From 1 July 2011, investments in exotic or unusual investments, such as collectables and personal use assets, must satisfy specific criteria to form part of a permitted investment strategy for a SMSF.
The rules restrict the fund’s interaction with related parties, such as members and relative, partners in a partnership and entities controlled by a family group and apply:
The transitional period provides SMSF trustees with existing investments in collectables and personal use assets time to comply with the new rules.
These rules apply regardless of whether the SMSF trustee fully owns or partly owns the asset.
The specified investments deemed to be collectables and personal use assets are as follows:
These are collectively referred to as “section 62A items”.
Artwork is defined in subsection 995-1(1) of ITAA97 as:
Coins and bank notes are collectables if their value exceeds their face value.
Spirits includes, but is not limited to, whiskey, gin, vodka, tequila, brandy and rum.
Should the SMSF be considering investing in a section 62A item, trustees must satisfy the following additional requirements:
A SMSF must not enter into a lease or lease arrangement of the section 62A item with a related party of the fund. Lease arrangements may include informal arrangements in the nature of a lease under which a person uses or controls the use of fund property, including where no rent is payable in exchange. It would also appear that a fund could not display or hang an artwork on the wall of a related business. This rule is intended to prevent SMSF trustees from making an investment in a section 62A item for the purpose of leasing it to a related party.
Section 10(1) of SISA defines a lease arrangement as “any agreement, or arrangement or understanding in the nature of a lease (other than a lease) between the 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”. The ATO considers the concept of “lease arrangement” can potentially encompass informal arrangements that may lack formal documentation.
Previously, it was possible for a work of art owned by an SMSF to be displayed in a member’s residence or office under a arm’s length lease arrangement between the fund & related party (eg, member), provided the market value of the art represented no more than 5% of the total assets of the fund.
A SMSF must not store a section 62A item in the private residence of a related party. This allows SMSF trustees to store a section 62A item in premises owned by a related party, such as a purpose-built storage facility, provided that the premises is not the home of a related party.
NOTE: Private residence includes the land used for a private residence and other buildings on that land, such as a garage, shed or granny flat.
A SMSF must keep a record of the reasons for the decision on where to store a section 62A item. This ensures that SMSF trustees give consideration to what is appropriate storage for maintaining their section 62A item as an investment that produces retirement income rather than one that provides current day enjoyment.
NOTE: Trustees must retain evidence of the storage decision for 10 year.
A SMSF must insure a section 62A item in the name of the fund within 7 days of acquisition of the item. This rule does not apply to memberships of a sporting or social club because these items generally cannot be insured. The aim of this rule is to protect the section 62A item from damage, which would result in a loss of retirement income.
NOTE: This rule applies regardless of the asset’s value or whether an insurance market for the item even exists for such items.
A trustee must not allow a related party to use a section 62A item held by the fund. This rule prevents a related party from obtaining personal enjoyment from the asset. It also severely limits the ability of an SMSF to derive an investment return from a collectable asset. The provisions also appear to prevent related parties from using a collectible car, including driving the vehicle for short distances for no reason other than to maintain engine and therefore the car’s market value.
ATO ID 2004/251 (withdrawn) indicates that an investment in art, which is displayed in the residence or office of a related party of the fund at a cost less than market value, would breach the arms length investment provisions (section 109 of SISA).
The ATO also indicated in SMSFR 2008/1 that where art is owned by an SMSF is displayed in a member’s residence or office at no cost, the fund may be in breach of the sole purpose test (section 62 of SISA).
A SMSF commits an offence if the fund disposes of a section 62A item to a related party at a price other than a market price determined by a qualified independent valuer. This ensures that a related party does not receive current day benefit from such a transaction, for example by purchasing the section 62A item from the fund at below market value, and also that the transaction does not cause detriment to the fund. Interestingly, there is no requirement for newly acquired assets to be independently valued, presumably because the item could only be acquired from unrelated parties.
NOTE: Section 109 of the SISA already operates to ensure disposals of fund assets are on arm’s length terms and auditors should already be obtaining sufficient appropriate evidence of market value when disposals occur in favour of related parties.
Each trustee that offends any of these provisions may be subject to a minimum penalty of $1,100 per breach (5 times that for corporate trustees). An offence of these provisions is a strict liability offence under the Criminal Code and of course, depending on the seriousness of the breach such as breaching the sole purpose test and arms length rules, the fund may be exposing itself to non-complying fund tax rates as well as civil and criminal penalties.
Consistent with the previous legislative framework, the ATO has long cautioned that trustees investing in alternative or unusual assets “should not do so unless the trustee understands the risks & costs associated with the particular investment”.
For example, the ATO says that trustees should seek expert investment advice, which may include examining the potential for income and capital growth from the asset and the ease with which the asset could be disposed of.
The trustees ought to possess a sound understanding of the asset, with specialist advice obtained as necessary, to demonstrate compliance. This should include details of research and investment rationale evidenced by minutes.
Trustees should consider the costs associated with the investment, including appropriate storage and insurance costs, as part of the overall investment strategy of the fund. They must also be able to demonstrate they are undertaking measures to adequately safeguard fund assets.
For example, jewellery should be kept in a secure location (eg, safe) and assets such as wine collections, art & other collectables should be stored in a suitable environment to avoid damage & minimise deterioration.