SMSFs that are using related-party transactions need to provide as many details as possible to avoid failing an audit, according to an audit provider, who warned not doing so may lead to a contravention report being filed against the fund.
ASF Audits technical services executive manager Shelley Banton said related-party transactions are usually rated as high risk, meaning the asset, and any transactions related to it, will always be audited.
“Trying to identify related-party transactions in an SMSF can seem like pulling apart a set of Russian dolls: the first entity links to another entity, which, in turn, has another entity inside of it and so on. The question is: how far do you continue searching to ensure that no related parties exist?” Banton said.
She pointed out that when any search for a potentially related company reveals a group of shareholders that are also companies or trustees for unit trusts, further searches have to be undertaken for each of those entities and can continue in each instance where a shareholder is a company.
“The more information provided upfront will result in fewer queries and a more efficient audit — a win for everyone,” she added.
She highlighted three rules to keep funds compliant when dealing with assets from related parties, related-party income and non-arm’s-length income (NALI).
“The first one is to provide annual market valuation documentation demonstrating that all transactions are booked at current market value to comply with regulation 8.02B of the Superannuation Industry (Supervision) Act,” she said, adding the ATO recommends the use of an independent valuer if the asset represents a significant proportion of the fund’s value.
The second rule, according to Banton, was to ensure all related-party income is being paid at market rates, adding “SMSF auditors are required to strap their professional scepticism hats on at the beginning of every engagement” related to these arrangements.
“When there’s a related-party transaction either in the fund or in a related unit trust, the auditor will look at the investment in a different light,” she said.
“They will start by questioning whether the rent is being paid at market value and whether the terms of the lease are conducted at arm’s length. It’s best that an independent rental assessment is provided to confirm the rent is at market rates at the time of submitting the audit to avoid delays.”
The third rule was to ensure transactions are undertaken on an arm’s-length basis, with Banton highlighting that failing to do so increased the tax payable by an SMSF.
“NALI is taxed at the highest marginal rate and applies regardless of whether the fund is in pension mode. Most importantly, it includes all of the income generated from the asset since the day of acquisition. Ouch,” she said.
According to the ATO, during the 2018 financial year it received 16,909 regulatory contraventions for 8215 SMSFs. The most common contraventions were related-party loans, loans to members, in-house assets, investing in related-party assets and separation of assets where members are not keeping their personal assets separate from the assets of the SMSF.