Arms Length Rule
Along with the flexibility of managing your own superannuation comes a greater responsibility to act in the best interests of the SMSF, over and above the interests of other parties with whom the SMSF may deal.
Members of an SMSF are typically the same individuals that manage the investments and ongoing administration of the fund. There is therefore an increased likelihood that an advantage or benefit may be provided to a related party, which is not appropriate in the superannuation environment, either inadvertently or wilfully.
In order to comply with the objectives of the Superannuation Industry Supervision Act 1993 (SIS Act) and prevent the abuse of the superannuation system concessions, all transactions in an SMSF must be conducted on an arm’s length rule (commercial) basis.
Understandably there may be many transactions which are not conducted ‘at arm’s length’ due to the close relationship the fund’s members will share with the trustee/s of the fund and the ability of the fund to have dealings with related parties (in some circumstances). Regardless of this non-arm’s length relationship, all dealings must be conducted in the same way as if both parties were actually unrelated and operating in a normal commercial relationship.
It is essential when a transaction occurs between the fund and another party, that “the terms and conditions of the transaction are no more favourable to the other party than those which it is reasonable to expect would apply if the trustee or investment manager, as the case may be, were dealing with the other party at arm’s length in the same circumstances” (Section 109(1)(b) SIS Act 1993).
Of particular note:
Purchases and sales of the assets of an SMSF should always be conducted at the appropriate market value.
Income from assets owned by the fund should always be indicative of the ‘going rate’ in an open market and should also be paid in a timely manner.
Where the SMSF is disadvantaged in any way, it is expected that appropriate action will be taken to protect the interests of the fund.
Conversely, transactions in the fund could potentially be biased toward the SMSF, resulting in the undermining of various superannuation policies, such as the imposition of contribution caps, and leading to the income of the fund being treated as non-arm’s length income (previously known as special income) and taxed at 45%. It is therefore important to ensure that the income received by your SMSF is not more than would be expected under a normal commercial arrangement.
The penalties for contravention of the arms length rule include civil and criminal charges, so it is well worth discussing your situation with your accountant or lawyer if you are in any doubt regarding this requirement.
Regulations exist to prevent the use of an SMSF to provide benefits to a member or related parties. Without these rules trustees may choose to use their superannuation entitlement to support their business, personal investments and their immediate wellbeing. Whether it is considered a prudent investment decision for the fund makes no difference. This concept is caught by the ‘In-house asset’ rules.
An in-house asset in simple terms is a loan to or an investment in a related party of the super fund. The definition also includes any asset which is subject to a lease between the trustee and a related party of the fund. In other words you cannot purchase a residential property or holiday home and then rent it to yourself or a relative even if commercial rent is being paid.
The term ‘related party’ is also very broad. It includes – relatives, business partners, companies controlled, and related unit trusts of the members and the standard employer sponsor, and any companies controlled by business partners or relatives of a member or the employer sponsor!
Like most legislation these definitions are subject to certain exclusions some of these include business real property (property that is being used as part of a business). In other words your SMSF can own the property you operate your business from providing it is leased at arms length and your business is paying the SMSF commercial rent.
Trustees should ensure that they are aware of these rules and if in any doubt seek advice before the transaction is entered into. Breaching the in-house asset rules can have serious consequences on the fund and can be very costly and difficult to unwind.
Separation of Assets
As a trustee it is important to ensure that all assets of your superfund are kept completely separate from your personal assets. This not only is a legislative requirement but it will also protect the assets which are held in the fund from financial disputes, particularly in the event of relationship breakdown and against potential creditors. By ensuring assets are kept separate removes any risk that the assets will be used for private purposes and it will be easy for the auditor of the fund to verify asset ownership. As such the fund will require its own bank account in the name of the trustees ATF the super fund. All income of the fund needs to be received and all payments should be made out of this account. In addition if the fund is trading shares it will also require its own share trading account in the name of the superfund too.
It should also be noted that the assets of the SMSF (such as a property) cannot be used as collateral when borrowing money for private or business purposes.
Trustees who do not comply with the separation of asset rules face being reported to the ATO for a compliance breach which can result in substantial penalties.
This information is provided by SuperGuardian Pty Ltd, AFSL No. 485643. The information is general information only and does not take into account your objectives, financial situation or needs. You should obtain professional advice before acting on any of this information. Please refer to SuperGuardian’s FSG (available at https:// www.superguardian.com.au/pdfs/Financial-Services-Guide.pdf) for contact information and information about any remuneration and associations with product issuers.