When SMSFs and SMEs get too close: eight traps to avoid

Almost 60% of reported contraventions by self-managed super funds involve illegal related-party transactions between a fund and its members, their families or their related entities.

Another 25% of reported contraventions involve a failure by SMSF trustees to separate super fund money from their personal or business assets.

Approved super fund auditors have reported these serious contraventions to the Australian Tax Office in its role as regulator of self-managed super.

Leading superannuation specialists have told SmartCompany SMSF trustees who own SMEs are particularly vulnerable to becoming involved in illegal related-party transactions including the use of super money to prop-up businesses experiencing financial difficulties.

Peter Crump, superannuation strategist for ipac South Australia, says some SME owners may have a genuine but ill-founded confidence that their troubled enterprise will recover – and then dip into SMSF assets to keep trading. In practice, an independent, arm’s-length investor might have decided there was a high risk that the business would fail, he emphasises.

Chris Malkin, senior consultant auditor with Baumgartner Superannuation, estimates approximately 5% of the SMSFs he audits each year have conducted dealings with the members’ SMEs that may breach superannuation law. Malkin is one of Australia’s most-experienced SMSF auditors.

Reported contraventions over the 10 years to June 2014 in terms of dollar value involved: exceeding the in-house asset limit (28.8%), failing to separate superannuation assets (25.4%), making loans to members or providing financial assistance (15%), borrowing from an SMSF (7.4%), failing to making investment on an arm’s length basis (7.5%), failing the sole-purpose test for super savings, which is to provide for members’ retirement (4.9%), and acquiring unauthorised assets from related parties (2.4%). The remaining contraventions mainly involved operating standards and administrative matters.

Approved auditors are required to notify the tax office, as SMSF regulator, of non-compliance that may affect the interests of members and beneficiaries. Further, auditors must report repeated breaches from a lengthy list that is dominated by related-party transactions. These are the transactions viewed by the ATO as most serious.

Superannuation specialists say the points SME owners should closely watch in regard to their SMSFs and their personal/business affairs include:

1. Don’t use super fund assets to finance your pre-retirement lifestyle or to prop-up your business

A super fund must be maintained for the sole or core purpose of providing retirement or death benefits to members.

Peter Crump, superannuation strategist for ipac, warns using SMSF money in an attempt to save a financially-troubled business owned by members’ may involve “chasing good money after bad” –apart from potentially severe financial penalties for any serious breaches of superannuation law.

“You could be doubly financially hit,” Crump adds. “It isn’t worth it.”

He suggests taking professional advice about other financing options for your business – if it is still viable.

2. Don’t arrange for your fund to provide personal finance help to members

SMSF trustees are barred from providing loans or financial assistance to members or their relatives – even under commercial terms. This prohibition includes going guarantor for loans to members and their relatives. Even a relatively small concession that applies to related entities (see point four below) does not apply for loans to members.

3. Don’t ignore the in-house asset rule

Under the “in-house asset rule” in superannuation law, SMSFs are generally prohibited from making loans, providing leases or having investments with related parties and entities that exceed 5% of its total asset value. (Certain exceptions apply. See point six below.)

4. Understand the limits on lending by an SMSF to related trusts and companies owned by members, their partners or their relatives

Under the in-house asset rule, as discussed, anSMSF is forbidden from making loans, providing leases or having investments with related entitles that exceed 5% of its total asset value. Compliance with this provision means dealings between the members’ businesses and their SMSFs must be extremely limited.

5. Conduct your fund’s dealings with related parties on an arm’s length basis

Transactions with related parties – when allowed under the in-house asset rule and other restrictions – must be on a strictly commercial basis.

6. Take extreme care when acquiring assets from members

SMSFs are prohibited from acquiring most types of assets from members or other related parties (including a member’s business). The main limited exceptions to this ban are listed assets and business real estate – obtained at market value. Other exceptions are assets from related parties within the five per cent under in-house asset rule, discussed earlier.

7. Watch out for conflicts of interest when your SMSF is also your business’s landlord

SMSFs are allowed to rent fund-owned business premises to their members’ businesses – without being restricted under the in-house asset rule. This is an exception to the in-house asset rule. Again, the arrangement must be on a strictly arm’s length basis.

Potential conflicts of interest may arise if the members’ business is struggling to pay the rent to its landlord, their SMSF.

“Your first duty is an SMSF trustee is the well-being of your fund, not to your business” says Crump. Your legal obligation is to enforce the lease even though your business is your fund’s tenant.

8. Begin to rectify contraventions as soon as possible

Chris Malkin of Baumgartner Superannuation suggests that SMSF trustees who realise before June 30 they have breached superannuation law should begin to rectify the problem even before an SMSF auditor starts the compulsory annual auditing of their fund.

“You will have taken the initiative to fix the breach,” says Malkin.

“I think the tax office will look more favourably on trustees.”

Malkin urges trustees who have contravened superannuation law to take professional advice about what action they should take.