SMSF rules in relation to helping out relatives

Since an SMSF is meant to benefit its members, it can be tempting to think that anything the fund does to assist members – such as extending a loan to their children for buying a house, for example – is okay provided it is properly documented and a commercial rate of investment return is achieved. But this is not the case.

This kind of financial assistance to a relative is strictly prohibited. It also counts as an ‘in-house asset’, which may not exceed 5% of the total market value of the fund’s assets.

Definition of an in-house asset

An in-house asset is a loan to, a lease with, or an investment in, a related party of an SMSF.

Here are some examples of an in-house asset:

• Making a loan to a member’s relative (strictly prohibited)

• Buying residential property and leasing it to a member’s relative

• Purchasing equipment and leasing it to a business wholly or partly controlled by a member

There are two tests to be met for this kind of financial activity by an SMSF. Firstly, is it an arm’s length and commercially viable transaction which will benefit the fund’s members (e.g. using market interest rates or rental amounts)? Secondly, is the total value of in-house assets no more than 5% of the fund’s total assets?

The only exception to this 5% rule is ‘business real property’. An SMSF can buy the premises of a business controlled by a member and lease them back to the business, even though the building represents far more than 5% of the fund’s assets.

Who or what is a related party?

Related parties include not only the fund’s members and their relatives (spouse, child, grandchild, parent, grandparent, brother, sister, uncle, aunt, nephew, niece), but also companies and trusts owned or controlled by members, and the members’ fellow directors or trustees.

Other prohibited related party transactions

There are other kinds of assistance to a related party which would fall foul of the rules governing an SMSF.

A gift, or interest-free or rent-free loan of cash or other assets to a member or related party would of course fail to meet both tests: the sole purpose test of providing retirement benefits and the arm’s length test. It would be a present-day benefit, not a retirement benefit, and there would be no commercial rate of return on the investment.

An SMSF is not allowed to purchase residential property from a related party, nor is it allowed to buy, sell or lease any asset for more or less than its market value.

The fund’s assets may not be used as security (to guarantee a loan to a related party, for example).

Collectables and other assets for personal use (such as artworks, jewellery, cars, boats and wine) cannot be leased to or used by a related party, or stored or displayed in a related party’s home.

This is not an exhaustive list of rules. The definitions are complex and the penalties for non-compliance are severe. Trustees should seek professional advice if they are planning to use an SMSF’s assets in any way (other than retirement benefits) which is  connected with a person or legal entity which could be considered related.

If you have questions relating to SMSFs please contact us on 02 4342 4578.

Important

This provides general information and hasn’t taken your circumstances into account.  It’s important to consider your particular circumstances before deciding what’s right for you. Any information provided by the author detailed above is separate and external to our business and our Licensee. Neither our business, nor our Licensee take any responsibility for their action or any service they provide.