All trustees have a duty to ensure that the way they operate their self managed super fund (SMSF) in a way that complies with the Superannuation Industry (Supervision) Act 1993 (SISA) and Regulations (SISR). Three of the most common and most serious contraventions are outlined below.
Section 65 of SISA prohibits the trustees of a fund from lending money or providing any other financial assistance using the resources of the fund to a member of the fund or their relatives. Relatives include parents, grandparents, brothers, sisters, uncles, aunts, nephews, nieces and lineal descendants. This section extends to leasing a fund’s residential property to a member or relative, even if at market value. Similarly, loans to members or their relatives are not allowable even if market interest rate were charged. It is the very act of providing the financial assistance in the first place that is a contravention of the SISA.
It is also important to note that this Section applies a look through approach to funds provided to related parties. If, for example, the fund made a loan to a related company and the company subsequently provided financial assistance to the members, then this would be a breach of Section 65 of SISA.
Section 109 of SISA requires that all investments of a superannuation fund are to be made and maintained on an arm’s length basis. This is to say that the terms and conditions of the transaction are to be no more favourable to the other party than those which it is reasonable to expect would apply if the trustee were dealing with the other party at arm’s length in the same circumstances.
An example of where this Section comes into play might be in the acquisition of a commercial property from a related party or leasing a commercial property to a related party. In regards to the latter, rent must be collected at market rent rates and typically on similar lease terms to what it would be with an unrelated party. Failure to pay rent period or falling behind in rent payments may result in a contravention of Section 109 and potentially Section 84 if the unpaid rent pushes the fund’s in-house assets over 5%. Another example that is typically overlooked is interest being charged at market interest rates on loans to related companies. Where this is an actual loan, a loan agreement on commercial terms should be put in place. Another example for trustees to consider is where the fund is entitled to a distribution from a related unit trust, but the trustees allow it to remain unpaid.
It is also important to note that failing to maintain all investments of the superannuation fund on arm’s length terms may result in the income from that investment being considered as non-arm’s length income (NALI), which is taxed at the highest marginal tax rate.
Section 82 of SISA allows a fund to hold up to 5% of its total assets as “in-house assets”. In-house assets are a loan to or an investment in a related party and an asset of the fund that is leased to a related party. There are some exceptions to assets being considered in-house assets, which include business real property that is leased between the fund and a related party and some investments in related non-geared trusts or companies.
A fund breaches Section 84 of SISA where it acquires an asset that would place the total in-house assets over 5% of fund assets at the time of acquisition and where total in-house assets are over 5% of fund assets at 30 June. When a fund contravenes this Section, the trustees are normally required to document how they intend to rectify the contravention, which is usually done by either contributing further money to the fund or by selling the in-house assets in question.
It is important to note that loans to members and their relatives would be included in the in-house asset calculation, as may rent or unpaid distributions from related trusts beyond a year. In some cases, such as renting a residential property to a member or their relatives in contravention of Section 65 would result in the residential property becoming an in-house asset and the most likely outcome would be the fund having to sell the property.
Repeated or serious breaches in compliance with the SIS Sections and Regulations, these three in particular, can result in the ATO issuing education directives and enforceable undertakings up to disqualification of trustees, civil and criminal penalties imposed on the trustee and marking the fund as non-compliant, which has a significant financial impact on the SMSF. It is therefore very important that trustees understand what they can and cannot do and if unsure, to seek professional advice.