Construction and substantial renovation projects can add value to an SMSF property, but they also bring real risks where related-party builders are involved. One of the most common problems occurs when the fund inadvertently acquires assets from a related party, triggering a breach of Section 66 of the SIS Act.
For accountants supporting SMSF clients, it’s a tricky area. The difference between allowable services and a prohibited acquisition of assets can come down to the way materials are purchased, invoiced and documented. Careful review and strong evidence are essential.
When a related-party builder can do the work
An SMSF is allowed to engage a related-party builder to carry out construction work, provided the arrangement is a commercial one and is properly documented. Labour and services can be supplied by the related party because the fund is paying for work, not acquiring an asset from a related party.
However, the moment materials are involved, the risk profile changes.
The Section 66 problem: Acquiring materials from a related party
Section 66 prohibits an SMSF from acquiring an asset from a related party unless an exception applies. In construction projects, this becomes an issue when:
- A related-party builder purchases materials and then on-sells them to the fund
- The builder buys materials using their own accounts and invoices the SMSF for both labour and materials together
- A related-party individual or entity is reimbursed for materials
- Substantial renovations are treated similarly to acquiring a new asset
In these scenarios, the fund is treated as acquiring the materials from a related party. Because no exemption applies, this is a breach of Section 66. This can occur even where the intention is entirely innocent, such as a family member who is a builder that buys materials in bulk for convenience.
Distinguishing services from assets
A key compliance test is the distinction between what is considered a service and what is considered an asset.
- Services (labour) provided by a related-party builder are allowed
- Materials acquired from a related party are not allowed
- Combined invoices that do not clearly separate materials from labour create a compliance risk
- Demonstrating evidence of who purchased the materials, when and in whose name is critical
If the fund cannot demonstrate that materials were purchased directly from an unrelated supplier, the auditor may have no choice but to treat the transaction as a prohibited acquisition.
Substantial renovations and construction: Higher scrutiny
The ATO pays particular attention to:
- New constructions funded by SMSFs
- Substantial renovations that change the character of the property
- Situations where materials represent a large proportion of total expenditure
- Builders or tradespeople who are related parties
In these cases, auditors look closely at invoices, receipts, supplier details and payment records to confirm whether the fund has purchased all materials directly from unrelated parties.
What accountants should review
To avoid Section 66 breaches, accountants should ensure the following documentation is provided:
- The building contract, including the scope of work
- Agency agreement
- Invoices issued by unrelated suppliers for all materials
- Evidence that the SMSF paid suppliers directly
- Separate invoicing for labour performed by the related-party builder
- Bank statements showing payments made by the SMSF
- No reimbursements to related parties for material purchases
- Trustee minutes or resolutions approving the work
If materials have already been purchased by a related party before the issue is identified, professional advice may be required to determine how best to remediate or disclose the breach.
What to do if a breach has occurred
If the SMSF has acquired materials from a related party, this will generally need to be reported. Steps usually include:
- Assessing the value of the materials
- Determining whether rectification is possible
- Discussing options with the auditor
- Preparing documentation for an Audit Contravention Report if required
- Ensuring future purchases are made directly by the SMSF
If you need support reviewing a current or upcoming SMSF property project, or have additional questions about the acquisition of building materials for construction within an SMSF, please contact us.