Self-managed superannuation funds (SMSFs) can offer significant flexibility, allowing the
members to make investments and enter arrangements that may not be available
through retail or industry superannuation funds. However, being an SMSF trustee does
come with important responsibilities to ensure that all dealings comply with
superannuation law.
Two critical areas to keep front of mind are:
·The sole purpose test, and
·The arm’s length requirements in both superannuation and taxation law.
The Sole Purpose Test
The sole purpose test requires that superannuation funds should be managed for the
sole purpose of providing retirement benefits to fund members. While some SMSFs may
have dealings with or/investments in related entities, these are subject to strict limits
and when arrangements are entered into it is important that first and foremost SMSF
trustees are considering the retirement benefits of the fund members rather than the
needs of any external parties.
The example below illustrates how SMSF trustees should apply the sole purpose test
when looking at making a related party investment.
Example: Investing in a Related Business?
Sachin and Deepthi have an SMSF which has a total balance of $1.2m. Their son Hardik
commenced a business 3 years ago using a company structure. Hardik has approached
his parents to invest $50,000 into his company via their SMSF.
Although Hardik is passionate about the business it has not grown as he would like, and
Sachin and Deepthi are aware that the business has had cashflow issues and profits are
not at a point where the business is growing or generating a profit.
Although the proposed investment amount is within the 5% in-house asset limit would
Sachin and Deepthi invest member funds in an unrelated business knowing the business
was in this same situation? That is, would they be placing their son’s interests ahead of
the interests of the fund members?
Based on Sachin and Deepthi’s knowledge of the business, if the SMSF was to go ahead
and make this investment they as trustees may have contravened the sole purpose test.
Arm’s Length Requirements
In addition to the sole purpose test there are superannuation and taxation law
requirements that SMSF trustees always deal on arm’s length commercial terms. This is
again particularly important when arrangements are with fund members and/or related
parties.
Where arrangements are not at arm’s length, SMSF trustees can be liable for
superannuation law penalties and in some cases fund income may be taxed at a higher
rate.
Some common examples and key issues are discussed below.
Example: An SMSF Owns a Commercial Property Which is Leased to a Related
Party Business
The rent should be on commercial terms and this needs to be evidenced by a rental
appraisal from a professional such as a real estate agent when a lease is entered into.
The lease agreement should:
· Be in writing;
· Clearly cover who is responsible for particular outgoings and maintenance; and
· Be prepared by a legal professional
Example: A Member of the SMSF or a Related Party Completes Work on an SMSF
Property
SMSF trustees should seek professional advice before commencing any work on SMSF
properties where the work may be performed by a member or a related party. All
arrangements with related entities should be commercial, including:
· If a related building company is used, the SMSF must pay market rates (same as the general public) and this should be supported by documentation to satisfy the fund auditor.
· If members (who are also trustees) perform work personally, strict rules apply to
whether they can be paid for their services.
· All materials should be purchased directly by the SMSF, not by individual members.
Please contact us to discuss these rules further if you are considering entering into any
transactions or projects involving SMSF-owned property and related parties.
Disclaimer: This article contains general information only and is not intended to
represent specific personal advice (Accounting, taxation or financial). No individual
personal circumstances have been taken into consideration for the preparation of this
material. It is recommended that you obtain your own personal professional advice
before making any financial or business decision. If you require any assistance or wish to
discuss above, please reach out to our friendly consultant on 03 9863 9779 or
admin@connectadvisors.com.
