Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 149

SMSFs need care dealing with related parties

SMSFs are allowed to invest in and transact with related parties however there are rules that surround these arrangements and sometimes they can be confusing. This article is a guide to the main issues of asset purchases and sales, borrowing and lending and investing in related parties.

The golden rule is at arm’s length

The golden rule for all related party interactions is that whenever you are dealing with a related party of the fund, all transactions must be conducted on an arm’s-length basis. That is, transactions must be carried out on the same terms and conditions as if they were with an unrelated, third party.

A related party of a super fund is defined under superannuation law as a member of the fund, a standard employer-sponsor of the fund and a Part 8 associate of either of these two. A Part 8 associate generally includes:

  • relatives of the members
  • the other members and trustees (or trustee directors) of the fund
  • business partners in a partnership (and their spouses and children) and the partnership itself
  • a trust controlled by a member of the fund
  • a company sufficiently influenced, or for which majority voting interest is held by a member

A standard employer-sponsor of a fund is an employer that contributes to a super fund for its employees due to an arrangement between the employer and the fund. Typically, this would not be relevant for SMSFs that have been established in recent years.

It’s not always easy to determine whether another party or entity is related, and professional advice is frequently advisable.

Can an SMSF lend money to a related party?

There is a prohibition on lending or providing financial assistance to members of an SMSF or their relatives (as opposed to a related party – see definition above). For these purposes, a relative is a spouse, parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the individual or their spouse. It also includes the spouse of any of the above.

Financial assistance includes any kind of financial aid, help or benefit using resources of the SMSF (even where it wasn’t requested). For example, a gift, debt forgiveness or paying an inflated price for services.

Because this ban on lending only applies to the member and their relatives, an SMSF can therefore lend to a related party that is not a relative but only under very limited circumstances. Such a loan would be termed an in-house asset (IHA).

An IHA is a loan to, or investment in, a related party of the fund. While allowable, IHAs must not constitute more than 5% of the total market value of the SMSFs assets.

Can my SMSF invest in my private company?

Yes, but the value of the investment cannot exceed 5% of the market value of the SMSF’s total assets. This is because the private company would be considered a related party and any investment in it is then an IHA. If the 5% level is exceeded, the SMSF trustees will need to put a plan in place to reduce the level back under 5%. This can be problematic if the value of the private company’s shares increases significantly such that it constitutes a higher percentage of the fund’s overall assets.

Dividends from the private company must also be paid to the SMSF on an arm’s-length basis. If dividends are received by the SMSF on a non-arm’s-length basis, they will be taxed as special income at a rate of 45% (plus 2% temporary budget levy).

Can my fund borrow from a related party?

A general prohibition exists on any super fund borrowing or maintaining an existing borrowing of money. However, there are limited circumstances in which a fund can borrow including from a related party. Temporary borrowings are possible for benefit payments, settlement of transactions and payment of surcharge but super laws place stringent criteria around when and how these are permissible.

The other exception to borrowing is for limited recourse borrowing arrangements (LRBA). These can include borrowings for assets such as listed securities or real estate but recourse by the lender in the case of default can only be against the actual asset for which the borrowing is undertaken.  It is possible for related parties to lend to the SMSF under such arrangements, but there are specific rules that must be adhered to. Importantly, the Australian Taxation Office (ATO) insists that borrowing arrangements involving a related party are undertaken strictly on commercial terms. This includes not only interest rates but other terms and conditions such as repayments and loan to value ratios.

Can an SMSF buy assets from a related party?

Generally, the answer is no but there are a few exceptions. An SMSF can purchase listed securities and business real property from a related party and certain ‘in-house assets’ (IHA) but remember, always at market value. Business real property refers to property that is used 100% for commercial purposes whether that is by a related party or not.

Can an SMSF sell assets to a related party?

An SMSF can sell its assets, at market value and on an arm’s-length basis, to a related party. The SMSF can also transfer an asset to a member of the fund as a lump-sum ‘in-specie’ member benefit payment where the member has satisfied the relevant criteria to start accessing their super benefits.

Where do trustees generally go wrong with related party investments and transactions?

Even where a particular transaction or asset acquisition is permissible, problems typically arise with trustees not dealing with related parties on an arm’s-length basis. SMSF trustees can be at risk of being ‘one-eyed’ when it comes to related party investments. They must be careful to ensure that investments are undertaken to maximise retirement savings and not using fund assets simply as a source of investment revenue for their personal businesses or for personal use.

An SMSF is a separate legal entity and trustees have an obligation to ensure that their dealings, including those with related parties, are conducted in the members’ best interests. Failure to do so is a failure to meet their fiduciary obligations as a trustee and can cause the fund to be scrutinised by the ATO, potentially incurring penalties.

If you are considering transactions between an SMSF and a related party, a professional adviser can help ensure you are operating within the bounds of the law.

 

Liz Westover is a Director with PricewaterhouseCoopers, Private Clients. This article is general information and does not address the circumstances of any individual.

 

RELATED ARTICLES

7 vital steps to compliance for your SMSF

Importance of updating your SMSF Trust Deed

What is the new work test exemption?

banner

Most viewed in recent weeks

Too many retirees miss out on this valuable super fund benefit

With 700 Australians retiring every day, retirement income solutions are more important than ever. Why do millions of retirees eligible for a more tax-efficient pension account hold money in accumulation?

Is the fossil fuel narrative simply too convenient?

A fund manager argues it is immoral to deny poor countries access to relatively cheap energy from fossil fuels. Wealthy countries must recognise the transition is a multi-decade challenge and continue to invest.

Reece Birtles on selecting stocks for income in retirement

Equity investing comes with volatility that makes many retirees uncomfortable. A focus on income which is less volatile than share prices, and quality companies delivering robust earnings, offers more reassurance.

Is it better to rent or own a home under the age pension?

With 62% of Australians aged 65 and over relying at least partially on the age pension, are they better off owning their home or renting? There is an extra pension asset allowance for those not owning a home.

Welcome to Firstlinks Election Edition 458

At around 10.30pm on Saturday night, Scott Morrison called Anthony Albanese to concede defeat in the 2022 election. As voting continued the next day, it became likely that Labor would reach the magic number of 76 seats to form a majority government.   

  • 19 May 2022

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Latest Updates

SMSF strategies

30 years on, five charts show SMSF progress

On 1 July 1992, the Superannuation Guarantee created mandatory 3% contributions into super for employees. SMSFs were an after-thought but they are now the second-largest segment. How have they changed?

Investment strategies

Anton in 2006 v 2022, it's deja vu (all over again)

What was bothering markets in 2006? Try the end of cheap money, bond yields rising, high energy prices and record high commodity prices feeding inflation. Who says these are 'unprecedented' times? It's 2006 v 2022.

Taxation

Tips and traps: a final check for your tax return this year

The end of the 2022 financial year is fast approaching and there are choices available to ensure you pay the right amount of tax. Watch for some pandemic-related changes worth understanding.

Financial planning

Is it better to rent or own a home under the age pension?

With 62% of Australians aged 65 and over relying at least partially on the age pension, are they better off owning their home or renting? There is an extra pension asset allowance for those not owning a home.

Infrastructure

Listed infrastructure: finding a port in a storm of rising prices

Given the current environment it’s easy to wonder if there are any safe ports in the investment storm. Investments in infrastructure assets show their worth in such times.

Financial planning

Power of attorney: six things you need to know

Whether you are appointing an attorney or have been appointed as an attorney, the full extent of this legal framework should be understood as more people will need to act in this capacity in future.

Interest rates

Rising interest rates and the impact on banks

One of the major questions confronting investors is the portfolio weighting towards Australian banks in an environment of rising rates. Do the recent price falls represent value or are too many bad debts coming?

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.