SMSFs using unrelated trusts to circumvent restrictions on the SMSF lending to a member of the SMSF — ATO Taxpayer Alert TA2010/5

The ATO has warned SMSF trustee(s) and private companies not to invest in trusts with the primary aim of making funds available to lend to members or trustee(s) of the SMSF.

Overview of Taxpayer Alert 2010/5

The ATO’s alert concerns an SMSF investing in an unrelated trust, which then lends the money to a member (or relative of a member) of the SMSF.

The ATO considers that such arrangements are an attempt to circumvent the prohibition on SMSF trustee(s) using the SMSF’s money to lend to, or to provide financial assistance to, members of the SMSF. The prohibition is in section 65 of the Superannuation Industry (Supervision) Act 1993 ( SIS Act ).

What is the current law?

The SIS Act prohibits SMSFs from using the SMSF’s resources to lend money to, or provide financial assistance to, a member (or to a relative of the member). [i]

Breaching this provision may render the SMSF non-compliant for tax purposes — which means the SMSF is taxed at 45% on the SMSF’s capital value and its current year income.

What is the arrangement the Tax Alert deals with?

The ATO is concerned with arrangements of the following type (or something similar):

• an 'organiser' creates a trust offering 'fixed rate of interest investments' to unrelated entities;
• an SMSF invests in the trust;
• a member (or relative) of the SMSF that has invested in the trust, borrows money from the trust;
• the borrower enters into a loan agreement with the trust, the terms of which may vary in the permitted use of the borrowed funds; and
• each borrower makes interest-only repayments on the loan to the trust for a substantial period of the loan.

What consequences are the ATO concerned about?

The ATO believes these arrangements present the following potential breaches of law:

• The sole purpose test under section 62 of the SIS Act: is the SMSF's investment in the trust for the sole purpose of providing retirement benefits to members. Answer: probably note. It is to enable a loan to the SMSF member (or their relative);
• The prohibition under section 65 of the SIS Act as discussed above;
• Early access to super benefits in breach of preservation rules; members of the SMSF may have illegally accessed superannuation benefits if they do not repay the loan from the trust;
• Section 109 of the SIS Act, which requires that SMSF investments are made and maintained on an arm's length basis;
• The in-house asset rules: the SMSF's investment in the trust may be an in-house asset under section 71 of the SIS Act and therefore subject to the 5% limit; and
• Section 85 of the SIS Act which may apply to a person undertaking an arrangement to artificially reduce the market value ratio of the SMSF's in-house assets to avoid application of the in-house asset restrictions.

Further guidance from the Commissioner on section 65(1)(b) of the SIS Act

The core issue of the alert is one that the ATO is most concerned about — namely, conferring benefits on members or their relatives. The Commissioner has other publicly available commentary on this issue. For instance, according to SMSF Ruling SMSFR 2008/1, a trustee contravenes section 65(1)(b) of the SIS Act by doing any of the following:

• giving a gift of an SMSF asset to a member or their relative;
• selling an SMSF asset for less than its market value to a member or their relative;
• purchasing an asset for greater than its market value from a member or their relative;
• acquiring services in excess of what the SMSF requires from a member or their relative;
• paying an inflated price for services acquired from a member or their relative;
• forgiving a debt owed to the SMSF by a member or their relative;
• releasing a member or their relative from a financial obligation owed to the SMSF, including where the amount is not yet due and payable;
• delaying recovery action for a debt owed to the SMSF by a member or their relative;
• satisfying, or taking on, a financial obligation of a member or their relative;
• giving a guarantee or an indemnity for the benefit of a member or their relative; and
• giving a security or charge over SMSF assets for the benefit of a member or their relative.

You can read SMSFR 2008/1 here .

You can read the ATO’s media release here .

What are the potential penalties?

The Trustee(s) of an SMSF who provide financial assistance in this way face potential penalties of:

• if they are individuals, $220,000 or jail for up to five years (or a fine and a jail term); and
• if they are a company, $1.1 million.

More information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask for a member of the Maddocks Superannuation or Tax and Revenue Team.

More Cleardocs information on taxation issues – www.cleardocs.com

Read

You can access various ClearLaw articles for more relevant information relating to taxation issues:

• Tax (Legislation and Law)

[i] Section 65(1)(b).