SMSF lending money to a related party - why the structure of the related party is crucial | Accurium

Lending

For several years, breaching the in-house asset rules and the prohibition on lending to a member or a relative of a member or providing financial assistance to a member or their relative using the financial resources of the fund, have consistently been in the top three audit contraventions. They are also contraventions that carry the most SMSF administrative penalty points, being 60 penalty points, a potential monetary fine of $13,3201 per trustee.

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An aspect of these two rules, that can be commonly misunderstood, is how they interact with each other. Whilst the in-house asset rules effectively provide a 5% allowance for a loan from an SMSF to a related party, where that related party is an individual, for example a sole trader or an individual partner in a partnership, section 65 of the SIS Act3 will also apply. Section 65(1)(a) SIS Act prohibits a fund from providing a loan to a member or relative of a member. Unlike the in-house asset rules, there is no 5% market value ratio calculation allowance for section 65.

Let’s consider the following scenario……

A client calls your office and asks the following question:

“Hi, there, just checking that my SMSF can lend up to 5% of the value of assets to my business?”

In this scenario, if the loan from the SMSF to the related party’s business did not result in the market value ratio (MVR) of the fund’s in-house asset exceeding 5% at the time of making the loan, it would not breach the in-house rules. Further, the 30 June MVR will also be required to not exceed 5%.

However, if the related party’s business was structured as a sole trader, or a partnership where a partner was an individual who was a member of the SMSF or a relative of a member of the SMSF, it would be a breach of section 65(1)(b) SIS Act. So, you would have an outcome of no breach of the in-house asset rules, but a breach of the prohibition on lending to a member or a member’s relative. The breach of section 65, as noted above, can still cost the SMSF trustee(s) an administrative penalty of 60 penalty points.

TIP: It’s always important to know the structure of the related party to ascertain if section 65 applies, in addition to considering the in-house asset rules.
 
Do not forget the sole purpose test!
 
Whilst this article has focused on the interaction of the in-house asset rules and prohibition on lending to a member or their relative, the sole purpose test should also be considered. The sole purpose test is to be complied with at all times and needs to be considered with all fund transactions.
 
In the scenario where the SMSF lends money to a related party and the related party is structured as an entity, for example, a company, the focus may solely be on ensuring the loan does not exceed 5%, both at the time of making the loan and at each 30 June. Whilst the prohibition on lending to a member or relative under section 65 SIS Act may not apply, the SMSF trustee will need to think about how they can evidence that the making of the loan to a related party complies with the sole purpose test under section 62. For further reading on the sole purpose test, refer to the ATO’s ruling SMSFR 2008/2.
 
1 From 1 July 2020 a penalty point is $222 - s.4AA Crimes Act 1914
2 Self-managed super funds: A statistical overview 2017-18; Table 18 Contraventions reported to the ATO by type
3 Superannuation (Industry) Supervision Act 1993

 


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