Superannuation was established to help individuals save for their retirement, supplementing government support. When contributing to superannuation, you can choose between two main investment options:
A registered superannuation fund, where a trustee makes investment decisions on your behalf, based on the risk strategy you select.
A self-managed superannuation fund (SMSF), which gives you more control over how your retirement savings is invested.
However, managing an SMSF comes with its advantages and challenges. While it offers autonomy, as the trustee, you are responsible for ensuring compliance with superannuation laws. Failure to do so can lead to actions by the Australian Taxation Office (ATO).
The ATO has reported taking actions in 2023, issuing penalties, tax liabilities, and interest amounting to $29 million, and disqualifying 753 SMSF trustees for non-compliance with superannuation laws.
It's crucial for SMSF trustees to understand their obligations. Below are some common breaches that could lead to serious consequences:
1. Lending to Members
An SMSF cannot lend funds to its members or their relatives, regardless of the arrangement's commercial nature. Loans to related businesses are allowed, but strict rules, such as the in-house asset limit (the "5% rule"), must be followed. Violating these rules could result in penalties up to $16,500, with trustees personally liable for these fines.
2. Risky Investments
While investing in high-risk assets isn't automatically a breach, it may go against the fund’s investment strategy. If the strategy doesn't align with the chosen risk profile, it could be considered a violation.
3. Residential Property Use
The sole purpose test requires that SMSF assets be used exclusively for retirement benefits. If a member resides in a residential property owned by another SMSF member, it likely violates this test. A member may only live in SMSF-owned property once they retire and it’s transferred out of the SMSF, subject to transfer duty implications.
4. Excessive Investment in Related Entities
Investing in related entities (in-house assets) is restricted. Under the 5% rule, the combined value of such investments must not exceed 5% of the fund’s total assets. If an SMSF holds $2 million, for example, the total related entity investments cannot exceed $100,000. However, business real property rented to a related business is exempt from this rule.
5. Life Insurance in Buy/Sell Agreements
SMSFs cannot hold life insurance policies for use in Buy/Sell Agreements, as this violates the sole purpose test. Trying to use SMSF funds to finance these agreements can result in a breach.
6. Purchasing Residential Property from a Member
An SMSF is prohibited from acquiring residential property from a related party, even at market value. The exception is business real property, which can be purchased under specific conditions. Violating this rule can lead to severe consequences for trustees.
7. Borrowing through an SMSF
An SMSF generally cannot borrow money, except through limited recourse borrowing arrangements (LRBAs) that meet strict ATO guidelines. Failure to comply with these rules can lead to penalties.
8. Non-arm's Length Income and Expenses
An SMSF must transact at arm’s length. Dealing on a non-arm’s length basis results in “Non-arm’s length income” (NALI) or “Non-arm’s length expenditure” (NALE), both of which are taxed at 45%. For example, purchasing a property below market value and leasing it to a third party could result in rental income including any future capital gain being taxed as NALI.
Non-compliance with these regulations can result in the SMSF losing its concessional tax rate and facing severe tax consequences. The ATO may also disqualify trustees deemed unfit for the role.
If you find yourself in a situation involving non-compliance or have received a disqualification notice, it's important to seek professional guidance. The Symmetry Accounting & Tax Superannuation team can provide expert assistance in such matters.
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