Investing in related party / In-house SMSF assets – What is allowed and a solution for property?
The Australian Tax Office (ATO) as regulator of SMSFs, is clear about the investing part of running and SMSF –
“You need to manage your fund’s investments in the best interests of fund members and in accordance with the law. The self-managed super fund’s (SMSF)’s investments must be separate from the personal and business affairs of fund members, including your own.” (From Here)
In summary from that page, you need to consider the following –
- Your Investment Strategy
- Sole Purpose Test
- Ownership and asset Protection
- Member Insurance
- Restrictions on Investments – especially considering Related Party Investing**
- Carrying on a Business in SMSF
- Tax on Income
**Restrictions On Investments
All investments must be made on a commercial ‘arm’s length’ basis. You can’t buy assets from, or lend money to, fund members (or other related parties) unless an exception exists. Generally, your fund can’t borrow money except under strict rules.
The purchase and sale price of fund assets should always reﬂect a true market value for the asset, and the income from assets held by your fund should always reﬂect a true market rate of return.
In Summary restrictions need to take into account – (click to get more info, any of the following) -
O Related parties and relatives *
o Loans or financial help
o Acquiring assets from related parties
o In-house assets
o Business real property
o Collectables and personal-use assets
*Related Parties and Relatives
The ATO says
A number of investment restrictions apply to transactions involving ‘related parties’ of your fund and ‘relatives of members’. This is because no-one associated with your fund should get a present-day benefit from its investments. Your fund needs to be maintained for the sole purpose of providing death or retirement benefits to your members or the members’ dependents.
A ‘related party’ of your fund includes:
- all members of your fund
- associates of fund members, which includes:
- the relatives of each member
- the business partners of each member
- any spouse or child of those business partners, any company a member (or the members or their associates) controls or influences and any trust the member (or the members or their associates) controls
- standard employer–sponsors, which are employers who contribute to your super fund for the benefit of a member, under an arrangement between the employer and a trustee of your fund
- associates of standard employer–sponsors, which includes:
- business partners and companies or trusts the employer controls (either alone or with their other associates)
- companies and trusts that control the employer.
A relative of a member means any of the following:
- a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the member or their spouse
- a spouse of any individual specified above.
Note there is a distinction that can be drawn between an ‘in-house asset’ and a ‘related party investment’.
An ‘in-house asset’ is an asset of the fund that is a loan to, an investment in or a lease with a related party of the SMSF.
A ‘related party investment’ is also an asset of the fund that is a loan to, an investment in or a lease with a related party of the SMSF that meets one of the exceptions of the ‘in-house asset’ rules.
They appear similar, but one is in fact a subset of the other and the distinction is important because a fund is not permitted to invest more than 5% of its capital in an ‘in-house asset’, whereas no such cap applies to a ‘related party investment’.
So, when is a ‘related party investment’ not an ‘in-house asset’? That is, what are the exceptions to the ‘in-house asset’ rules?
Some of the exceptions to the ‘in-house asset’ rules include (ie these are allowed):
- a life policy issued by a life insurance company, but not a life policy acquired from a member of the SMSF or a relative of a member;
- an investment in a pooled superannuation trust made on an ‘arm’s length’ basis;
- business real property subject to a lease, or to a lease arrangement, between the trustee of the fund and a related party of the fund, if the property is business real property of the fund throughout the term of the lease or lease arrangement;
- an investment in a widely held unit trust;
- Investment in a non-geared related unit trust or company (see below for restrictions)
- a unit trust in which the unitholders have fixed entitlements to all of the income and capital of the trust and fewer than 20 entities between them do not have fixed entitlements to 75% or more of the income or capital of the trust;
- property owned by the fund and a related party as tenants in common, other than property subject to a lease or lease arrangement between the trustee of the fund and a related party.
Also, an SMSF is able to invest in a unit trust or a company without that investment being considered an in-house asset if certain conditions are met. These include, but are not limited to, the unit trust or company not acquiring an asset from a related party of the fund other than business real property, do not directly or indirectly lease assets to related parties other than business real property and do not conduct a business.
(Also see The three Rs: responsibility, related party transactions and rules Stuart Forsyth, Assistant Deputy Commissioner, Compliance, Strategy, Risk and Delivery, Superannuation)
Property – when the SMSF hasn’t enough to borrow itself – using a non-geared related unit trust or company
From August 1999, the only other alternative for your SMSF to invest in a related party unit trust or company (holding greater than the 5% in-house asset limit) is via the non-geared exemption under SIS regulation 13.22B and 13.22C. A SMSF investment using these provisions is not considered an in-house asset.
One of the benefits of the non-geared unit trust or company holding business real property, is it can provide flexibility of ownership between your SMSF and other related parties compared to direct ownership via tenants in common. Of course, you will need to consider the potential impact capital gains and stamp duty may have when transferring units or shares between parties.
However, these non-geared unit trusts and companies are significantly limited to what assets they can hold or activities they can undertake. The restrictions include not being able to:
- Borrow or allow a charge over any assets
- Run a business
- Hold an interest in another entity (e.g. can’t hold shares in company)
- Loan money to another entity
- Lease an asset to a related party, except if the asset is business real property
- Acquire an asset from a related party of the SMSF after 11 August 1999 except if business real property
- Acquire an asset that has previously been owned by a related party since the later of 11 August 1999, and three years before the SMSF first invests in the non-geared entity.
Most importantly, if the non-geared unit trust or company breaches any one of the above provisions, then the exemptions under SIS regulation 13.22B and 13.22C ceases immediately; resulting in your SMSF’s investment in the non-geared unit trust or company being classified an in-house asset. This is regardless if the breach is rectified during the current or future financial years.
For a good explanation, see THE SMSF Coach article
Interested to know what self-managed super (SMSF) is all about, and if it is for you? Come to a FREE seminar with bonuses, run every month – Self Managed Super Fund Roadmap (all you need to know) for the next monthly event, see 1 SMSF – FREE Seminars or our other seminars above – Navigate Shares and Property Boost (every few months) in the menu above or call us 0407 361 596