (being the goods or materials).'
At the December 2010 NTLG Superannuation Technical Sub-Group meeting, the ATO confirmed this view and said in cases where an SMSF engages a related party to construct a building on land owned by the SMSF, it must be clear that the related party is only providing building services and not any materials used if a breach of section66 is to be avoided.
During the meeting a question was asked about agents and whether the supply of goods and materials by a related party agent appointed by the trustees, would avoid a breach of section66. The chair invited the industry to submit this question to the ATO.
The appointment of an agent in this scenario would typically involve the SMSF trustees appointing the related entity as their agent under a deed of agency agreement, or by a variation to the building contract.
The deed of agency agreement would confer upon the agent the terms of the agency and would authorise the related party to acquire the goods and materials as an agent on behalf of the trustees. Alternatively, the agency appointment, and the authority to act conferred upon the agent, could be expressed or implied in the building contract.
The agent would acquire the goods and materials and then invoice the trustees for the cost of the purchase either on a progressive payment basis or only once the work has been completed. The cost of services provided may be invoiced separately or together with the costs of the goods and materials. The invoiced cost of the goods and materials may be increased by a profit margin charged by the related party builder.
As an alternative, a new bank account could be opened in the name of the builder and the builder executes a deed of bare trust confirming that it holds the bank account on bare trust for the SMSF trustee and that all things purchased with the bank account proceeds belong to the SMSF. Funds are then transferred from the SMSF to the bank account and neither the builder nor any other entity puts any money in the bank account. The builder buys building supplies from the bank account as directed by the SMSF trustee and those supplies are then affixed to the SMSF land.
Industry view/suggested treatment provided by member
The law of agency is well established. Under the agency contract, the agent is given the authority to do certain things on behalf of the principal. The principal is bound provided the agent acts within actual or ostensible authority. An agent can provide a purchasing service and order goods and materials from a third party on behalf of their principal so long as the purchase is made within the scope of the agent's authority and it is within the power of the principal to make the purchase itself. In such instance, the principal must pay for the goods because they are effectively bound through the agent in a contract with the third party. The agent, on the other hand, is not liable under the purchase contract.
As the agent is not liable under the purchase contract to acquire the goods and materials, there has been no acquisition of the goods and materials by the agent (the related party builder). Instead the goods and materials have been acquired by the SMSF trustees as the SMSF trustees (and not the related party builder) are contractually bound to acquire the goods and materials under the purchase contract. Paragraph 14 of SMSFR 2010/1 states:
'An asset is acquired whether it is an asset that exists prior to its transfer or assignment to the SMSF or it is an asset (for example, rights under a contract) that upon its creation is acquired by the trustee or investment manager.'
Therefore, the trustees of a SMSF will not breach section66 of the SIS Act if the trustees appoint as their agent, a related party to supply a purchasing service being a service to purchase goods and materials on behalf of the trustee used in the construction of a building on land owned by the SMSF.
Similarly, the principles of bare trusts are well established.
[The member's organisation] notes that many APRA regulated funds use bare trustees or custodians to be the registered owners of their assets. It is well accepted these arrangements are 'looked through' for the purposes of s 66 as well as the in-house asset rules.
Although the builder's name is on the bank account, it is holding that money on trust for the trustee of the SMSF. Consistent with the High Court's description of bare trusts in CGU Insurance Limited v One.Tel Limited (in liq) (2010) 268 ALR 439 [36], the bare trustee (that is, the related party builder) has no active duties to perform other than those which exist by reason of the office of trustee, with the result that the money awaits disposition at the direction of the SMSF trustee. The SMSF trustee directs the bare trustee to release the funds to the agent to acquire the relevant goods and materials. Because the goods and materials are purchased with the SMSF's moneys, the goods and materials would always belong to the SMSF. Accordingly, because the goods and materials already belong to the SMSF, there is no acquisition when the bare trustee releases the money to the agent in exchange for the goods or materials as directed.
This treatment would be consistent with GSTR 2008/3. It would also be consistent with prior ATO comments in respect of a SMSF borrowing that the transfer of an acquirable asset from the holding trustee to the SMSF trustee does not breach section66.
Technical reference
Subsection 66(1) of the SIS Act
SMSFR 2010/1
Impact on clients suggested by member
High, if the views in draft SMSF ruling SMSFR 2011/D1 prevail (that is, if assets acquired under a limited recourse borrowing arrangement are permitted to be improved). Also high for SMSF clients who hold vacant or underdeveloped land in their fund.
Priority of issue where ATO view is required suggested by member
Medium
ATO initial response
Question 1
Section 66 of SISA prohibits, with some exceptions, the acquisition of assets by the trustee of an SMSF from a related party of the SMSF. Consequently, if a related party builder acquires materials in their own right which are then supplied to the SMSF, this would result in a contravention of section66.
Alternatively, where a related party only acts as an agent, arranging for the acquisition of building materials on behalf of the SMSF trustee from an unrelated vendor, and the related party at no times holds legal title to the building materials, the SMSF trustees have acquired the materials from that vendor, not the related party. Therefore, section 66 of SISA would not apply to the acquisitions.
Whether the particular arrangements under which building materials are supplied do amount to a direct acquisition by the SMSF trustee from the original suppliers, with the related party only acting as an agent, will be determined by the application of the normal laws of contract and agency to the facts of each case.
As stated in the industry suggested treatment, where there is a direct acquisition by the SMSF trustee from the original supplier it is the SMSF trustee who has the contractual obligation to pay the original supplier for those materials.
If the related party pays for building materials and invoices the SMSF either progressively (that is, at regular intervals) or at the end of the project, especially where a mark-up or profit is added, this might be indicative of the purchase of the materials by the related party in their own right and on-sale to the SMSF trustee rather than a purchase by the SMSF trustee through the related party as agent. If the related party builder claims GST input tax credits in respect of the acquisition of the building materials, this might also be indicative that the related party builder acquired the building materials as part of their business operations and then supplied these to the SMSF trustee.
In addition, if the agent has outlaid funds to acquire the materials on behalf of the SMSF, an arrangement to defer reimbursement of that amount may amount to a borrowing by the trustee in contravention of section 67 of the SISA. This is discussed in paragraphs 70 to 74 of SMSFR 2009/2: Self Managed Superannuation Funds: The meaning of 'borrow money' or 'maintain an existing borrowing of money' for the purposes of section 67 of the Superannuation Industry (Supervision) Act 1993.
Question 2
The ATO does not believe that payment for the building materials out of a bank account which is held by the related party on bare trust for the SMSF will, of itself, cause a contravention of section 66 in respect of the acquisition of those building materials. As discussed in question 1 above, the application of section 66 will depend on whether the building materials are acquired by the SMSF trustee from the original suppliers, with the related party only acting as an agent, or whether the related party acquires the building materials in their own right which are then supplied to the SMSF trustee.
The ATO would be interested to discuss the commercial rationale for the use of a bank account held by the related party on bare trust for the SMSF trustee.
Meeting discussion
The member who raised this issue gave a background overview of the issue, which is related to a question discussed at the December 2010 meeting of this sub-group.
A member noted that the industry view provided in the question referred to the look through of bare trusts and that the ATO initial response did not raise this. The member queried if this was because the ATO accepted the view that bare trusts and custodian trusts are looked through. The ATO noted that in the second question only the bank account was held on bare trust by the related party and therefore the question was answered on the basis that the related party was still only acting as an agent for the superannuation fund in respect of the acquisition of the building materials. As this would result in the superannuation fund acquiring the building materials directly from the unrelated vendor, the ATO did not consider that it was necessary to consider the treatment of such assets held on trust.
A member noted that the ATO had not yet published a position in relation to the use of bare trustees or custodians as the registered owners of assets of a superannuation fund, and whether these arrangements will be looked through for SIS regulatory purposes. The ATO explained that this was still being considered and also noted that work is being undertaken within the Tax Office to examine this area of the law in respect of income tax. It was agreed amongst members that a confirmed ATO view on this issue will be required.
No other questions were raised by members.
- Last modified: 06 Feb 2012QC 25426