With revisions to superannuation law, new strategies have emerged that will help small to medium business owners manage their assets.
The close relationship between owners of small to medium businesses and self-managed superannuation funds is set to become much closer following amendments to superannuation law.
Commercial real estate - including the premises of members' businesses - has long been one of the few assets that self-managed funds are allowed to acquire from members.
The amendments unequivocally allow self-managed funds to borrow to buy investments, including costly business property, provided stringent conditions are met.
This is despite a general ban on borrowing to invest by self-managed funds that has been in force since the 1980s. Until the amendments were passed, many fund trustees were understandably unsure about how the borrowing ban operated in practice when various investment strategies and financial products were marketed.
Super funds have the advantage of acquiring a potentially appreciating asset, a known tenant and rental income, and capital gains that are taxed at the concessional rates only applying to super. Further the funds get all of the tax benefits of a landlord.
Here are eight strategies for owners of emerging businesses to make the most of self-managed super funds within the confines of super and tax law.
1. Don't overlook negatives
Business owners who consider holding their business premises in their funds should weigh up the possible negatives rather than merely focus on the positives.
Many funds will take advantage of the new borrowing provisions in super law to buy their members' business premises.
Business real estate is not only one of the few assets that funds are allowed to acquire from their members, but also an asset that funds can lease to related parties - including fund members and their businesses - without a restriction on the value.
But the ownership of a business property in a fund can mean its investments are dominated by a large, high-value asset that may not readily sell when money is needed to pay member retirement or death benefits. It's possible that the property may not even produce enough rent to pay sufficient pensions to retired members.
Factors to consider before buying business property in a self-managed fund includes investment diversification, the level of risk for members and fund liquidity.
Trustees should also ensure that investment in business property is within the fund's written investment policy, which a fund must have under super law.
In addition, there could be possible difficulties when business premises remain in a fund after the founders retire and the business passes to the next generation.
A business may go through a tough trading period and the retired founders may need their retirement benefits.
2. Understand borrowing law
Business owners who consider using the new borrowing provisions for their funds to buy business property or any other valuable assets should understand the stringent conditions.
Each of the borrowing conditions set out in the amendments should be ticked off to check whether a proposed loan complies with the new law. The main conditions include that the investment must be held in trust for the fund until the final payment when the fund gains legal ownership, and the lender cannot make a claim against any of the fund's assets in the event of default - apart from the asset being financed by a loan. This relates to instalment warrant type investments only. Check with your financial tax advisor before seriously considering this option.
Interest on the loan is deductible to the fund and capital gains tax will not be crystallised when the asset is transferred from the trust to the fund.
3. Check CGT breaks
Small business owners who sell or contribute their business properties to their self managed funds may receive tax breaks on the transaction if eligible.
Special CGT concessions for eligible small business owners - together with the standard 50 per cent CGT concession for assets owned for at least 12 months by individuals and trusts - may eliminate CGT on increases in a property's value to date.
The contribution, not the sale, of business properties to self-managed funds may also be tax deductible to self-employed small business owners within the annual limits set out in superannuation law.
For eligibility to the CGT small business concessions, the net market value of a business owner's business and private assets must not exceed $5 million. For the first time, businesses with a turnover of less than $2 million have become eligible for the small business CGT concessions, even if the $6 million threshold is exceeded.
For these eligible small businesses, proceeds from the disposal of active business assets are either exempt from CGT or qualify for CGT discounts. The CGT tax breaks should apply if a business property was either contributed or sold to a self managed super fund.
4. Claim deductions
Self employed business owners - as distinct from employees of family companies - are entitled to tax deductions for some personal super contributions, including those in the form of business property.
From July this year, the self employed are entitled to 100 per cent deductions on contributions within annual dollar limits. Previously, only partial deductions were allowed.
Fund members younger than 50 years of age can make so-called annual "concessional" contributions of an indexed $50,000 a year while those older than 50 have a non-indexed cap of $100,000 a year.
Deductions can be claimed on these contributions which are taxed at 15 per cent upon entering a fund.
If the business is operated through a company it can contribute a company owned business property to the employed owner's self managed fund as a non-cash contribution.
The company should then be entitled to deductions, taking into account the annual caps on concessional contributions.
A business property can be contributed in a combination of concessional and non-concessional contributions (which are not deductible) provided the amounts fall within the annual caps for each type of contribution.
5. Protect assets:
Since the amendments to the Bankruptcy Act in July, business owners should understand how to use their funds to make the most of the improved asset protection for super.
There is also another reason for business owners to transfer their business premises to their funds: if there is a financial setback, super savings are protected from the trustees in bankruptcy, provided contributions were not made in an attempt to cheat present and future creditors.
Previously, super did not provide protection from bankrupt trustees above what was then known as the pension reasonable benefit limit (RBL) of about $1.3 million in 2006-07. Super savings above this limit were exposed.
But with the abolition of RBLs in the new super regime, the Bankruptcy Act was amended to fall into line. The explanatory memorandum to the amendments clearly states: "A bankrupt's entire interest in superannuation is protected from being divisible among creditors."
Super contributions should be made with the primary purpose of making sound investments and saving for retirement - not to gain protection for debts that may later arise. The way to show your super contributions are part of a legitimate investment plan is to contribute regularly.
6. Don't go too far
Avoid carrying the close relationship between a business and a self managed fund too far by attempting to operate the business through the fund. This tactic is asking for trouble with the tax office, in its role as fund regulator of self managed super.
The sole purpose test in superannuation law stipulates that a super fund must be operated only to provide retirement benefits for its members. This means members cannot gain pre-retirement benefits apart from receiving a transition to retirement pension.
Although there is no provision in super law prohibiting self managed funds from running businesses, funds that provide trustees and their families with financial benefits before retirement are breaching the sole purpose test.
7. Separate private assets
Use a self managed fund to build up private investments rather than tying up all of a business owner's savings in a business.
In the event the business suffers a serious setback, the owner should aim at having super savings to fall back on.
Superannuation is the most tax effective way you can extract value from your business. If left in the company, in the case of incorporated businesses, earnings would be taxed at 30 per cent - against 15 per cent in super. And within annual limits, the company can even gain tax deductions for contributions.
The passing of family businesses between generations provides another reason for the founders to have private assets.
8. Contribute sale proceeds:
Vendors of small businesses should try to take advantage of unique tax benefits by contributing at least some of sale proceeds to a super, if appropriate, for their circumstances.
Many vendors of small businesses are eligible to make non-concessional (after tax) contributions to an indexed lifetime limit of $1 million from certain sale proceeds. But first, the proceeds must qualify for the 15 year ownership CGT exemption or the gains must qualify for the CGT retirement exemption to a limit of $500,000 per person.
This special cap applies in addition to the much lower annual contribution limits in place since July this year.
Geoff O'Neil & Tony Martin - Directors, Advantage One