The strategy: To keep my self-managed super fund out of trouble with in-house assets and related-party transactions.
Do I need to do that? These things keep cropping up in the Tax Office’s compliance program and this year it will be paying particular attention to non-arm’s length transactions in pension funds. It says pension income (which is tax exempt) does not include non-arm’s length income, so some funds are getting their claims wrong. The head of technical services at SuperIQ, Kate Anderson, says non-arm’s length income is taxed at 45 per cent.
Broadly speaking, Anderson says, income is regarded as non-arm’s length if it comes from a scheme or investment in which the parties weren’t dealing with each other at arm’s length, and if it is more than the fund might have expected to get if those parties had been dealing with each other at arm’s length.
For example, she says income received by a self-managed fund as a beneficiary of a discretionary trust is non-arm’s length income and would be taxed at the higher rate.
The Tax Office says it will contact 3000 pension funds this year to encourage voluntary amendments.
So I’m OK if my fund isn’t a pension fund or isn’t receiving this sort of income? Not at all. As a general rule, all super funds are required to invest on a commercial, non-arm’s length basis. The Tax Office says it will also review 100 self-managed funds this year to ensure they are complying with this requirement. Anderson says there are specific rules in the super laws relating to related-party transactions and in-house assets that all funds must comply with.
What are the rules? Unless an exception applies, the Tax Office says self-managed funds generally can’t lend money or provide financial assistance to related parties or buy assets from them.
A related party is any person, including the member themselves, who is related to you out to second cousins or any entity that is controlled by a related party, such as the fund’s employer sponsor.
Anderson says an exemption to the ban on related-party transactions allows super funds to buy listed securities or widely held trusts at market price or business real property (a technical term meaning the property must be used solely for business) from related parties, so long as the purchase is made on commercial terms.
Business real property can also be leased to a related party at a commercial rent. For assets that don’t fit the exemption there is a provision for a small amount of the fund’s value to be invested in in-house assets.
OK, I’ll bite. What is that? This limits assets bought from related parties, along with investments in or loans to related parties and assets that are leased to related parties, to no more than 5 per cent of the total fund’s assets.
Those exempt assets referred to earlier are also exempt from this rule.
The problem with the in-house assets test, Anderson says, is that it applies on a daily basis. So if your fund also owns shares and those shares fall in value, you could inadvertently breach the 5 per cent limit without changing your investments.
This caused problems for many self-managed funds during the global financial crisis.
She says funds also need to be aware of the sole purpose test – an overarching requirement that all investments made by the fund be made solely for the purpose of providing retirement benefits.
So if you enter into a transaction because you want to help your business or free up funds for personal use, you’ll run foul of the super rules even though you may be under the 5 per cent limit.