Who is a related party?
The definition of a “Related Party” under s.10 of the Superannuation Industry (Supervision) Act 1993 (“SISA”) is very broad and includes:
- Members of the Self-Managed Superannuation Fund (“SMSF”);
- Relatives of members of the SMSF;
- Any business associates of the SMSF members and their relatives;
- A partner in a partnership business, including the spouse and children of the partner;
- An associate of a partner in a partnership business;
- A company where the members and/or their relatives in relation to the company have more than fifty per cent (50%) of the shares and voting rights of the company; and
- A trust where the members and/or their relatives in relation to the trust control the trust or have a fixed entitlement to more than fifty per cent (50%) of the capital or income of the trust.
Who is a relative?
A “Relative” of a member of an SMSF includes a spouse, parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the member or of his or her spouse.
Members of same-sex relationships and children from those relationships are included in the above definition and receive the same treatment as opposite-sex relationships under the SISA.
What requirements are there?
The following provisions also apply to investment transactions with related parties. Those provisions in the SISA are:
- Sole Purpose Test: The investment must not conflict with the sole purpose of providing retirement-related benefits to the member and/or dependants of the SMSF;
- Arm’s Length Transaction: The purchase price paid on the asset acquired by the SMSF must be at market value and the transaction must be conducted at arm’s length;
- Investment Strategy: The asset acquired by the SMSF must be in accordance with the investment strategy formulated for the SMSF;
- Borrowings: If the SMSF needs to borrow money to acquire the asset, then the borrowing must be structured correctly and in accordance with the limited recourse borrowing provisions.
Acquisition of Assets from a Related Party
Section 66 of the SISA provides a list of assets that can be acquired by an SMSF from a related party:
- Business Real Property: An interest in land and any built structure that is wholly and exclusively used in a business. It does not necessarily have to be a commercial property, it can be a residential property, as long as the property is wholly and exclusively used in a business at the time the SMSF acquired it;
- Listed Securities: Shares, units, bonds, debentures, rights and options listed on a licensed market, e.g. ASX, and approved stock exchange or an exempt market under the Corporations Act 2001;
- In-house Asset: An asset that meets the definition of an “In-house Asset” under s.71 of the SISA and does not cause the SMSF to exceed the five per cent (5%) In-house Asset limit;
- Tenants in Common: An SMSF is able to own a real property with a related party as Tenants in Common, as long as the property is not subject to a lease arrangement between the SMSF and a related party;
- Widely Held Unit Trust: An SMSF is able to invest in a Widely Held Unit Trust that has fixed entitlements to income and capital of the trust and there are at least twenty (20) entities that are entitled to seventy-five per cent (75%) of the income or capital of the trust;
- Non-Geared Entities: An SMSF is able to purchase units in a non-geared related unit trust or shares in a non-geared related company.
In-House Asset Provisions
An “In-House Asset” under s.71 of the SISA is an asset of an SMSF that is a loan to, or an investment in, a related party of the SMSF, or an asset of the SMSF subject to a lease between a trustee of an SMSF and a related party of the SMSF. A trustee can enter into an In-House Asset transaction with a related party as long as the transaction does not exceed five per cent (5%) of the market value of the SMSF’s total assets.
- A loan to a related party: An SMSF can loan money to a related party (apart from members and relatives) as long as the money lent does not exceed more than five per cent (5%) of the value of the SMSF’s total assets. Note that an SMSF cannot loan money to a Member of the SMSF or relatives of a member of the SMSF (even though members and relatives are included in the definition of a Related Party), as it is specifically prohibited under s.65 of the SISA. Only loans made to a Related Party such as a related company or a related trust are allowed.
- An investment in a Related Party: An SMSF can purchase unlisted shares in a related company or unlisted units in a related unit trust, provided the total value of the shares or units do not exceed five per cent (5%) of the value of the SMSF’s total assets.
- An asset of the SMSF leased to a Related Party: An SMSF can lease an asset belonging to the SMSF to a Related Party, provided the value of the assets is no more than five per cent (5%) of the value of the SMSF’s total assets. If an SMSF wishes to lease a residential property (non-business property) to a Related Party, it can only do so as long as the value of the residential property is no more than five per cent (5%) of the value of the SMSF’s total assets.
- However, if an SMSF wishes to purchase a residential property owned by a Related Party, it can only do so if the property is leased to a Related Party at all times and the value of the property does not exceed five per cent (5%) of the value of the SMSF’s total assets.
- SMSF leasing a Business Real Property to a Related Party: There is an exception in the SISA that allows not only property that meets the definition of a “Business Real Property” to be acquired by SMSF’s from related parties, it can also be leased to related parties regardless of the value of the property, that is, it does not matter that the Business Real Property exceeds five per cent (5%) of the value of the SMSF’s total assets.
It is important before entering into these types of transactions to look at the end result first and assess, once an SMSF owns the asset, whether it would satisfy the definition of an In-House Asset. If it does, then you need to determine whether the investment will put the level of In-House Asset over five per cent (5%) of the value of the SMSF’s total assets. If the value does not exceed five per cent (5%), then the SMSF can acquire the asset from the Related Party.
If a Trustee of a SMSF wishes to invest more than five per cent (5%) in a Related Party such as a related company or a related trust, they may do so as long as the Related Entity satisfies all the conditions under Regulations 13.22A to 13.22D of the Superannuation Industry (Supervision) Regulations 1994. These entities are often referred to as “Non-Geared Entities”.
The conditions under Regulations 13.22A to 13.22D are that the related entity (i.e. the related company or the related trust):
- Does not borrow (no borrowings or loans taken out);
- Does not have a charge over any of its assets (no mortgage or lien);
- Does not conduct a business;
- Conducts all transactions on an arm’s length basis;
- Does not invest in other entities (does not hold shares in listed or unlisted companies or units in a unit trust);
- Does not lend money to other entities (loans to related parties or anyone else);
- Has not acquired an asset from a Related Party since 11 August 1999 other than Business Real Property; and
- Does not lease assets to related parties other than Business Real Property.
To get around the borrowing restrictions, one of the ways was to establish a related entity such as a related company or related unit trust. Individual members of the SMSF would then purchase shares/units in the related entity to raise capital. The SMSF would then also invest in the related entity by purchasing shares/units in the entity. Individual members in their private capacity joining forces with the SMSF allowed the SMSF to invest in larger value assets which it could not on its own.
Two common types of assets that can be acquired by an SMSF are listed shares and Business Real Property. Not only can a Business Real Property be acquired by a Related Party, it can also be leased to a Related Party. If an SMSF is interested in acquiring any other type of asset from a Related Party, careful consideration needs to be given to the In-house Asset provisions and the In-House Asset limit of five per cent (5%) of the SMSF’s total assets value.
For more information on acquiring assets from an unrelated party, click here.
If you would like further information or advice on SMSF’s, contact the experienced wills and estates planning team at Rockliffs Lawyers.