A question I am often asked is whether SMSFs can invest in overseas real estate?
Under the superannuation law, whether SMSFs invest in properties situated in Australia or overseas, the legal requirements are the same. For example:
Sole Purpose Test: The property investment must be made solely to provide retirement benefits for members and cannot be for private use or for use while holidaying in the foreign country.
Trust Deed and investment strategy: The property acquisition must be allowed by the SMSF’s Trust Deed and be consistent with the SMSF’s investment strategy.
Arm’s-length transactions: The purchase price for the property and rental income from the property must be at the market rate.
Related-party acquisitions: The property should not be acquired from members or related parties of the members unless it meets the legal definition of a ‘business real property’.
In-house asset rules: The purchase of the property and leasing of the property must comply with the in-house asset rules under the law.
Borrowing: If borrowing is required, it must be a legally complying Limited Recourse Borrowing Arrangement (LRBA).
Understand the ownership laws in the foreign country
If the laws and customs of the foreign country allow a foreign investor (ie the SMSF) to invest directly in real properties (without a local entity intermediary), then the SMSF will not have a problem as long as it satisfies all the requirements of the superannuation law. The SMSF trustee will need to maintain documentary evidence as proof that the SMSF owns the overseas property and that the ownership is recognised in the foreign country.
In many countries, however, a foreign entity cannot hold a property directly. Therefore, an SMSF may need to establish a local entity which buys the property for the SMSF, with the SMSF owning all the interest in the local entity. The local entity may also need to be a taxpayer in that foreign country. As a result, indirect investment in overseas real estate can be a problem for SMSFs.
I have encountered transactions where the SMSF trustees needed to establish a Limited Liability Company (LLC) in the foreign country with its own bank account. The SMSF then invested in the shares of the LLC which then used the capital to finance the acquisition of the overseas property. The LLC is used as a flow-through vehicle for tax purposes. Any tax paid by the LLC may be eligible to be claimed back as a credit in Australia under the double tax agreement.
Watch the ‘in-house asset’ test
The problem with this requirement is that the investment by the SMSF in the LLC is treated as an ‘in-house asset’ under the superannuation law. The law only allows an SMSF to invest in a related entity and for the related entity not to be treated as an in-house asset, if the related entity is a non-geared entity. One of the requirements of a non-geared entity is that it does not have a loan with another entity unless the loan is a deposit with an authorised deposit taking institution which falls within the auspices of the Banking Act 1999. Unfortunately, overseas bank accounts do not comply with our banking legislation and therefore the SMSF investment in the LLC would be considered an in-house asset. This means the SMSF is restricted to an investment in the LLC of 5% of the total value of its assets.
An SMSF trustee would also need to consider the risks associated with fluctuations in foreign currency and exchange rates. All superannuation assets need to be converted into Australian dollars for financial statements. The dollar variations could affect other calculations in SMSFs such as member balances and minimum pension payment requirements.
If an SMSF needs to enter into a LRBA to acquire an overseas property, it may have difficulties finding a lender, as the lender would be lending money to the SMSF to acquire shares in the LLC. Most banks will not lend if the security on the LRBA is overseas shares. If a foreign bank provides the loan to an SMSF, the documentation on the loan may not be consistent with the LRBA requirements under the superannuation law and the nature of the loan may, therefore, not be limited recourse.
Overseas investments can be complex and also come with higher risk due to the laws and customs of the foreign country. SMSF trustees need to consider overseas investments very carefully.
Monica Rule is an SMSF specialist and author, see www.monicarule.com.au. This article is general education only and readers should seek specialist advice before taking action.