Any arrangement, whether it’s called Joint Venture Agreement or not, with the following characteristics will be caught under the superannuation in-house assets rules and therefore would only be allowed if the arrangement does not exceed more than five per cent of the total value of assets in the SMSF.
A typical example of a Joint Venture Agreement (JVA) follows:
• The members of the SMSF need additional capital to purchase properties from unrelated parties. The members with the assistance of their advisers organise a written JVA between their SMSF and themselves. The purpose of the JVA is to buy properties to provide mutual financial rewards to the SMSF and themselves.
• Under the JVA, the SMSF makes a monetary contribution. The contribution is NOT a loan as there is no obligation to repay the contribution to the SMSF. The contribution represents a risk capital to the SMSF.
• The members use the SMSF contribution plus their own contribution to purchase properties. The legal title of the properties lies with the members and not the SMSF. The SMSF does not hold any legal, equitable or other interest in the properties.
• The members may also borrow further amounts from a financial institution to make improvements to the properties. The properties may also be used as security for the borrowings.
• The JVA also states that the SMSF shall not be required to guarantee or indemnify the repayment of any borrowings or other obligations of the members.
• The JVA provides the SMSF with rights to a proportionate share of the profits. That is, the rent and profits from sale are split in proportion to the risk capital invested by the SMSF and the members based on the gross profit.
• The return on the properties, and the investment risk, is dependent on the members’ management of the properties. The JVA stipulates that the members control and manage the properties and are entitled to all receipts from the properties.
• The members pay all the expenses on the properties.
• The SMSF’s pecuniary interest in the arrangement is limited to its entitlement to receive the contractual payments from the members.
The ATO has examined these types of arrangements to determine whether it is an in-house asset under section 71 of the Superannuation Industry (Supervision) Act 1993 (SISA). The question of whether the SMSF holds an in-house asset is determined by whether the SMSF has made an investment in a related party of the SMSF as a consequence of the arrangement.
The phrase “investment in” requires a direct link between the investment and the related party to be established. However, the interest is not necessarily an interest in any particular asset of the related party. Further, the definition of “invest” under subsection 10(1) of the SISA means to apply assets in any way, or make a contract for the purpose of gaining interest, income, profit or gain.
It is the ATO’s view that where money or assets are provided for the benefit of a related party for the purpose of receiving income, interest, profit or gain, a sufficiently close connection will be established between the investment and the related party to enable it to be described as an “investment in” the related party. It is the reliance on the related party for payment on the investment which will be a determinant factor.
Therefore, the above arrangement between an SMSF and the members clearly involves the SMSF making an investment, as the SMSF has made a contract for the purpose of gaining income, profit or gain. The contract is made with a related party and the income, profit or gain is sourced from the contract. It is therefore, an in-house asset of the SMSF.
The only asset that the SMSF is stated to acquire under the arrangement in return for its contributions is its right to the SMSF’s entitlement. The SMSF’s entitlement is generally calculated by reference to the level of contributions, the asset’s cost and the receipts from the asset. The SMSF’s legal rights under the arrangement constitute a chose in action enforceable against the related party. As a consequence, the SMSF has made an investment in the related party under the arrangement and therefore has an in-house asset under section 71 of the SISA.
For more in-depth reading on JVAs, please refer to the following ATO publications: ATOID 2006/335, SMSFR 2009/4, and Taxpayer Alert 2009/16.