Providing financial assistance to members is one of the most common breaches SMSFs make, and understandably so; it’s tempting to want to dip into the retirement honey pot if you find yourself in a situation where you’re strapped for cash and you have all this money sitting in super.
But breaking the law is not a wise financial choice.
Super legislation prohibits a self managed super fund (SMSF) trustee or investment manager from lending money to members of the SMSF or their relatives, or giving them any other financial assistance using the resources of the SMSF.
The rationale for this centres on the sole purpose test, which requires the trustees to ensure that the fund is maintained solely for core purposes, such as benefits to members upon retirement, and certain, other ancillary purposes. Lending money or providing financial assistance to members and their relatives contradicts this fundamental objective of super funds.
To understand the extent to which this rule relates, the following terms need to be understood.
Who is a relative?
Unlike certain other provisions within super legislation that apply to the all-encompassing term ‘related party’, the financial assistance prohibition is limited to members and their relatives. A relative is defined as a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the individual or their spouse, and a spouse of any of these individuals. Therefore the definition of relative is confined to a natural person, and does not include companies or trusts.
However, further rulings by the ATO have indicated this prohibition may still apply where financial assistance is provided to a member or a relative through a third party or interposed entity. For example, where an SMSF loans money to a company which then loans the money to the SMSF member.
What is financial assistance?
Whilst financial assistance is not defined in super legislation, it extends beyond the provision of loans and other kinds of money or property. It includes giving a guarantee, indemnity, security or charge, or assuming an obligation that is financial in nature to assist a member or relative using the resources of the SMSF.
The following examples are considered financial assistance in the context of this provision:
- Gifting an SMSF asset to a member or their relative.
- Selling an SMSF asset for less than its market value to a member or their relative.
- Purchasing an asset for greater than its market value from a member or their relative.
- Acquiring services from a member or their relative in excess of what the SMSF requires, or paying an inflated price for their services.
- Forgiving a debt owed to the SMSF by a member or their relative, or releasing them from a financial obligation owed to the SMSF, including where the amount is not yet due and payable.
- Delaying recovery action for a debt owed to the SMSF by a member or their relative.
- Satisfying or taking on a financial obligation of a member or their relative.
- Giving a guarantee or indemnity for the benefit of a member or their relative.
- Giving a security or charge over SMSF assets for the benefit of a member or their relative.
With a vast array of examples of where financial assistance is provided, the context and substance of the arrangement will determine whether this provision has been breached. Factors include whether the arrangement:
- exposes the SMSF to a credit or financial risk;
- is on non-arm’s length terms that are favourable to the member or their relative;
- is inconsistent with the SMSF’s investment strategy;
- is not a usual or commercial arrangement in the context of which SMSFs operate;
- equates to a loan with or without an interest component; or
- results in the decrease of assets of the SMSF either immediately or over time.
The next hurdle
Once it has been determined that an arrangement or transaction satisfies this provision, trustees or investment managers must consider the application of other provisions within super legislation. These include:
- the sole purpose test
- investment strategy requirements
- acquiring assets from a related party restriction
- in-house assets
- arms-length requirements
For example, an SMSF may loan money to a company which is a related party of the SMSF. Whilst this transaction is not a loan to a relative and is therefore not prohibited within this provision, it will fall within the in-house asset restriction which limits the loan to a related party to no more than 5% of the total assets of the SMSF. Further, the loan must be on arms-length terms, be consistent with the SMSF’s investment strategy and satisfy the sole purpose test.
It is therefore imperative that each transaction performed by the SMSF is considered within the context of the entire super legislation, and not just individual provisions.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.