A Self-Managed Super Fund (SMSF) is a trust fund that provides its members with a way of saving for retirement. The members of a SMSF receive the benefit of the fund and also have control of those benefits through their position as trustees.
A SMSF can technically buy and run a business by either:
- purchasing it as an investment (i.e. by buying shares); or
- running it through the SMSF.
However, the SMSF must ensure acquisition complies with all relevant prudential standards so that it maintains complying superannuation fund status. In this article, we look at five key issues you should consider before buying and running a business through your SMSF.
1. SMSF Tax Concessions
To be eligible for SMSF tax concessions, and therefore concessional tax treatment, your fund must meet the Sole Purpose Test. This test states that the sole purpose of the fund must be to provide retirement benefits to its members.
If you are considering buying through your SMSF, ensure you figure out whether this will change your fund’s sole purpose. This will depend on your particular situation. When determining whether your fund’s purpose may change, consider factors such as whether:
- the SMSF employs members of relatives;
- the SMSF contracts with related entities in carrying on the business; and
- business assets are used for private purposes of members of relatives.
If engaging in business purchase and operation activities creates complications for the Sole Purpose Test, you risk becoming a non-complying fund, therefore becoming ineligible for SMSF tax concessions. If you buy a business through your SMSF and are not eligible for the tax concessions, this can leave you with a large tax obligation.
2. Investment Strategy
SMSFs must also have a formulated investment strategy in place that works in the best interests of its members.
So if you choose to carry on a business through a SMSF, those operations must either:
- accord with its investment strategy; or
- result in an updated SMSF investment strategy.
The decision should follow careful consideration of the various issues and the possible results of each option.
3. Arm’s Length Transactions
Prudential standards state that a SMSF must deal at arm’s length and generally cannot acquire assets from related parties. An arm’s length transaction is one where the buyer and seller act independently, without a pre-existing relationship.
Key exceptions to the related party acquisition prohibition include:
- listed securities or business real property of the related party acquired at market value; and
- an in-house asset that is not worth more than 5% of the total value of the SMSF.
An in-house asset includes:
- related party loans; and
- investments in related companies or trusts or leases between the trustee of the SMSF and a related party.
Where a SMSF invests in a private company, there may also be adverse tax consequences even if the various prudential standards are satisfied. That is, where a dividend is paid by a private company to a SMSF, it can be considered not arm’s length income (NALI) unless it is in accordance with an arm’s length dealing.
Unless this arm’s length dealing requirement is met, the private company dividend will be NALI and taxed at 45% (instead of the general 15% tax rate). This can have a large impact on your SMSF if you purchase a business because of the potential that your SMSF may be subject to a large tax liability.
4. Financial Assistance
A SMSF cannot lend money or provide financial assistance to its members or relatives. Further, any loans that the SMSF makes to any other individuals or entities must be:
- related to its investment strategy; and
- in accordance with the arm’s length dealing requirements.
Accordingly, this could be problematic for a SMSF which was running a business, as this could extend to vendor financing arrangements or credit terms with related parties.
5. Borrowing Money
SMSFs are generally prohibited from borrowing money. This could significantly impact a SMSF’s ability to operate a business.
The main exception to this borrowing prohibition is the limited recourse borrowing arrangements. These allow SMSFs to enter into limited recourse loan arrangements where a special-purpose trustee/custodian holds legal title to the asset whilst the loan is being repaid. The trustee then transfers the asset to the SMSF on final repayment.
Although it is technically possible to carry on a business in a SMSF, there are several overlapping prudential standards and tax issues to consider before you make a purchase decision.
How these rules will apply depends on your particular situation. You should monitor your compliance with these rules at all times to avoid a breach and maintain complying fund status. If you have any questions, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
Was this article helpful?
We appreciate your feedback – your submission has been successfully received.