Can I buy ART in my Superannuation?

ART AND SELF-MANAGED SUPERANNUATION (SMSF)

If art is managed correctly, it could be of benefit to generations of your family. Art can make an excellent addition to your self-managed super fund, but you need to keep a close eye on the rules. Whether you're investing in art for love or investment purposes, it does not matter as the same capital gains tax (CGT) ramifications take place just like when buying shares, property or ownership in a business.


INHERITANCE AND CONTINUITY

You can spend a lifetime gathering a collection, but at the end of the day what will happen to it, and who will you pass it onto? Strangely, art institutions aren't that keen to be given bequests because of the cost involved in maintaining them (See an article regarding art Philanthropy in our Media section). By bequeathing a valuable painting to family or friends you could be saddling them with a tax liability if they sell it.

If an artwork was bought before capital gains tax was introduced in September 1985, it would generally not be subject to the tax. But if someone inherits an artwork, then capital gains begins from the date they inherited. If the artwork was bought after 1985, the capital gain is based on the difference between the purchase and sale price. Fifty per cent of that gain is then assessable and added to the vendor's income in that financial year. As a result, clients who may have been in a lower tax bracket are pushed up into the higher marginal tax bracket and can loose a large part of the gain in tax.

That's where a self-managed superannuation fund (SMSF) can be very useful.

SMSF is probably the most effective estate planning vehicle that is available to us today which will allow art collections to go on. One of the major benefits of an SMSF is that during the accumulation phase up until you retire the fund pays lower, 15 per cent, income tax and 10 per cent capital gains tax. Once you reach retirement, the fund moves into pension phase and zero tax is payable on both income and capital gains within the fund.

Clients could actually buy works of art as with their SMSF during the accumulation phase, sell it during the retirement phase and have no capital gains tax implications. Then you have cash reserves to diversify into other types of assets to fund your happy retirement.


SMSF: TAKING CARE OF RULES AND REGULATIONS

While any collectable or unique investment can be in an SMSF the asset has to be valued every year the question is: how do you intend to provide for your retirement if these collectables are still in your fund when you retire?

The trustees are required to make sure the assets are being cared for and insured. To accomplish this, the ATO recommends that the collection is placed in storage or leased to an art gallery or commercial premises. If the collection is leased it will be producing an income. But it's rare that all artworks when leased would produce sufficient income to sustain someone in retirement.

And whatever, you do, avoid buying art with SMSF then hang on the wall in your house.



RESTRICTIONS

Provided the Investment Strategy permits the investment in artworks, the following additional factors must then be considered:

• Where will the artworks be displayed – the Sole Purpose Test prohibits trustees from making investment decisions to obtain a benefit prior to retirement:

a. if a member obtains the benefit at no cost, then the sole purpose test may be breached; or
b. if a member or related party obtains a benefit, but pays a commercial lease entered into after 23/12/99, then the Agreement must be documented and the In House Asset rules must be considered (ensure the artwork is less than 5% of the market value of the fund’s assets).

• Detailed expert advice should be sought if the artworks will be held for capital appreciation purposes (as opposed to deriving an income stream).

• Annual costs such as insurance and storage.

• Valuation costs.

Typically the asset allocation within an SMSF might need to change, especially if you are thinking of using 100 per cent of funds towards art using SMSF. In addition, when you come to retire there may be a need to make more changes to the fund to ensure it is able to produce income, unless there is income from other sources.

When buying art as an investment you should seek good advice. Galleries, the primary market, are a source of information but they invariably promote their own selective artists, hence they are quite biased. Auction houses, on the other hand, are like a stock exchange where people are putting their shares back on the market for sale and the market determines how much the market is prepared to pay. They show art sales historical data and the percentage of growth in any particular artist's work. The draw back that you might pay extra 15-20% extra in ‘buyer’s premium’ for the privilege of buying through an auction house.


Sole Purpose Test

If an investment provides some personal benefit, the trustee will need to consider whether that personal benefit is consistent with the ‘sole purpose test’. As a general rule, the sole purpose test provides that the superannuation fund needs to be run exclusively for genuine retirement purposes. There are a limited number of other purposes that are allowed, such as providing against total and permanent disability, but the pleasure of looking at art is not among them. The Administrative Appeals Tribunal has indicated in previous decisions that it will look to whether the trustee has a secondary purpose to make the assets available for their own use and for the use of family and friends in determining if the investment is consistent with the sole purpose test. Where the trustee stores artwork on their wall at home they may be considered to be deriving personal use or enjoyment from the asset. It is not the storing of the artwork on the wall that is the issue; it is the trustee deriving personal use or enjoyment from the asset, such as looking at it. To avoid any doubt, the trustee may need to put it into storage or even place it on loan to an art gallery in return for the gallery providing storage.


Risk Management

Trustees need to be able to demonstrate from a custodian viewpoint that they are taking adequate precautions to protect any artwork held by the fund – it should be kept in a secure location and be stored to minimise damage. The artworks must be adequately insured (by the fund). All these procedures need to be minuted properly.




SMSF: ART LOAN
The dignity of the sole purpose test set out in section 62(1) of SIS has been strained - severely. The Tax Office has set out its thoughts in Draft Self Managed Superannuation Funds Ruling SMSFR 2007/D1 which recognises that while a SMSF may be maintained solely for the purposes set out in section 62(1), a fund may (incidentally) provide members or other entities with benefits other than those specified:



Example A

Use of work of art at no cost: breach of section 62.

A trustee of an SMSF acquires a work of art and does not seek independent advice in relation to that investment. The investment strategy of the SMSF requires the fund to hold a certain percentage of its asset in a portfolio of listed securities. The trustee liquidates all of the listed securities that the SMSF has invested in to fund the acquisition of the work of art. Soon after the work of art is acquired, it is displayed in the home of a member at no cost to that member.

The trustee contravenes the sole purpose test in these circumstances. Where the work of art is provided for the use of the member at no cost, or at less than market value, it indicates that a purpose of the investment is to provide a benefit otherwise than in accordance with subsection 62(1). The liquidation of a class of assets forming part of the SMSF investment strategy reinforces the conclusion that the provision of the benefit outside of those stipulated in subsection 62(1) was purposeful.


Example B

Lease of work of art to member at market value: no breach of section 62

SMSF maintains an investment in a significant art collection as part of its investment strategy, and commonly leases works of art to unrelated third parties at market rates. The trustee has expertise in investing in works of art, but nevertheless receives independent advice in relation to each of its investments.

The SMSF acquires a work of art after it has received independent advice regarding the soundness of investing in it. The SMSF then enters into an arrangement with a member whereby the member leases the work of art from the SMSF at market rates and subject to normal commercial conditions and controls. The work of art is displayed in the home of the member. There is no contravention of the sole purpose test in these circumstances. The benefit to the member is the opportunity to use the SMSF assets by paying an arm's length amount. There is no cost or financial detriment to the fund as a consequence of the use of the work of art by the member.

Nevertheless, trustees need to ensure that they do not provide a purposeful benefit to the members when undertaking SMSF activities, even if there is no net cost to the SMSF in providing the benefit. Although the impact of an arrangement on the SMSF resources is a relevant consideration, it is ultimately the objective purpose of providing the benefit rather than the net financial impact of the arrangement on the SMSF resources that determines whether the sole purpose test is contravened.


Example C

Loan of work of art to an unrelated party: no breach of section 62

Following on from Example A, the SMSF provides, at no cost, the work of art to a local gallery, for display in a special exhibition that is to run for two months. The work of art provides a benefit for the community at large. However the facts given in this example establish that there is not a
contravention of the sole purpose test as the cost or financial detriment to the fund and the benefits provided by the SMSF outside of those specified by subsection 62(1) are remote and insignificant. The display of the work of art at the exhibition may in fact enhance its future value.


Example D

Loan of work of art to a related party: breach of section 62

Following on from Example A, a related party of the SMSF owns a gallery. The related party charges the general public an admission fee for viewing the works of art at the gallery. It also sells picture cards and pens in the gallery gift store, promoting the paintings currently on display. The SMSF regularly loans its works of art to the gallery at no cost. Its investment choices are also largely determined by the art gallery's desire to acquire certain paintings. In this example there is a pattern of events that result, when viewed in their entirety, in a contravention of the sole purpose test.


Australian Legislative Framework

In Australia Self Managed Superannuation Funds are primarily governed by the rules contained within the Superannuation Industry (Supervision) Act 1993. The relevant sections:

• Section 52(2)(f) - requires Trustees to formulate and give effect to an Investment Strategy that has regard to the whole circumstances of the fund including risk, diversification, liquidity and solvency

• Section 66 – subject to certain exceptions, the Trustee is prohibited from intentionally acquiring assets from related parties of the fund

• Sections 69-85 – outlines the In House Asset rules

• Section 109 – requires the Trustee to operate on commercial terms

• Section 62 – essentially requires the Sole Purpose of the fund to be the provision of retirement benefits and/or death benefits

ATO ID 2004/248 Investment in Art by a SMSF
ATO ID 2004/249 Investment in Art by a SMSF and its display
ATO ID 2004/250 Investment in Art by a SMSF – in house asset
ATO ID 2004/251 Retirement Income Entities – arms length arrangement

Find more at www.ArtBank.ch