Selling the farm

The proposed Division 296 tax put SMSFs holding farm land in focus. Michael Hallinan examines the application of transfer duty should trustees decide to divest in these assets.

Many SMSFs have primary production land, or the farm, as a fund asset. Many trustees though are now reviewing whether their fund should retain the farm in the fund or if it should be held in another associated entity. This review of the investment strategy of the SMSF could be prompted for many reasons, including the:

• suitability of the farm as a retirement-phase asset,

• inability to borrow for capital improvements while the farm is in the SMSF,

• need for diversification and to remove a lumpy asset from the fund’s asset pool, and

• likely enactment of the Division 296 tax.

Extracting the farm

Extraction could be achieved simply by selling the primary production land, whether to a related party or a third party. The extraction could also be achieved by an in-specie distribution as a benefit payment. Additionally, there may be a strong desire to retain the farm within the family of the investor or under the control of the investor. Unfortunately, the sale of the farm to a family member or entity or the in-specie distribution as a benefit payment will normally give rise to a liability for transfer duty. Fortunately, if the asset is situated in New

South Wales, there may be transfer duty relief on the extraction, whether it is a sale or in-specie transfer. This relief is provided by section 274 of the NSW Duties Act 1997. Recent amendments, that took effect from 19 May 2022, have considerably expanded the application of the section.

In respect of extraction of the farm from the SMSF, the transaction may be free of transfer duty where the purchaser or recipient of the in-specie benefit payment is a discretionary trust, private unit trust or a private proprietary company that is associated with the investor who is a member of the SMSF. Naturally there are fine details to understand and satisfy before the transfer of title to the farm is marked exempt by the NSW Office of State Revenue.

This article will illustrate the application of the amended section 274 of the NSW Duties Act by use of this simple scenario. Bill and his spouse, Bernie, are members of the B&B Super Fund, an SMSF with a corporate trustee. Both Bill and Bernie are currently in retirement phase with current balances of $1.6 million and $2.8 million respectively. The farm is leased to the Big Bill Pastoral Company Pty Ltd controlled by Bill, who is the entity’s sole director and majority shareholder.

The proposal is for Bill to commute 80 per cent of his pension of $1.6 million, resulting in a lump sum benefit entitlement of $1.28 million, which is to be discharged by a cash payment of $80,000 and the transfer of the title to the farm, which has a market value of $1.2 million. What is the transfer duty on the transfer of title? If section 274 does not apply, the duty would be $48,529. If section 274 does apply, the duty would be nil.

For reasons buried in the depths of the text of section 274, the section will only apply if Bill is not the transferee of the title even though he is the relevant member. However, the section will apply if the transferee is the Big Bill Pastoral Company Pty Ltd. Two issues need to be considered.

Firstly, why does section 274 apply? Secondly, how, consistently with the benefit payments standards of the Superannuation Industry (Supervision) (SIS) Regulations, is it possible to pay the in-specie benefit payment of Bill to another entity?

Section 274 issue

The transaction will be eligible for nil transfer duty if four requirements are satisfied. The first is the land must qualify as “primary production land” as defined in section 10AA of the Land Tax Management Act 1956. Essentially, if the farm is exempt from land tax, this requirement will be satisfied.

The second requirement relates to the relationship between the transferor, in this case the SMSF, and the transferee, in this case Big Bill Pastoral Company. This requirement will be satisfied if “the person directing the transferor”, as defined in section 274, is a family member of the “person directing the transfer”. Notwithstanding that the expression “the person directing” the transferor or transferee, as the case may be, may have the meaning of the controller of the relevant entity, the expression is defined and it only takes its defined meaning.

The words “person directing” must be treated merely as a label that has no other than the defined meaning and the words of the label do not influence or colour the defined meaning. Applying the defined meaning when the transferor is an SMSF, it simply means “a member of the fund”. There is no textual reason to read into the definition any requirement that the member must be the controller or controlling member or the member who is at the centre of the transaction.

In this case Bernie would qualify as “the person directing the transferor” even though the transaction does not involve her superannuation interest and she has not requested the benefit payment and that the benefit payment is not payable to her. Bill is the person directing the transferee as he satisfies the definition when the transferee is a private proprietary company because he beneficially owns shares of Big Bill Pastoral and his shares confer voting rights, and he has an entitlement of having a 25 per cent or more entitlement on any winding up of the company.

Once two natural persons have been identified who respectively satisfy the definition of “person directing the transferor” and “person directing the transferee”, the first requirement will be satisfied as the former is a family member of the latter. Family member is defined and includes a spouse. As Bill, the person directing the transferee, is the spouse of Bernie, the person directing the transferor, then the first element will be satisfied. Interestingly, if Bill was the sole member of the SMSF, this requirement would not be satisfied as he cannot be a family member of himself.

Both the third and fourth requirements concern the issue of whether the primary production business is a family business both before the transfer (third requirement) and after the transaction (fourth requirement).

The third requirement is that the primary production business being carried on before the transfer must be carried on by the transferee or a family member of the transferee or by the person directing the transferee or a member of the family of the person directing the transferee. In relation to the scenario, this requirement is satisfied as the transferee is Big Bill Pastoral, which is carrying on the primary production business before the transfer.

The fourth requirement is the primary production business will continue to be carried on by the transferee after the transfer. In relation to the scenario, this requirement is satisfied as the transferee is Big Bill Pastoral, which is carrying on the primary production business after the transfer.

Consequently, the requirements of section 274 will be satisfied and the duty on the transfer will be nil and not $48,529.

It must be noted the section expressly requires the chief commissioner to be satisfied as to each requirement. Consequently, sufficient supporting information and documents and a detailed explanation as to how the circumstances of the particular transaction satisfy all of the relevant requirements are needed. Also, applications for assessment under section 274 will be assessed by the NSW Office of State Revenue and not by an authorised agent.

SIS payment standards

In the case of an in-specie benefit payment, if the member directs the trustee to transfer title to an associated entity of the member, does this contravene the SIS benefit payment standards and in particular SIS Regulation 6.22? This issue was considered in Asgard Capital Management Limited v Maher [2003] FCAFC 156. This case considered the text “a member’s benefits in a regulated superannuation fund must not be cashed in favour of a person other than the member”. The full court held the phrase “in favour of” was held to mean “payable to or to the order of” the member. So long as the member has in fact correctly instructed the trustees to pay the benefit to an associated entity, and the trustees act on that instruction, there is no breach of SIS Regulation 6.22.

Applying the reasoning of the full Federal Court in the Asgard Capital case to the scenario above, if Bill makes a formal request for the partial commutation of his pension and expressly directs the SMSF to transfer the title to an entity, Big Bill Pastoral, and provides the SMSF with a release that transfers title to the farm to Big Bill Pastoral, he will be deemed to have discharged, to the extent of $1.2 million, the trustee’s liability to pay $1.28 million. Bill, for taxation purposes, will be treated as having constructively received $1.28 million and any tax consequences arising from that constructive receipt will be borne by him. Fortunately, the tax consequences are that Bill has received $1.28 million of non-assessable non-exempt income. As the payment by the SMSF is a payment of a non-assessable nonexempt amount, the SMSF has no obligation to withhold taxation instalment deductions from the payment.

Other possible objections

There are a number of objections to the transaction.

• No power in trust deed or governing rules – There must be express power in the trust deed or governing rules to permit an in-specie benefit payment or sale to a party associated with a member. If such an amendment were required, it would be an uncontroversial one to implement. This objection is easily resolved.

• No occurrence of an unrestricted release condition – The payment cannot be made as Bill has not satisfied a release condition. In this case Bill has attained age 65 and thereby satisfied a release condition.

• Breach of sole purpose requirement – If the farm is transferred as an in-specie benefit payment, there would be no breach of the sole purpose test, section 62 of the SIS Act, assuming the member is entitled to a benefit payment and the market value of the farm does not exceed the value of the member’s entitlement. In the case of a sale to the member, with a special condition to transfer title to an entity associated with the member, there would be no breach of section 62 if the sale was for market value. As the transfer is for market value, there is no value stripping from the SMSF. Also the full or partial commutation of a retirement-phase pension is not a breach of the sole purpose test as this test does not require benefits to be only taken as income streams.

• Breach of financial assistance prohibition (section 65 of the SIS Act) or the statutory covenants – If the member has a right to be paid $1.28 million by reason of the partial commutation of the pension and the trustee transfers an asset or assets that have a market value of $1.2 million, where is the financial assistance? While Big Bill Pastoral has received financial assistance, this assistance is from Bill and it has arisen by reason of the direction he has given to the fund trustee, which discharges the SMSF’s liability to Bill arising from his exercise of his right to commute his pension. While the SMSF has chosen to transfer a particular asset rather than other assets of equal value, there are sound reasons for such a choice, such as to dispose of a low-yield, illiquid, highly concentrated asset that will ultimately give rise to liquidity and concentration risks as Bill and Bernie’s minimum pension drawdown rate increases.

• Breach of the best financial duty (section 52B(2)(c) of the SIS Act) – Is the decision of the trustee to pay a benefit by way of an in-specie transfer or the payment of a benefit by way of the in-specie transfer of a particular asset in the best financial interests of the members? The decision to discharge a debt owed to a member by the in-specie transfer of a particular asset has not affected Bernie’s interest in the fund. The value of her superannuation interest is unchanged. The removal of a lumpy, lowyielding asset has improved the likelihood that her pension payments will be made in cash as and when due.

• Is the in-specie benefit payment consistent with the investment strategy? – As previously mentioned, there could be sound investment reasons for the exit of a low-yielding lumpy asset from a fund that is in retirement phase. Investment strategies are not set in stone and can and should change over time as the conditions of the fund change. An investment strategy cannot prevent a member from exercising his pension commutation rights. The terms of the pension may, however, restrict those rights, but the pension is a commutable account-based pension.

Section 274 concession is difficult to determine

Whether a particular transaction is one to which the section 274 concession applies can be difficult to determine. However, the successful application of the concession will provide a significant financial benefit.