SMSF investment rules: What every trustee should know (2024)

SMSFs need to comply with thesole purpose test, which requiresyoursuperfund berun for the sole purpose of providing retirement benefits for members.

The sole purpose test applies toall superfunds, not just SMSFs. You can read more about how itrelates to SMSFs in‘Self-managed superannuation funds rulingSMSFR 2008/2: sole purpose test’.

The sole purpose test in section 62 prohibits trustees from maintaining an SMSF for purposes other than for the provision of benefits specified in subsection 62(1). The core purposes specified in that subsection essentially relate to providing retirement or death benefits for, or in relation to, SMSF members.

The SMSF can also maintain the fund for one or more of these purposes and other specified ancillary purposes, which relate to the provision of benefits on the cessation of a member’s employment and other death benefits and approved benefits not specified under the core purpose.

Essentially if you, or anyone related to the fund, receives a financial benefit not related to your retirement then your fund might not meetthe sole purpose test.

Assets in name of fund

It is a legal requirement of SMSFs that you invest in assets in the name of the fund – not in your own name. Your SMSF is required to have its own bank account and fund assets must be held in the name of the individual trustees as trustees for the fund (or a corporate trustee).

As the assets belong to the fund, they are somewhat protected in the event of a personal legal dispute against one of the member’s assets.

The penalty for failing to keep the assets of the fund separate from members’ personal assets is 20 penalty units where each penalty unit is $275 (as at 1 January 2023)and applies to each trustee, which would be $5,500for each member of the fund.

Investing in the name of the fund is relatively straightforward for most kinds of assets. However, if yourfundinvestsin propertyandthe property is not owned outright by the fund, youmust be careful aboutwhat legal entity is the holder of the asset. This is particularly the case if your fundacquiresthe asset via a limited recourse borrowing arrangement (LRBA).

In these cases, aholdingtrust will need to be set up to acquire the asset, and it is the holding trust that needs to be on the contract. However, this will depend on state in which the asset is locatedso it’s important to get legal advice on the issue.

Restrictions (on investments)

An SMSF isn’t a free-for-all when it comes to investments. There are restrictions around what you can and can’t invest in that have evolved over time as the regulator cracks down on (real or perceived) loopholes.

In addition to possible penalties for breaching the rules, if you don’t abide by these restrictions your SMSF may lose its concessional tax treatment, which would increase its tax rate from 15% to the highest marginal tax rate of 45% (2022–23). A trustee can also be disqualified.

Collectables

The regulations for investing in collectables have tightened since 2011 and now state that collectables or personal use assets cannot be stored in the private residence of any related party of the fund.

Itemsmust also be insured in the fund’s name within seven days of acquisitionand must be allowed in the fund’s trust deed and explained in the fund’s investment strategy.

Borrowing

Rules around borrowing to buy assets, such as property, have evolved over time. Where originally it was barely allowed at all, a relaxation of these rules in 2007 means that in very specific circ*mstances SMSFs canpurchase properties, and occasionally other assets, through limited recourse borrowing arrangements(LRBA)or through instalment warrants. Both these types of borrowings limit the lender’s rights to the asset, that is, the lender cannot claim on other assets held in the SMSF.

Also, in limited circ*mstances your SMSF can borrow money for a short period of time if the amount is less than 10% of the fund’s total assets. Those circ*mstances are:

• A maximum of 90 days to meet benefit payments or to pay an outstanding surcharge liability, or
• A maximum of seven days to cover the settlement of security transactions. You can also only do this if when you bought the securities you did not think you would need to borrow funds.

All investments by your SMSF need to be made on a ‘commercial arm’s length basis’. If you invest in an asset you need to get a market rate of return for it. If you buy(or sell) an asset, that needs to be at market value as well. If it isn’t, you will be breaching the arm’s length requirements.

When it comes to complying with the arm’s length requirement, one of the biggest challenges for SMSF trustees isthe rules about related parties and investments.

A related party is not just a relative or another member of your SMSF – it includes associates of all members of the SMSF.This is defined by theATO as:

• The relatives of each member
• The business partners of each member
• Any spouse or child of those business partners
• Any company the member,or their associates,control or influence
• Any trust the member,or their associates,control.

‘Business partners’ refers to the situation where the member, or a relative, is a partner in a partnership and other partners in the partnership are included as related parties.

Employers who contribute to your superand associates of employers who do so (business partners and companies or trusts the employer controls and companies and trusts that control the employer) are also related parties.

Problems arise when related parties, say a son or business associate, sell an asset to an SMSF at below market value. That would be in breach of the arm’s length rule.

In-house assets

Assets that have connections to related parties are called in-house assets and can be an investment in a related trust of your fund, a fund asset that is leased to a related party, or an investment in (or a loan to) a related party of your fund.

An in-house asset cannot be more than 5% of your SMSF’s total assets at market value. Exceptions to this rule include business real property or commercial property.

A trustee’s company (as opposed to the property the business operated in) would not be an exception to the in-house asset test. So,the SMSF could only invest 5% of the fund’s assets in the trustee’s company. The investmentwould also have to beat market value in accordance with the arm’s length rule.

Lending money and early access

Under Section 65 of the Superannuation Industry (Supervision) Act 1993, SMSF trustees are not able to lend money or give any other financial assistance using the resources of the fund to a member of the fund or a relative of a member of the fund.

Withdrawing funds from the SMSF to give to a relative of a member would fallunder ‘other financial assistance’ and would in fact be regarded as early access to super.Early accessis illegal if the trustee has not met a condition of release that allows the trustees to pay the benefit.

“The most common [SMSF] contravention relates to members having accessed their retirement savings early which is often reported as a loan to member or a payment standards breach,” ATO assistant commissioner SMSF risk and strategy, Justin Micale, said in late 2022.

Letting a family member stay in a property owned by an SMSF rent-free would also be considered financial assistance and not allowed.

There are some limited instances when an SMSF canlend to a related party, providing it is not a member or their relative, as long as it does not breach the in-house assets test. The loan needs to be on an arm’s length basis and the SMSF’s investment strategy would also need to explain how the loan is in the members’ best interests.

Exotic investments such as foreign currencies, commodities, options and cryptocurrency

Foreign currencies and commodities are usually traded via contracts for difference or CFDs.

SMSFs can invest in CFDs, but they do have to be careful whendepositing funds with the CFD provider. They can deposit funds when they open their account but they should not, under a separate written agreement with the provider,deposit fund assets as security for margin calls on the investment. That would create a charge over the fund assets, which is not allowed.

An SMSF’sinvestment strategy and trust deed need to allow CFDsand explain how investing in CFDs benefits the fund. Also, a risk assessment statement – called a Derivatives Risk Statement – needs to be part of the investment strategy.

CFDs are a very complex leveraged instrument and any risk assessment statement should include an explanation of the trustee’s level of knowledge and experience with the asset class.

Investments in options and cryptocurrency are also allowed provided the trust deed allows it, and the investment strategy explains the motivation and includes a risk assessment statement.

For tax purposes cryptocurrenciesare not a form of money but are capital gains tax assets.

Carrying on a business within an SMSF

Like many of the ‘out of the box’ investments mentioned above, your SMSF can invest in a business if you can show that it is a business being run for the sole purpose of retirement savings, is conducted on an arm’s length basis and is allowed under the trust deed. The investment strategy mustexplain why and how the investment is in the members’ best interests.

The ATO has cited the following as the kinds of cases that attract their attention when it comes to businesses conducted by the trustees of SMSFs:

• The trustee employs a family member (we look at things such as the stated rationale for employing the family member and the salary or wages paid)
• The ‘business’ is an activity commonly carried out as a hobby or pastime
• The business carried on by the fund has links to associated trading entities
• There are indications the fund’s business assets are available for the private use and benefit of the trustee or related parties.

Bottom line

There are many investment options available to SMSF trustees but whatever you choose to invest in, you need to adhere to the relevant investment rules. You must also explain in your investment strategy how each investment is the SMSF members’ best retirement interests.