Ensuring SMSF compliance at all times is quite the job. For financial advisers and accountants, it means close scrutiny of the transactions and investments made by trustees through the fund. One of the more complicated issues that arises with SMSF compliance is investments that do not follow the arms-length rule - how does this occur?
Acquiring business real property and other assets from a related party
When an SMSF purchases business real property from a related party, it has to be done at market value, and the rent has to represent market rates too.
For many purchases, this means trustees have to secure an independent, authoritative valuation of the asset to back up the purchase. Without sufficient documentation to prove this, there can be delays in the SMSF auditing timeline.
Government capital values are a start, however in many cases are not always representative of the property's market value. Official valuations and appraisals, or equivalent for assets in the funds you manage, are an absolute necessity. You can read more on finding the right documentation, particularly around property, in a recent SMSF auditing article here.
For related parties leasing business real property it is important to have a written lease agreement that represents arms-length terms, and should generally include term of the lease, rent due (whether monthly, fortnightly, etc), obligations for maintenance and repairs, and any other miscellaneous terms and restrictions.
Acquiring assets from related parties
As a general rule, SMSFs cannot purchase or invest in assets they acquire from a related party. Related parties can be defined as:
- Members of the fund
- Standard employer sponsors of the fund
- An associate of either member or standard employer sponsor of the fund.
An associate includes:
- Any relative of the member (spouse, parent, grandparent, uncle, aunt, nephew, niece, son, daughter, adopted child, or spouse of any relative in this list)
- The other members of the fund
- A business partner of the individual or a partnership in which the individual is a member, and in the case of the former, the spouse or child of that partner
- A trustee of a trust controlled by the individual
- A company sufficiently influenced by, or in which a majority voting interest is held by the individual and/or the individual's associates.
The only general exceptions where an SMSF can acquire assets from a related party are, shares or managed funds, and business real property. In limited circumstances related party trust investments can be acquired. They must be acquired at market value and regular checks would need to be made to ensure the level of the fund's in-house assets does not exceed 5% of the market value of the fund's assets.
Strict rules apply to SMSF's to ensure the fund's assets are safeguarded thereby protecting member's retirement benefits.
Consequences of purchasing at non-arms length
The consequences of breaching these guidelines can be severe.
The consequences of breaching these guidelines can be severe. The ATO will usually tax non-arms length income at the maximum possible rate, and contraventions found during an SMSF audit can result in further reprimand.
Accountants and financial advisers should always be on the lookout for ample, authoritative documentation proving purchases occurred at arms length.
If you're unsure about whether an SMSF has breached the arms length rule, talk to the SMSF auditing experts at Audit your Superfund.