Fractional investing company Domacom has lost on two out of three points in a Federal Court appeal which would have otherwise made it easier for SMSFs to buy property which could be leased to relatives.
The Federal Court has given its ruling in Aussiegolfa Pty Ltd (Trustee) v Commissioner of Taxation  FCAFC 122. Aussiegolfia is the trustee company of the Benson Family Superannuation Fund, which has as its sole member an employee of Domacom.
The SMSF had invested in a ‘sub-fund’ of the Domacom Fund. This sub-fund had purchased a residential property, which was leased to three tenants – one of whom was the daughter of the member.
The Federal Court had ruled that the sub-fund was a separate trust and would be an in-house asset of the SMSF. It was also found that leasing the property to a relative of a member of the found wouldn’t satisfy the Sole Purpose Test. The ruling was appealed.
Three judges of the Federal Court have now ruled that the original judge was correct that the sub-fund was a ‘related trust’ of the SMSF and that the units did not constitute an investment in a widely held trust – leading to the investment being an in-house asset, and in excess of the 5% limit.
However the appeal succeeded on a third point, with the Court finding that leasing the property to a relative of a member would not breach the Sole Purpose Test – at least in this case.
The ruling is likely to be seen largely as a failure for Domacom (update: though if the Domacom stock price since the judgement is any indication it is being seen as a positive). The sub-funds being in-house assets greatly reduces the ability of SMSFs to use the services of the company to buy residential property and lease it to relatives.
The appeal was brought by Aussiegolfia, but the case has been the matter of statements from Domacom to shareholders and executives have publicly been in favour of using SMSF assets to buy property which is rented by relatives.
The decision that the Sole Purpose Test would not be breached in this case largely seems to revolve around market rent.
“Importantly, in the present case, although the Burwood Property, being the underlying property associated with the Burwood Sub-Fund units held by Aussiegolfa, would be leased to the daughter of the sole member of the Benson Fund, the lease would be at market rent,” said Judge Moshinsky, in the ruling.
“In these circumstances, there does not appear to be any financial or other non-incidental benefit to be obtained by Ms Benson by leasing this property rather than another; nor does there appear to be any financial or other non-incidental benefit to be obtained by Mr Benson by the property being leased to his daughter rather than another tenant.”
“It is true that Ms Benson would obtain a benefit in the sense that she obtains accommodation. But in circumstances where this is obtained at market rent, it does not appear to be a relevant benefit for present purposes.”
“Further, I do not consider the fact that (as the primary judge found) the selection of Ms Benson as the tenant was explained, in part, by the desire of Mr Benson and DomaCom to test the ability for residential properties held by self-managed superannuation funds to be used by related parties, to be a relevant factor. ”
Though the Judge also says that this conclusion is “necessarily dependent on the facts and circumstances of the particular case”.
“For example, the situation would be different if the lease were not at market rent.”
“The situation would also be different if the Benson Fund’s investment policy had been affected by the leasing of the property to Ms Benson.”
The Federal Court ruling also impacts an appeal to a decision by the Administrative Appeals Tribunal (AAT).
“In circumstances where the Commissioner’s appeal against the Tribunal decision is effectively contingent on Aussiegolfa succeeding on the in-house asset issues in the Federal Court Appeal, it follows from the rejection of the grounds of appeal relating to those issues that the AAT Appeal is to be dismissed.”
ATO leaves open option of appeal
An ATO spokesperson said the Commissioner was currently reviewing the decision of the Court and its broader meaning, and notes that the appeal period has not yet ended.
“We note that the decision supports that fund trustees must take all reasonable steps to ensure that the in-house asset rules are complied with, and cannot invest more than 5% of their assets in in-house assets. An in-house asset includes an asset that is leased to a related party, and a related trust that leases its assets to a related party, subject to some limited exceptions,” said the spokesperson.
“We also note that the sole purpose test is a fundamental regulatory requirement which ensures that SMSFs are established and maintained for the sole purpose of providing retirement and/or death benefits for members. Any question of whether a SMSF is maintained in accordance with the sole purpose test will turn on the particular facts and circumstances of that SMSF and its investments.”
Ruling a “milestone” for SMSFs: DomaCom
DomaCom CEO Arthur Naoumidis said the company was “very pleased” with the finding of the Court on the Sole Purpose Test aspect of the case.
“We believe that this finding, on its own, represents a milestone for the SMSF
industry,” said Mr Naoumidis, in a statement to the stock market on Monday afternoon.
However it appears that DomaCom is not done with the issue of in-house assets.
“In relation to the related trust determination, we are reviewing the comprehensive judgment with our lawyers and will make a further announcement about the effect, if any, of the decision on the DomaCom Fund,” said Mr Naoumidis.
“The DomaCom Fund disclosure documents have been amended significantly since the Burwood sub-fund was created in 2015. Accordingly we will analyse the effects of the judgment on sub-funds created using the current version of the DomaCom Fund constitution and disclosure documents. If our analysis determines that it is necessary, we will consider amending our constitution and disclosure documents to address this issue with respect to future sub-funds.”
This article has been updated to reflect the statement from the ATO and DomaCom.