28/10/2016

It is important to be aware of what your fund can and cannot do, and with whom. In this article we take a look at when a (seemingly obvious) relative or related party is in fact not a relative or related party after all.

We know that with a self managed superannuation fund there are restrictions for trustees regarding who they can deal with and how they can deal with them. It is worth considering the exact meaning of a ‘related party’ in relation to your SMSF, and particularly when there is a related party loan arrangement.

There is a prohibition on a superannuation fund lending to its members under the Superannuation Industry Supervision Act (1993) (“SIS Act”) and that same prohibition prevents the fund from lending to relatives of the fund as well. It is prudent to consider who falls into the category of relative.

There is a restriction on loans to related parties of the fund, and this centres around the in-house asset rule. A loan to a related party of the fund is subject to the 5% test. That is, that the total value of in house assets must not exceed 5% of the total value of the fund at any time, not just at the time of making the loan.

Let’s put this into a scenario:

There is a self managed superannuation fund (“SMSF”) with two members, Ariel and Eric. Ariel’s cousin Elsa has asked Ariel and Eric for a loan of $50,000 to start her own frozen yoghurt business. Ariel and Eric don’t have money at their disposal in their individual capacities, however, they have a balance of $400,000 in their SMSF. Ariel and Eric want to make a loan from their SMSF to Elsa, but surely being a first cousin means she is a related party – right?

Maybe not!

“Relative” has many connotations, but the issue is how it is defined in the SIS Act. It is specifically defined to include a number of people or classes of people, and interestingly cousin is not listed. It is prudent to confirm the definition of “related party” as well to ensure cousin doesn’t fall into that either; we take the view that it does not.

Well, now that it seems possible to make the loan, what do Ariel and Eric need to consider?

First and foremost, does the trust deed allow this kind of investment? If it doesn’t then the trust deed will need to be amended if they intend to proceed with the arrangement.

Next they must consider the investment strategy of the fund. They should sit down with their financial adviser to discuss whether or not the investment in Elsa’s business is a good investment for their fund. Part of this will include thinking about the purpose of the investment and whether or not that is likely to jeopardise the fund’s primary purpose.

The terms of the loan should be on arm’s-length, therefore they should be commercial and available in the market.

The loan should be correctly documented, including an appropriate security document.  

These are just the basics.  There are other things to consider too but this will get you started.

What is the next step?

If this is something that you or your clients are wanting to consider – first seek financial advice, and second come and see us! We are able to prepare all the necessary documentation to help with this type of transaction. As always, having the appropriate documentation is of fundamental importance.

For further information, please contact Townsends Business & Corporate Lawyers on (02) 8296 6222.