Trustees could apply a straightforward rule of thumb to related-party transactions to avoid any compliance issues as many had been found trying to manipulate the legislation, according to an SMSF auditor.
“Prior to undertaking any related-party transaction, SMSF trustees should ask themselves: ‘Could I enter into this type of arrangement with a stranger?’” SuperAuditors director Shelley Banton said.
“If the answer is no, then the likelihood of the transaction being compliant with section 109 of the Superannuation Industry (Supervision) (SIS) Act is highly doubtful.
“Making sure your SMSF clients stay on the right side of the legislation is critical and you need to tread carefully to make sure they don’t start any SMSF fires because manipulating the in-house asset rules means they’re going to get burned. Badly.”
The in-house asset rules, along with all SIS rules, were in place to stop SMSF trustees receiving a benefit from their SMSFs before they retired, but although the definition of an in-house asset appeared to be straightforward, the legislation surrounding in-house assets was anything but simple, Banton said.
“It contains a complex set of rules, which explain a myriad of situations and circumstances, such as investment exceptions, transitional arrangements for pre-11 August 1999 unit trusts and what happens in the cause of a relationship breakdown,” she explained.
“Specific investment exceptions allowed under the rules is an SMSF investing in a related company or unit trust that meets the requirements of Superannuation Industry (Supervision) Regulations 13.22C, or 13.22B if the investment is pre-28 June 2000.
“Although any non-permitted asset, such as shares in a related company, can be acquired, the SMSF can’t exceed the 5 per cent permitted level of in-house assets to remain compliant.
“Providing the acquisition is done at market value, this exception applies to all assets across the board.”
Further, she revealed some “savvy” SMSF trustees were scrutinising the in-house assets rule and starting to “play around the edges” of the 5 per cent limit.
“Here’s where the fire starts: SMSF trustees are exploiting the 5 per cent rule by using fund assets during the year, then ensuring in-house asset levels are just under the 5 per cent limit at the end of the financial year,” she said.
“A real-life example of this manipulation is where SMSF trustees dip into retirement savings to prop up their cash-strapped businesses during the year.
“Booked as a loan in the fund’s financials, the loan is then paid down to just under the 5 per cent in-house asset limit prior to the end of the financial year.
“To make matters worse, these ‘loans’ are then hidden as investment loans in the balance sheets of their own companies.”
She warned the ATO was now laying down the full force of the law and taking action against those trustees, including administrative penalties of $10,000, ordering the fund assets be returned and also winding up funds.
In those instances, the trustees forgot one of the most importance rules, the prohibition of avoidance schemes under section 85 of the SIS Act, she said.
“Section 85 specifically prohibits SMSF trustees from participating in schemes that artificially reduce the value of in-house assets to avoid in-house asset contraventions,” she explained.
“Trustees should be aware that other contraventions can also get caught in the in-house asset net, such as the sole purpose test under section 62 and the arm’s-length rule under section 109, both of which come with their own set of administrative penalties.”