Your SMSF: when expenses and investments are not at arm's-length
We often get questions from clients about what they can and cannot do in their SMSF. Often the questions relate to related party transactions – that is, interactions between the SMSF, its assets, and its members (or relatives of members). We've set out some of the common questions and answers.
In general, all interactions between your SMSF and its members should be at arm's length – that is, the terms of the transactions are the same as what would be entered into between independent parties, but there are circumstances where the interests of the fund and its members intersect.
A transaction which is favourable to either party is deemed to be at non-arm's length terms, which could create some taxation issues.
Can I charge my SMSF for work that I do?
Let's say your SMSF owns a residential rental property and the property needs a fence. You're a builder and can build the fence. Can you charge the SMSF for the fence? The answer is maybe.
What you charge and how it is charged is critically important here.
If the fund acquires the fencing material, and is invoiced by the building business to construct the fence, and pays a market rate for the labour involved, then there is unlikely to be a problem as the charges are transparent and at market value. However, documentation is essential and you may also need to verify that the labour cost charged is the market rate.
However, if the business decides to install the fence for no charge, or alternatively charge an excessively high rate, then the transaction could be deemed to be non-arm's length.
If the building business acquires the fencing material and then installs the fence at arm's length rates for the SMSF, this could still cause in-house asset issues as the fund has acquired an asset from the member; the fencing material. It all gets very messy and it might just be easier to have someone else do it!
What happens if the building business either charges below market rates or does not charge the fund for labour cost? The rules have recently been extended to capture non-arm's length expenses where a related party is acting in a capacity other than as trustee and a non-arm's length expense was not charged. i.e., where the fund benefits from work performed by a member in a capacity other than trustee. The ATO sees these non-arm's length expenses as potentially artificially inflating an SMSFs earnings.
The market value of the work performed might be treated as a contribution, or all of the income from the asset could be deemed to be non-arm's length, which means the highest marginal tax rate will be charged on all income and capital gains derived from the asset.
This same scenario applies to any member of an SMSF (or relative of a member) who provides services to their SMSF – electricians, plumbers, accountants, real estate agents, etc.
The rule is, work that is done for the SMSF by a related party in their professional capacity must be equivalent to arm's length market value, with no acquisition of materials. Free, below market value, above market value, may breach the superannuation rules. And, where work is performed by a related party at market value, it must be documented and provable.
If you are not a qualified professional you cannot undertake work on behalf of your fund unless you are fulfilling your duties as trustee.
Can I charge for the work I do to administer my fund?
Trustees of an SMSF cannot be remunerated for the work that they do for the fund. The exception is where you are qualified to provide certain services to your fund and act in that professional capacity. For example, you are a real estate agent and are buying and selling property assets for the fund. In this case, you are not being paid for work you do in your capacity as trustee but as a professional providing a service at market value (see Can I charge my SMSF for work that I do?).
Can my SMSF purchase a rental property that I own?
Your SMSF cannot acquire property from a related party of the fund unless the property (land and buildings) is used wholly and exclusively in a business (business real property).
Under these circumstances your SMSF could purchase the commercial premises used by a business you own and lease the property back on commercial terms.
If business real property is used in a primary production business such as a farm, it can still meet the test of being used wholly and exclusively in a business even if it contains a dwelling that is used for private or domestic purposes.
But, the dwelling must be in an area of land no more than two hectares and the main use of the whole property can't be for domestic or private purposes.
Can I lend money to my SMSF?
Members of a fund can lend money to their SMSF in very limited circumstances, and usually to buy property, if the following conditions must be met:
- It is a limited recourse loan to the SMSF and is appropriately documented, and
- The SMSF is not charged higher than an arm's-length rate of interest for borrowing, i.e., the loan is on commercial terms, there are 'safe harbour' guidelines provided around loan to value ratios, and repayment terms to ensure the loan is at arm's-length.
Can my SMSF lend me money?
No. Your SMSF cannot lend you or any of your related parties money. The superannuation rules specifically prohibit the fund providing financial assistance to members. This includes where a member takes money out of the SMSFs account for a short amount of time and replaces it in full. Just don't do it.
SMSFs are fraught with complex rules; speak to your accountant
SMSFs are a complex part of tax planning and we always recommend talking to your accountant about any changes, loans, or investments as part of your tax planning. Please call us on 02 9957 4033 for more information.
This article is provided for information purposes only and correct at the time of publication. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.