Self Managed Super Funds (SMSF)

What the regulators are watching with SMSFs and certain structures

By Graeme Colley
Executive Manager, SMSF Technical and Private Wealth - SuperConcepts Sydney, Australia

The structure used by an SMSF can determine whether it complies with the Superannuation Industry (Supervision) Act 1993 (SIS Act) and regulations. Take for instance SMSFs that invest on a co-operative basis in partnerships and joint ventures. Depending on the structure used, you may end up with compliance issues for the fund.

What is a partnership?

As a general description, a partnership is where at least two parties manage an activity such as a business or investment to share in its profits. The rights, obligations and contribution of each partner is set out in a partnership agreement. Partners may share liabilities and profits as agreed or may have limited liability in relation to their interest in the partnership.

For tax and superannuation purposes, a partnership has a broader meaning and uses the definition in the tax legislation. It includes situations where the parties are in receipt of income jointly which means there is no requirement for a business to exist. The tax definition is important where it is claimed a joint venture exists as it may be a partnership under the legislation.

For SIS purposes, the tax definition of partnership is used in:

  • the definition of entity in section 10(1), 
  • the definition of a self-managed superannuation fund (SMSF) in section 17A, 
  • section 66 relating to the acquisition of assets from related parties,
  • part 8 for purposes of the in-house asset rules, and
  • the meaning of associate of a partnership in section 70E of the in-house asset rules.

What is a joint venture?

In contrast, a joint venture does not have a technical meaning but refers to arrangements involving two or more parties who undertake an activity where each party mutually benefits from the arrangement. The parties in a joint venture will hold property and other resources as tenants in common rather than via a formal structure like a partnership, company or trust.

Examples of common joint ventures can be found in the mining and oil industries. Each joint venturer may contribute different skills or resources to undertake the activity. The skills or resources could be rights over property, labour supply or the contribution of capital to the joint venture.

When it comes to SMSFs it is often claimed that the fund has invested in a joint venture to develop land or undertake other similar activities. Whether or not some of these arrangements meet the requirements of a joint venture rather than a partnership can be highly debateable.

To be considered a joint venture the arrangement can include the following features:

  • property may be held by each venturer as tenants in common, 
  • joint venturers may contribute money, property or skills in different proportions,
  • the debts of each participant are borne by each joint venturer rather than incurred jointly. Any liabilities are usually limited to each participant’s ownership of the property, 
  • control is usually exercised by each participant over the joint venture activity,
  • an operator or manager may be appointed to conduct the joint venture activities, 
  • the ‘product’ of the joint venture is taken by each participant as agreed rather than accounting for a joint venture profit with each venturer taking their profit share.

Joint ventures have contractual relationships which can be created in many ways. For example, it can be by conduct of the parties, verbally or documented. However, the most common practice is to have the terms of the joint venture in writing.

The advantage of a joint venture is its flexibility as it can provide different rights and obligations to each participant. It may also be able to allocate the risks of the joint venture in different ways to each of the joint venturer for the mutual benefit of the parties.

Contrasting a joint venture to a partnership

The advantages of a joint venture compared to a partnership are considered to be:
 

Joint venture  Partnership
 The liability of the parties in a joint venture is several and determined under the joint venture agreement. But it is possible that some liabilities of the joint venture may be jointly shared by one or more of the joint venturers. Each partner is jointly and severally liable for the debts of the partnership and for the acts of the other partners.  
Each participant in the joint venture claims their own tax deductions and makes their own tax elections. The partnership will usually claim its tax deductions and depending on the tax law partners may be entitled to claim deductions.
Each joint venture participant may account for the transactions of the joint venture in a different way. A partnership will account for transactions as a single entity.
The joint venturers are not jointly and severally liable with the other partners except to the extent of the joint venture agreement. The partners are jointly and severally liable with the other partners. To some extent there is a fiduciary relationship with the other partners in existence.
Joint venture participants may enter into their own financial arrangements in relation to their joint venture interests. Partners will enter into joint financial arrangements in relation to the partnership interests.
Greater flexibility is available in a joint venture as it is not subject to some rules and regulations such as the partnership legislation in each State and Territory Partnerships may not be as flexible as joint ventures in view of the relevant State and Territory laws.

How to identify a joint venture from a partnership

A joint venture needs to be distinguished from a partnership for taxation, superannuation and other purposes.

The main features of a joint venture are:

  • Joint venturers do not receive income jointly which means profits are not determined or calculated jointly as in the case of a partnership. There are many alleged joint venture agreements which determine profits which are distributed to the joint venture parties.
  • A joint venture does not receive income jointly. Therefore, no joint profit is determined or calculated.
  • The parties to a joint venture carry on the venture severally rather than as an entity type arrangement. This may involve separate taxation and accounting treatments and that third parties are aware that the interests of the joint venture participants are several rather than joint. 
  • A manager may be appointed for the joint venture operations as agent of the joint venture parties. 
  • Joint venturer participants are unlikely to have rights that bind each other, as is usually the case with a partnership. 
  • Statements that the activity carried on is a ‘joint venture’ must be examined on the facts as it may merely be indicative but not conclusive.

What the ATO says

The ATO has published SMSF Ruling SMSFR 2009/4 which provides a description of a joint venture arrangement as an example of what is meant by 'asset', 'loan', 'investment in', 'lease' and 'lease arrangement' in the definition of an 'in-house asset'. The ruling does not refer to ‘joint venture’ but refers to ‘contractual arrangements’ being in existence probably because there is no technical meaning of the word joint venture.

Paragraphs 91 to 94 of the ruling describes an amount contributed for an SMSF towards the acquisition of an asset to be acquired by a company that is related to a fund member. The contract between the SMSF and the related company stipulates that the company controls and manages the asset and receives all the receipts in relation to the asset.

As part of the arrangement, there is no requirement on the SMSF to guarantee or indemnify the repayment of borrowings or other obligations of the related company. The SMSF acquires no legal, equitable or other interest in the asset and any interest is limited to its entitlement to receive contractual payments from the related company. Any right of the SMSF to receive payments from the related company which is calculated as a proportion of the proceeds from the sale of the property, lease or other use of the asset for which the SMSF has made the payment.

The ATO considers that such an arrangement is considered to be an investment by the SMSF in the related company as capital has been paid to the related company and used for its benefit. In exchange the SMSF has certain rights to ‘a share of profits’ from the use of the asset (para 94 of SMSF 2009/4). Any return on the investment is reliant on the actions of the related company and the financial risk that goes with the investment. It is concluded that the amount paid by the SMSF is an investment in the related party.

Whether this conclusion can be supported seems to be based on other information which is not disclosed in SMSFR 2009/4. The amount paid by the SMSF seems to be an investment in a related party for purposes of the in-house asset rules in section 71(1) of the SIS Act

It is unlikely that the arrangement would be a joint venture as the example indicates that the related company pays a share of profits to the SMSF due to the amount paid by the fund. The receipt of income jointly is a feature of a partnership under the tax definition and not a joint venture. This seems to conflict with other statements in the example that the SMSF is entitled to a proportion of the proceeds from the sale of the property etc. which would indicate the arrangement is a feature of a joint venture (para 93 of SMSFR 2009/4).

The ATO also issued Taxpayer Alert 2009/16: Circumvention of in-house asset rules by self-managed superannuation funds using related party agreements. TA 2009/16 describes an arrangement where an SMSF enters into an agreement with a related trust in a joint venture type arrangement to acquire assets such as rental property in order to obtain taxation and superannuation benefits. The ATO is concerned these arrangements may breach the superannuation in-house asset rules.

What APRA has said

APRA have also mentioned the term joint venture in paragraphs 31 to 33 of APRA Circular III.A.4 (archived) as it relates to the operation of the sole purpose test and the joint ownership of property. The Circular says at para 33:  

the sole purpose test is unlikely to be satisfied in situations where the investments of the fund and those of the employer-sponsor or some other associated person become intertwined. For example, joint ventures where trustees invest in a particular asset or assets with the fund’s employer sponsor (such as an investment in real estate as tenant in common) may not, in certain circumstances, comply with the sole purpose test.

Unfortunately, APRA does not provide examples of types of investments which would be unacceptable in these circumstances and cause the fund to breach the sole purpose test, possibly because it is determined on the facts of the case.

This statement is consistent with court and tribunal cases where superannuation funds were used by employers as a mere extension of their business operations and it was co-incidence that employees received any benefit from the fund. These cases mainly relate to the operation of the law prior to the introduction of the SIS Act in 1994.

Whether a joint venture or partnership is in existence for taxation and superannuation purposes depends on the facts and the relationship of the parties. What may be considered a joint venture, in some situations, may actually be a partnership. If there is any doubt, legal advice of an administrative ruling from the ATO should be obtained to confirm that the arrangement is as intended to avoid any compliance issues and penalties being imposed on the fund.

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Graeme Colley, Executive Manager, SMSF Technical and Private Wealth, SuperConcepts
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While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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