SMSF Technical Education & Strategies

 

Investment restrictions of SMSFs

With the awareness and growth of Self Managed Superannuation funds (SMSFs) at an all time high, a significant issue that is emerging is the importance for trustees to be highly knowledgeable as to their responsibilities in running these funds. Of these, probably the most important responsibilities for you to come to grips with as a trustee are the restrictions that the law imposes with regard to the investments within your SMSF.

Failure to do so can easily result in serious breaches of these laws, which in turn can have disastrous financial consequences with trustees being fined and/or the fund losing its complying status. Whilst the superannuation law does not state exactly what a fund can and cannot invest in, it does however restrict a number of investment practices. Ignore them at your peril.

 

Investments on an arms length basis

The first and most straightforward rule is that investments must be made and maintained on a strict commercial basis, that is buying and selling of assets must always reflect their true market value. Similarly, any income from these assets should always reflect a true market rate of return.

 

Borrowing

Except in limited circumstances, you cannot borrow money in your SMSF. The exceptions include borrowing (for not more than 90 days and the borrowing does not exceed 10% of total assets) to pay member benefits or surcharge liability, and to settle security transactions (for not more than 7 days) as long as it was not foreseen as being needed at the initial time of transaction. New regulations now also provide the ability for borrowing for investment purposes via a "Limited recourse borrowing arrangement" structure. See the articles on "Borrowing" in the SMSF Technical education & strategies section for more details.

 

Loans to members or a members relative

Trustees cannot engage in providing financial assistance or loans to members of the fund (or their relatives). The concept of the loan is very straightforward, however financial assistance can be a trap. For example the use of a holiday home (owned by the SMSF) by a member or members relative for no cost would constitute a contravention of this restriction. Further to this, the property (or any other asset of the fund) could not be used as a guarantee to secure a personal loan for a member or members relative.

 

Acquisition of assets from 'related parties'

Trustees are prohibited from acquiring assets from a ‘related party’ of the superannuation fund. The limited exceptions to this rule include assets acquired at market value, if:
- the acquisition is an 'in-house asset' which, after being acquired by the trustees would not result in the level of ‘in-house assets’ of the superannuation fund exceeding more than 5% of the superannuation fund’s assets;
- the asset is a listed security (for example, shares, units or bonds listed on an approved Stock Exchange);
- the asset is ‘business real property’. (SISA 66) ‘Business real property’ of an entity generally relates to land and buildings used wholly and exclusively in a business. Trustees of SMSFs are permitted to acquire up to 100% of the fund’s total assets as ‘business real property’.

 

In house assets

An in house asset is an investment in, a loan to, or leases with a related party of the fund. You cannot have more than 5% of the funds assets invested in this way. The exception is business real property subject to a lease between the fund and a related party. This can be up to 100% of the funds assets. Note that there are some transitional arrangements for those with in-house asset structures existing before 11th August 1999. In addition SMSFs may invest in a unit trust or a company, without that investment being considered an ‘in-house asset’, if certain conditions are met [Superannuation Industry (Supervision) Regulations 1994 (SISR) 13.22C]. The main conditions being that the trust or company:

· does not borrow;
· has no assets with a charge over them;
· does not loan money to individuals or other entities (other than deposits with authorised deposit-taking institutions);
· does not acquire an asset from a related party of the superannuation fund other than business real property acquired at market value;
· does not directly or indirectly lease assets to related parties, other than business real property;
· does not conduct a business; and
· conducts all transactions on an arm’s length basis.

 

Related Party

So what is a related party ? Quite simply, this includes all members of the fund and their associates, their employer sponsors, and any of their associates or employer sponsor’s associates. Associates include relatives, business partners, and any companies or trusts that they control.

 

Derivatives

Derivatives are allowed in SMSFs, however you need to be aware of how you calculate your exposures for your Investment strategy, and you will also need a Derivatives Risk Statement (as per Reg 13.15A) if an asset of the fund is held as margin on any of your derivatives. See our article on Derivatives for more details.

 

Sole purpose test

Overlaying all of this is the sole purpose test. This test is there to basically ensure that your SMSF is maintained for the purpose of providing benefits to members upon their retirement, or their dependants in the event of the member’s death before retirement. If you make an investment and it appears that you are gaining current benefit from the use of that asset, you may be contravening the sole purpose test. For more info, see our article on the sole purpose test.