SMSFs can’t lend to members or their relatives, but can lend to unrelated parties if done at arm’s length and within the fund’s investment strategy. This article covers key SMSF lending rules and best practices to keep your fund compliant and secure.
SMSF Lending: What You Need to Know
One of the key rules for Self-Managed Super Funds (SMSFs) is that they cannot lend money or provide direct or indirect financial assistance to fund members or their relatives. This includes actions like guaranteeing personal loans for members. However, lending to unrelated parties, such as a friend, is allowed—as long as the loan complies with the relevant superannuation rules.
Lending to Members and Relatives: The Prohibition
The Australian Taxation Office (ATO) strictly prohibits SMSFs from lending money to members or their relatives. Actions considered as lending to related parties, and therefore prohibited, include:
- Gifting an SMSF asset to a member or their relative;
- Selling an asset for less than its market value to a member or their relative;
- Purchasing an asset for more than its market value from a member or their relative.
While trustees can lend to unrelated parties, it’s essential that these loans are made on arm’s length terms, meaning they must be made under commercial conditions as if dealing with an independent third party.
Watch Out for Indirect Lending
One tactic trustees may consider is lending funds to an unrelated trust, which then on-lends the money to a member or their relative. This type of arrangement aims to circumvent the rules, but the ATO may view it as a breach of super laws.
It’s also important to remember that lending money is simply another form of investment, so all trustee duties apply. Trustees must ensure that any loan made aligns with the SMSF’s investment strategy and complies with the legal obligations set out in superannuation law.
Lending to Other Related Parties
Although lending to a member or their relative is prohibited, SMSFs can lend to other related parties, but these loans are classified as in-house assets. Strict rules apply to in-house assets, including a limit that these investments cannot exceed 5% of the SMSF’s total asset value.
Additionally, the Superannuation Industry (Supervision) Act 1993 contains provisions that prevent schemes designed to artificially reduce the market ratio of in-house assets.
Investment Strategy and Loan Terms
if lending is part of an SMSF’s investment strategy, trustees must ensure that the loan:
- Is in the best interests of members;
- Does not place members’ benefits at risk;
- Is conducted on a commercial, arm’s length basis as required by the SIS Act.
Striking the right terms for a loan is crucial, particularly when lending to related parties. If the loan is too favorable to the borrower (e.g., a low-interest rate), the arrangement may breach the SIS Act. On the other hand, if the terms are too favorable to the SMSF, it may be subject to non-arm’s length income (NALI), resulting in higher tax rates.
Best Practices for SMSF Lending
Before an SMSF trustee lends money, it’s essential to seek legal advice. Trustees should ensure that they:
- Write a formal loan agreement specifying all terms, including:
- Security for the loan;
- Repayment terms and interest rates;
- Ensure all parties sign the loan agreement;
- Receive all repayments according to the agreement;
- Take legal action if the loan is not repaid as agreed;
- Properly prepare security documents and register securities where needed.
By following these guidelines, trustees can protect the SMSF’s investment and avoid any breaches of super laws.
Conclusion
While SMSFs can lend money under certain conditions, strict rules apply, particularly when lending to related parties. Trustees must ensure that all loans align with the SMSF’s investment strategy and are made on commercial terms to avoid penalties and breaches of super laws.
