Generally, a self managed superannuation fund (SMSF) cannot run a business. However, a SMSF may be able to invest in an entity that carries on a business. There are a number of factors that a SMSF trustee should consider before making a decision to invest in a private entity that carries on a business. In this factsheet, solicitor Hannah Byrne looks at the key issues that SMSF trustees should consider when it comes to investing in a private business, as well as the restrictions that may prevent particular investments from being made.
There are a number of initial considerations that a SMSF trustee should take into account before making any investment decisions:
- Trust deed: The SMSF’s trust deed must give the trustee broad investment powers, and the trustee of the SMSF must ensure that it complies with the provisions of the trust deed when making any investments.
- Investment strategy: SMSFs must have a written investment strategy in place. The investment strategy provides the trustee with a framework for making investment decisions to increase members' benefits for their retirement. The trustee of the SMSF must ensure that any investments it makes are in accordance with its written investment strategy.
- Sole purpose test: The sole purpose test requires the trustee of a superannuation fund to ensure that the fund is maintained for certain core and ancillary purposes, which include providing retirement benefits to members or death benefits to members’ dependants. Therefore, any investment needs to be made with the intention that it will appreciate in value or receive ongoing income to provide for the retirement or death of a member.
- Carrying on a business: The Australian Taxation Office has indicated that if a superannuation fund is conducting a business, then it is not being administered for the sole purpose of providing benefits for members and beneficiaries of the fund (that is, it is not complying with the sole purpose test). However, the ATO has also stated that the usual investment activities of a trustee will not constitute the carrying on of a business.
- Arm’s length rules: Investments must be made and maintained on an arm’s length basis. Trustees of SMSFs must ensure that they document and maintain all investments on arm’s length terms.
Restrictions on acquisitions from a related party
SMSF trustees are prohibited from intentionally acquiring an asset from a ‘related party’ of the fund under the Superannuation Industry (Supervision) Act 1993. However, there are certain exceptions to this rule - for example, if:
- the asset is a listed security (eg shares, units or bonds listed on an approved stock exchange) acquired at market value;
- the asset is ‘business real property’ of the related party acquired at market value;
- the asset acquired would otherwise be an in-house asset, so long as the asset is acquired at market value and the acquisition would not cause the fund to breach the in-house asset limit; or
- the asset is an asset which the ATO determines, in writing, may be acquired by the fund.
There are two important issues that arise from this restriction - firstly, who is considered to be a ‘related party’ of the fund, and secondly, what is ‘business real property’?
The term 'related party' is defined as any of the following:
- A member of the fund
- A standard employer-sponsor of the fund
- A ‘Part 8 associate’ of a member or standard employer-sponsor
A ‘Part 8 associate’ of an individual can include:
- relatives of that individual;
- members of the same SMSF, or if the SMSF is a single member SMSF whose trustee is a company, each director of the company, or if the fund is a single member SMSF whose trustees are individuals, those individuals;
- a trustee of a trust where the individual controls that trust (an individual can control a trust where they have a fixed entitlement to more than 50 percent of the income or capital, or where the trustee is under an obligation to act in accordance with the individual’s directions, or where the individual is able to appoint or remove the trustee); and
- a company that is sufficiently influenced by, or in which a majority voting interest is held by, the individual, a Part 8 associate of the individual, or two or more of these entities. For the full list of ‘Part 8 associates’, please refer to section 70B of the Superannuation Industry (Supervision) Act.
‘Business real property’ is any freehold or leasehold interest in real property where the real property is used wholly and exclusively in one or more businesses.
Accordingly, the trustee of a SMSF will contravene superannuation law if it intentionally acquires an asset from a related party and the asset does not fall within one of the exceptions outlined above. However, if the asset does fall within one of the exceptions listed above, then the fund can acquire the asset provided:
- the acquisition is made at market value; and
- if the asset is an in-house asset, that acquisition wouldn’t result in the level of in-house assets in the fund being greater than five percent.
In-house asset rules
The Act provides that a superannuation fund must ensure that the total value of any in-house assets of the fund do not exceed five percent of the value of the fund.
An in-house asset is any of the following:
- A ‘loan’ to a related party
- An ‘investment in’ a related party
- An asset of the fund that is subject to a lease or lease arrangement between the trustee of the fund and a related party
The traditional definition of ‘loan’ has been expanded to include not only an arrangement involving the payment and repayment of money, but also the sale of goods or land on credit, instalment payment arrangements, arrangements for the deferral of payment of debts or entitlements, and arrangements where there is no objective purpose of gaining interest, income or profit (eg an interest free loan).
‘Investment in’ a related party will occur where a SMSF provides money or assets to a related party for the purpose of receiving income, interest or profit.
Can a SMSF invest in a private entity that carries on a business?
It is possible for a SMSF trustee to acquire shares in a private entity that carries on a business. The SMSF trustee could even acquire shares in a private entity from a member of the SMSF. However, the SMSF trustee, before making this investment, would need to ensure that it complies with the restrictions on related party acquisitions and that it will not breach the in-house asset restrictions.
For example, the SMSF trustee could acquire, from a member of the SMSF, shares in a private company that is a related party of the SMSF, provided that the shares are acquired at market value and do not exceed the five percent permitted level for in-house assets (because this is one of the exceptions to the related party restrictions listed above). The SMSF trustee would need to be vigilant of the in-house asset limit to ensure that the value of the shares in the private entity does not exceed the five percent limit.
Before considering this type of investment, the SMSF trustee should also consider the taxation consequences of investing in a private entity. A dividend that is paid by a private company to a complying superannuation fund is non-arm’s length income, and is subject to income tax at 45 percent (instead of the usual 15 percent). The Commissioner can deem the dividend not to be non-arm’s length income having regard to the matters listed in section 295-550 of the Income Tax Assessment Act 1997 (Cth).
There is considerable scope for SMSF trustees to invest in a wide range of entities (including a private entity that carries on a business), but there are also many complexities and restrictions that SMSF trustees must be aware of before making any investment decisions.
It is very common for SMSF trustees to be approached to help fund a new business concept. SMSF trustees need to not only look at the commercial side of these proposals, but must also have one eye on their regulatory and tax obligations to ensure that any investments made comply with the various restrictions listed above.
For more information on self managed superannuation fund investments, please contact HopgoodGanim’s Taxation and Revenue team.