Related restrictions

SMSF transactions involving related parties invoke a significant number of additional compliance restrictions that have considerable adverse consequences if breached. Deloitte partner and national SMSF leader Liz Westover details the relevant definitions and the related rules.

SMSFs are able to invest in an almost limitless array of assets and, in most cases, there are few rules hindering the manner in which they do so except when related parties are involved. Once this occurs, investment rules become far more restrictive, with a raft of legal requirements coming into play. Nevertheless, related-party dealings are commonplace in SMSFs so advisers need to have a solid grasp of who or what a related party is together with when and why it matters.

When does it matter?

The two key rules of which to be aware with respect to related parties involve the acquisition of assets and in-house assets (IHA).

Section 66 of the Superannuation Industry (Supervision) (SIS) Act 1993 prescribes a general prohibition on the intentional acquisition of assets by a trustee, or their investment manager, from a related party. A number of exceptions exist, most notably business real property, listed securities, certain IHA (acquired at market value and not causing a breach of the permitted level of IHA) and upon relationship breakdowns. Understanding which are the ‘certain’ IHA is important as the exception covers a broader range of assets other than those defined in section 71(1) of the SIS Act.

Section 71(1) gives the basic meaning of an IHA as a loan to or investment in a related party of the fund, including a related trust, or an asset subject to a lease arrangement with a related party. While an SMSF is able to hold IHA, the total of these types of assets is limited to no more than 5 per cent of the total market value of fund assets.

Identifying a related party is also relevant with respect to SuperStream, limited recourse borrowing arrangements and collectables or personal-use assets. Each of these areas has specific rules where related parties are concerned.

Who is a related party?

A related party of an SMSF is a member of the fund, a standard employer-sponsor of a fund and any Part 8 associates, as defined by the SIS Act, or either of these.

A member of a fund generally takes its ordinary meaning, noting that the SIS Regulations are able to provide for a modified meaning and in fact do for the purposes of Part 2 of the regulations. Even then, it still refers to a member as a person who is a member, receives a pension or has a deferred entitlement to a benefit from a fund.

A standard employer-sponsor of a fund is an employer that contributes to a super fund for its employees due to an arrangement between the employer and the fund. Typically this would not be relevant for SMSFs established in recent years, however, trust deeds of older funds should be reviewed to confirm whether or not the fund has a standard employer-sponsor. Should an SMSF have a standard employer-sponsor, the definition of a related party of the fund may need to be assessed in the context of Part 8 associates of a company or partnership as appropriate.

A standard employer-sponsor is distinct from an employer-sponsor that is an employer who contributes to a fund for an employee because of an arrangement with the member of the fund.

SMSF trustees are also the members of the fund so the distinction is somewhat grey. Generally, however, it is accepted arrangements written into the deed are taken to be arrangements with the trustee unless the deed specifically states otherwise. As such, deeds may need to be considered carefully for any hint of an arrangement that may give rise to an employer being determined to be a standard employer-sponsor.

A deed update may assist in removing a standard employer-sponsor, but the provisions for such removal in an existing deed need to be carefully followed to ensure a deed update is effective. Similarly, prior deed updates may need to be reconsidered to ensure they also are deemed to be effective. If these have not been performed correctly then the older deed, possibly referencing a standard employer-sponsor, may be the one that is actually the relevant or effective deed.

Part 8 associates

A Part 8 associate of an individual member includes:

• a relative of the member,

• the other members and trustees (or trustee directors) of the fund,

• business partners in a partnership (and their spouses and children) and the partnership itself,

• a trust controlled by a member of the fund,

• a company sufficiently influenced or for which majority voting interest is held by a member or another entity or entities to which these provisions would also apply.

A relative of a member

This includes a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the individual or their spouse. It also includes the individual’s spouse and the spouse of any of the above. It does not include a cousin.

A child includes an adopted child, stepchild or ex-nuptial child of a person, a child of a person’s spouse and a child within the meaning of the Family Law Act 1975. Assessing relationships with respect to a child should be done as if the individual was the natural child of the pension in question.

Other members

Other members of the fund are Part 8 associates and in the case of a single-member fund it will also include other individual trustees of the fund and/ or other directors of a corporate trustee.

Partners and partnerships

For these purposes, partners and partnerships have the same meaning as in the Income Tax Assessment Act 1997 (ITAA).

The ITAA determines a partnership to be:

(a) an association of persons (other than a company or a limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly, or

(b) a limited partnership.

A limited partnership is the same as (a) above, but where liability of at least one of the partners is limited. It also includes a range of other associations of individuals who have a separate legal personality from those persons.

This definition of a partnership would capture not only the traditional form of business partnership, but also joint ownership of property where the property was held for income-producing purposes. That is, a coowner of property would be considered a Part 8 associate of a fund member.

A trustee of a trust, in the capacity of trustee of that trust, is a related trust where the trust is controlled by a fund member or a Part 8 associate of that member.

Control of a trust

This is frequently taken to be where a member or a group in relation to the member has a fixed entitlement to more than 50 per cent of the capital or income of the trust. However, control can still be established in cases where 50 per cent or less of these entitlements are held by the member or the group.

Control can also be taken to exist in circumstances where the trustee of the trust, or a majority of the trustees of the trust, act in accordance with the directions or wishes of a member or their group, whether those directions are given directly or through interposed companies, partnerships or trusts.

Further, where a group is able to remove or appoint the trustee, or a majority of the trustees, control will also be taken to exist.

A group for these purposes includes the member or a Part 8 associate acting alone or together or two or more Part 8 associates acting together.

A company significantly influenced

A majority voting interest in a company is held where a member and/or their Part 8 associates are in a position to cast or control the casting of more than 50 per cent of the maximum number of votes that might be cast at a general meeting of the company.

Similar to trusts, sufficient influence of a company by a member and or their Part 8 associates exists where the company, or a majority of its directors, act in accordance with the directions or wishes of the member and/or their Part 8 associates whether those directions are given directly or through interposed companies, partnerships or trusts.

Anti-avoidance provisions

Section 66 of the SIS Act contains specific provisions placing a prohibition on avoidance schemes that might otherwise be implemented to circumvent the ban on acquiring assets from a related party.

With respect to IHA rules, SIS Act section 71(2) determines where a loan, investment or lease arrangement is made under an agreement and that carrying out that agreement effectively results in a loan, investment or lease arrangement with a related party, then the loan, investment or lease arrangement will be taken to be with a related party, irrespective of the agreement made. As such, the 5 per cent IHA limit would apply. The ATO also has the power in section 71(4) of the SIS Act to deem an asset to be an IHA.

Further, SIS Act section 85 prohibits a scheme being entered into with the intention that the market value ratio of a fund’s IHA is artificially reduced to avoid the application of IHA rules.

Breach of anti-avoidance provisions can have civil and criminal consequences, including imprisonment.

Consequences of getting it wrong

Auditors are required to form an opinion and report on specific provisions of the SIS Act and SIS Regulations. This includes acquisition of assets from related parties and IHA. If they do not believe trustees have complied with these provisions, they will issue a Part B qualification in their auditor’s report. If the contravention meets relevant reporting criteria, they must also lodge an auditor contravention report (ACR) with the ATO.

The ATO has a range of responses available to it for non-compliance with super law. An administrative penalty of 60 penalty units can be imposed for breaches of IHA rules. One penalty unit is currently $313 so fines of up to $18,780 per breach per trustee can be imposed. Alternatively, the ATO may issue rectification or education directions or in some cases a non-compliance notice for the fund. It can also disqualify a trustee or seek civil or criminal penalties. Its approach will be influenced by the nature and severity of the breach, whether it was deliberate, if it has been rectified and trustee behaviour with respect to the breach, rectification and engagement with the regulator.

What to do when it goes wrong

When things go wrong, it is best to engage with the fund’s auditor and, if needed, the ATO. The regulator will view more favourably a reported breach that has already been rectified so it is recommended to work with the auditor to ensure trustees have the opportunity to rectify before the auditor lodges their ACR. If rectification is not possible or problematic, consideration should be given to lodging a voluntary disclosure with the ATO. This involves providing the regulator with the facts and any mitigating circumstances that gave rise to the breach and, importantly, a proposal for rectification (or not) and the timeframes over which this will occur. The key is to offer a reasonable solution to facilitate an acceptable outcome for both parties.