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.
Note: The material and contents provided in this publication are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.
