Avoid common SMSF breaches

By Scott Quinn, Technical Services Manager

In 2020/21, auditor contravention reports (ACRs) were lodged for 13,900 SMSFs reporting 40,200 contraventions.

The same three contraventions: 

  • providing loans or financial assistance to members
  • in-house assets
  • separation of assets

continue to top the contraventions list, contributing 50% of all SMSF contraventions.

SMSF Contraventions Top 3.png

Providing loans or financial assistance to members

An SMSF is prohibited from lending money or providing financial assistance to a member of the fund, or a relative of a member. Similarly, an SMSF cannot provide a loan or financial assistance through another entity to circumvent this restriction.

A relative of a member includes a member and their spouse’s:

  • parents and grandparents and their spouses
  • siblings and their spouses
  • aunts and uncles and their spouses
  • nephews and nieces and their spouses
  • children and their spouses
Loans

An SMSF cannot lend money to a member of the fund or a relative of a member.

An SMSF can lend money to:

  • an unrelated party; or
  • to a related party that is not a member or a relative of a member (eg a related trust or company), subject to the in-house asset rules and all dealings to be conducted at arm’s length (ie reflect commercial terms). A breach may still occur if the ATO decides that there is ‘sufficient connection’ to determine that financial assistance to a member or relative of a member has been provided indirectly (refer SMSFR 2008/1).

The loan would have to form part of the SMSF’s investment strategy and be an authorised investment under the trust deed.

There is a common misconception that an SMSF can lend up to 5% of fund assets to members or a relative of a member. An SMSF can lend up to 5% of fund assets to a related party, provided that the related party is not a member or a relative of a member.

If an SMSF lends money to a member, it generally constitutes illegal early access. Penalties may apply (refer to ‘Penalties for breaching SMSF rules’) and the amount is included in the recipient’s assessable income.

Financial assistance

An SMSF cannot provide financial assistance to a member of the fund or a relative of a member. 

Financial assistance includes:

  • selling an SMSF asset for less than its market value to a member or relative of a member 
  • purchasing an asset for greater than its market value from a member or relative of a member 
  • acquiring services in excess of what the SMSF requires from a member or relative of a member 
  • paying an inflated price for services acquired from a member or relative of a member 
  • satisfying or taking on a financial obligation of a member or relative of a member 
  • forgiving a debt or delaying recovery action for a debt owed to the SMSF by a member or relative of a member 
  • giving a guarantee or an indemnity for the benefit of a member or relative of a member 
  • giving a security or charge over SMSF assets for the benefit of a member or relative of a member.

In-house assets

In-house assets are generally investments in, loans to or fund assets leased to related parties and are limited to 5% or less of the market value of the fund’s total assets. SMSFs can acquire an in-house asset provided the acquisition is at market value and the asset acquired does not result in the fund exceeding the 5% limit.

Common related parties include a member of the fund, a spouse of a member, relatives of the member and their spouses and a controlled private trust or company.

Certain assets are exempt from being an in-house asset and include:

  • a life insurance policy issued by a life insurance company (other than a policy acquired from a member of the fund or from a relative of a member)
  • a deposit with an authorised deposit taking institution (eg bank or building society)
  • investments in a pooled superannuation trust
  • business real property subject to a lease arrangement with a related party
  • an investment in a widely held unit trust
  • an investment in a 13.22C unit trust or company.
5% in-house asset limit

In-house assets are limited to 5% or less of the market value of the fund’s total assets. This is tested at the time an in-house asset is acquired or established and each 30 June.

An in-house asset cannot be acquired or established if it will result in a breach of the 5% in-house asset limit. If the market value ratio of the fund’s in-house assets at the end of the financial year exceeds the 5% limit, the trustees of the fund must prepare and implement a written plan before the end of the next financial year. The plan must specify the excess amount and set out the steps to be taken by the trustee to dispose of one or more in-house assets with a sufficient market value to ensure the in-house asset level is reduced to below the 5% limit.

If the market value of the fund’s in-house assets falls below the 5% limit before the trustees have implemented their plan to dispose of an asset and the trustees subsequently did not dispose of the asset as planned (prior to the next 30 June), they would still be considered to have rectified the issue as the in-house asset level is below the 5% limit.

Separation of assets

Assets of the SMSF must be held separately from the member’s personal and business assets. Sale agreements should be executed and assets held in the name of either:

  • the individual trustees ‘as trustees for’ the SMSF
  • the corporate trustee ‘as trustee for’ the SMSF.

Where an asset of the fund cannot be held in this naming convention (eg due to state law), ownership by the SMSF can be clearly established by executing a caveat, or creating an instrument or declaration of trust.

Corporate trustees

The surest way to achieve separation of assets is to use a corporate trustee with the sole purpose of acting as trustee for the SMSF. Any changes in membership of the fund / directors of the corporate trustee won’t require ownership documents to change as the assets will be held the name of the corporate trustee ‘as trustee’ for the SMSF.

Multi purpose trustee companies may have difficulties with clear delineation of what is an SMSF asset and could put the funds assets at risk (eg in the event of death, relationship breakdown and insolvency or bankruptcy). 

Individual trustees

With individual trustees, there is a greater risk that SMSF assets won’t be clearly delineated from personal assets. SMSF assets must be clearly owned by the individual trustees ‘as trustees for’ the SMSF. If a member joins or leaves the SMSF this will require a change in trustees and an update to all ownership documents for each asset of the SMSF (the ownership change should be included in the SMSF records along with clear evidence to support the fund’s ownership of the asset).

Penalties for breaching SMSF rules

The following table outlines the courses of action available to the ATO to deal with SMSF non-compliance.

Course of action Description
Education direction Require the individual trustees or directors of a corporate trustee to undertake an education course to improve their SMSF knowledge and skills.
Enforceable undertaking The SMSF trustee proposes a solution to the ATO to rectify the breach and prevent it from recurring. The ATO chooses whether to accept the undertaking.
Rectification direction The ATO specifies what action must be undertaken to rectify the contravention and prevent it from recurring.
Administrative penalties Impose a financial penalty on the corporate trustee, or in the case of individual trustees, on each individual trustee. These penalties are not tax deductible and cannot be paid for from fund assets. For example, the penalty for a contravention of lending to members and relatives, or the in-house assets is $13,320 (60 penalty units at $222 per penalty unit).
Disqualification of a trustee Disqualify an individual from acting as a trustee or director of a corporate trustee. This will also prevent the individual from being a member of the SMSF as all members of a fund must either be an individual trustee or director of a corporate trustee.
Civil and criminal penalties Apply to the courts to impose civil or criminal penalties.
Notice of non-compliance Issue a notice of non-compliance to the SMSF. In the year that an SMSF becomes non-compliant, the market value of the fund’s total assets, less any contributions the fund received that were not part of the taxable income of the fund, are taxed at 45%. For every year that the fund remains non-complying, the income of the SMSF will be taxed at 45%.
Freezing an SMSF’s assets Issue a notice to a trustee or investment manager to freeze the assets of the SMSF.

Avenues to check a transaction or arrangement prior to implementation

If an SMSF trustee is unsure whether a transaction or arrangement will breach the rules, the trustee could consult their SMSF specialist adviser, their SMSF auditor, apply for an SMSF specific advice or apply for an ATO private binding ruling prior to implementing the arrangement. Checking the arrangement upfront will significantly reduce the risk of a contravention and may provide certain benefits or protection.

An SMSF auditor is responsible for ensuring that the SMSF complies with super rules. They are responsible for identifying and reporting any contraventions to the ATO.

An SMSF specific advice service is provided by the ATO and outlines how super law applies to a particular SMSF transaction or arrangement. SMSF specific advice can be provided for:

  • investment rules including:
    • an investment by an SMSF in a company or unit trust
    • acquisition of assets from related parties
    • borrowing and charges
    • in-house assets
    • business real property
  • in-specie contributions/payments
  • payment of benefits under a condition of release.

SMSF specific advice cannot relate to the complying status of an SMSF, trustee covenants or the residency status of an SMSF.

However, SMSF specific advice is not binding on the ATO. If the ATO later determines that the law applies less favourably, where all relevant facts were fully disclosed by the SMSF, acting in accordance with the SMSF specific advice would be looked at favourably by the ATO when deciding what compliance action, if any, will be applied.

A private binding ruling is provided by the ATO and outlines how tax law applies to a particular SMSF transaction or arrangement. For example, you would apply for a private binding ruling for the residency status of your SMSF. A private binding ruling is binding on the ATO. If the private ruling is later found to be incorrect, the ATO can only apply the law correctly if this will provide a more favourable outcome for the SMSF.

The ATO aims to provide an SMSF specific advice or private binding ruling within 28 days, complex matters may take longer. Consider sufficient lead time for any transaction or arrangement subject to time pressure.

Summary

Consistently, the same three contraventions contribute to 50% of all SMSF contraventions. Understanding restrictions on providing loans or financial assistance to members, in-house assets and the requirement to keep SMSF assets separate will go a long way from keeping an SMSF from being a statistic.

If in doubt as to whether a particular transaction or arrangement contravenes the law, seek appropriate guidance prior to implementation. It reduces the risk of a contravention and may provide certain benefits or protection. 


More information

If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.

Disclaimer
The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.