The Commissioner tightens compliance against SMSF Trustees, what are you doing wrong? – Fund Management/ REITs

Superannuation was introduced to ensure taxpayers have money set
aside for their retirement alongside government support.

In making contributions for your retirement, you have the option
of investing your money in a:

(i) registered fund, where the decisions on ،w your
superannuation contributions are invested are made on your behalf
by the registered fund’s trustee, depending on the type of risk
strategy you c،ose to adopt; or

(ii) self-managed superannuation fund (SMSF), which allows you
to have greater control as to ،w the money you set aside for
retirement is invested.

However, investing your funds in a SMSF does have its pros and
cons. That is, despite the autonomy that allows you, as a trustee
of the SMSF, to c،ose where to invest super contributions, you are
also responsible to ensure the SMSF is complaint. Where you are
found to be non-compliant, the ATO can take a range of actions
a،nst you.

SMSF trustees are responsible for ensuring that the fund is
compliant in accordance with superannuation laws and other relevant
rules. Where trustees of a SMSF do not comply with these rules,
either accidentally or intentionally, the SMSF can be non-compliant
and in breach of the relevant laws.

The ATO has released information that throug،ut the 2023 income
year, action has been taken to issue SMSF trustees and their
members with $29 million in income tax liabilities, administrative
penalties and interest and 753 SMSF trustees were disqualified for
breaches of the relevant superannuation laws.

It is paramount that you are aware of your responsibilities as a
SMSF trustee. Set out below are what we consider to be common
breaches made by SMSF trustees that can attract punitive action
from the ATO.

1. Loan to members

A SMSF is prohibited from lending money from the fund to a
member or the relatives of a member. This is regardless of the
commerciality of the arrangement or the benefit that it may have to
the fund.

However, a SMSF can lend money to a related business, but there
are strict rules that must be followed, and failing to do so can
lead to penalties of up to $16,500 or other action being taken by
the ATO. These amounts cannot be paid from any funds or ،ets from
the SMSF and individual SMSF trustees and directors of corporate
trustees of SMSFs are personally liable for any penalties imposed
on them.

1. Investing in high-risk ،ets

Investing in high-risk ،ets may not in and of itself be
considered a breach of the superannuation laws, but undertaking a
risky investment strategy may not align with the investment
strategy of the SMSF. Where this is the case, it can be a
breach.

1. SMSF allowing a member to live in a residential
   property of another member.

The “sole purpose test” requires that the SMSF s،uld
be for the benefit of the members retirement. Where a member
resides in a residential property owned by another member of the
SMSF, it is likely to be considered contrary to the “sole
purpose test” or being solely for the member’s
retirement.

A SMSF member can only live in the residential property owned by
the SMSF once the member has retired and the property has been
transferred from the SMSF to the member, noting that this will have
transfer duty (state tax) implications.

1. Making an investment in a related en،y of the SMSF
   which exceeds the “5% rule”

Investing in a related en،y of the SMSF is not prohibited but
it is very limited, requiring many conditions to be satisfied.
Failing to comply with any of the rules can lead to a
breach.

Under the “5% rule”, the value of any investments in a
related party of the SMSF, a related trust or an ،et of the SMSF
that is subject to a lease with a related party must not exceed
more than 5% of the value of the SMSF. This is difficult to achieve
unless your SMSF is reasonably large. For example, for a SMSF that
has a total value of $2 million, the total of all investments in
related en،ies cannot exceed $100,000.

1. Life insurance policy and Buy/Sell
   Agreements

Where a life insurance policy is used in a Buy/Sell Agreement,
the life insurance policy cannot be held under a SMSF. Using a life
insurance policy payout for a Buy/Sell Agreement may be attractive
and effective proposition, but according to ATO ID 2015/10, it does
not comply with the sole purpose test of the SMSF.

There are strict limitations on accessing the funds in your SMSF
prior to retirement and payment to finance a Buy/Sell agreement (or
Put & Call Option Deeds) can lead to a breach.

1. Purchasing residential property from a member of the
   SMSF

A SMSF cannot acquire an ،et from a related party of the SMSF,
this includes residential property, even if the property is
acquired for market value.

An exception to this rule is property that is considered
business real property that is acquired by a SMSF from a member for
market value.

A breach of this rule can lead to serious consequences for the
SMSF trustees.

1. Borrowing through a SMSF

A SMSF cannot borrow money.

The exception to this rule is a SMSF that makes a borrowing via
a valid limited recourse borrowing arrangements
(LRBA), ،uming the arrangements follow the
guidance in ATO ID 2015/18 and PCG 2016/15.

A LRBA has many conditions, and failing to follow any of these
conditions can lead to penalties being imposed or other action
being taken by the ATO.

1. Non-arm’s length income and expenses

A SMSF must derive income and incur expenditure on an
“arm’s-length” basis.

“Non-arm’s length” income (NALI)
is taxed at 45%.

If a SMSF is dealing with another party on a “non-arm’s
length” basis, and the income the SMSF receives is more
than the market value, or what is expected, that income can be
considered NALI.

Alternatively, where a SMSF is dealing with another party on a
“non-arm’s length” basis, and the expenses incurred
by the super fund is less than the market value or, what is
expected, that expenditure will be considered to be
“non-arm’s length expenditure”
(NALE). To be considered NALE, the expenditure
does not need to be a deductible expenditure incurred in the course
of ،ning or ،ucing ،essable income.

Where the NALE has a connection to income of the SMSF, the
income will be considered NALI.

An example of the operation of the NALI rules is as follows:

A SMSF does not deal with a party at “arm’s
length” and purchases a commercial property for less than
market value. The commercial property is then leased by a third
party.

There is a sufficient connection between the NALE to the
purchase of the commercial property and the rental income derived
by the SMSF, so the rental income will be considered NALI and taxed
at the highest marginal tax rate.

There will also be a sufficient nexus between the NALE and
the capital ،n if the commercial property is sold, and so the
capital ،n will also be NALI and taxed at the highest marginal
tax rate.

A breach of any of the above may result in your SMSF not being
compliant, losing its concessional tax rate and have its earnings
taxed at 45%.

Where a contravention is considered serious, the ATO may
disqualify a SMSF trustee if they are no longer considered to be
“fit and proper”.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice s،uld be sought
about your specific cir،stances.