Self-managed superannuation funds (SMSFs) provide members with a high level of control and flexibility over their retirement savings. Trustees can choose investments and enter arrangements that may not be available through retail or industry super funds. 

However, this flexibility comes with significant responsibilities. SMSF trustees must ensure the fund operates strictly within superannuation and taxation laws.

Two key compliance principles every trustee should understand are:

• The sole purpose test, and
• Arm’s length requirements under both superannuation and tax legislation.

The Sole Purpose Test

The sole purpose test requires that an SMSF be maintained solely for providing retirement benefits to its members (or benefits to their dependants if a member dies).

While SMSFs can invest in or transact with related parties in certain circumstances, trustees must ensure that every decision is made with the members’ retirement interests as the primary objective. If an arrangement appears to benefit someone outside the fund—particularly family members or related businesses—it may raise compliance concerns.

Example: Investing in a family business

Sachin and Deepthi manage an SMSF with a total balance of $1.2 million. Their son Hardik started a company three years ago and asks his parents to invest $50,000 from the SMSF into the business.

Although the proposed investment would fall within the 5% in-house asset limit, the business has experienced cash-flow difficulties and has not yet generated consistent profits.

The key question for the trustees is: Would the fund make this investment if the business belonged to an unrelated party? If the investment is motivated by supporting their son rather than by a sound investment decision for the fund, the trustees could potentially breach the sole purpose test.

Arm’s Length Requirements

SMSFs must also ensure that all dealings occur on commercial, arm’s length terms. This means transactions should reflect the same conditions that would apply between unrelated parties in the open market.

If arrangements are not conducted at arm’s length, the consequences can be significant. Trustees may face superannuation penalties, and the fund’s income from the arrangement may be taxed at a higher rate under the non-arm’s length income (NALI) rules.

Below are some common situations where trustees need to be particularly careful.

Example: Leasing SMSF Property to a Related Business

If an SMSF owns a commercial property that is leased to a related party business, the lease must be conducted on genuine commercial terms.

This typically requires:

• Market-based rent, supported by an independent rental appraisal
• A formal written lease agreement
• Clear terms outlining responsibility for outgoings, maintenance, and repairs
• Legal documentation prepared by a qualified professional

Maintaining proper documentation helps demonstrate that the arrangement is consistent with normal commercial practices.

Example: Work Performed on SMSF-Owned Property

Trustees should also exercise caution where fund members or related parties perform work on SMSF property.

Key considerations include:

• If a related building company undertakes the work, the SMSF must pay market rates, supported by appropriate documentation for audit purposes.
• If members perform work themselves, strict rules apply regarding whether they can receive payment for their services.
• Building materials and expenses should be purchased directly by the SMSF rather than by individual members.

Because these arrangements can be complex, trustees should seek professional advice before proceeding.

Staying Compliant

SMSF trustees must always ensure that their decisions and transactions align with the best financial interests of the fund members and the regulatory framework governing superannuation.

If you are considering an investment involving related parties or planning work on an SMSF-owned property, it is important to understand the rules beforehand. The team at Bates Cosgrave can help ensure your SMSF remains compliant while continuing to work toward your long-term retirement goals.