SMSF investment restrictions
Although as a trustee you have control over the investments of your SMSF, certain restrictions are imposed by legislation, particularly in connection with transactions involving members and related parties. You should be aware of these restrictions as you prepare, and implement, on an ongoing basis, an SMSF investment strategy.
Arm’s length investments and market value
Any investments or sale price of the SMSF assets should happen on a commercial arm's length basis. The income from the assets in the fund should reflect the real market rate of return.
Assets should be bought or sold under current market valuation, and the conditions for the transaction should reflect as if the transaction has been conducted with an unrelated party.
Definition of related parties
The definition of related parties and relatives includes:
- Members of the fund.
- Relatives of any member of the fund include a parent, brother, sister, grandparent, uncle, aunt, nephew, niece, lineal descendant or adopted child of the member or their spouse.
- Business partners of the SMSF members, and the spouse or child of those business partners.
- Any company or trust in which the members or relatives influence the decisions the company make.
Loans and financial assistance to members
One of the rules is that the SMSF must NOT lend money to a member of the fund or their relatives. Some of the examples are:
- Lend money to your son for his house deposit, although he is paying it back.
- Take money for yourself (outside of the rules regarding payment of benefits)
- Lend money to your daughter to buy a car
- Take funds out of the bank account of the SMSF for emergency payments
Trustees are not allowed to provide members and their relatives with financial assistance. These restrictions include:
- Presenting gifts to a member or a relative of a member by using the resources of SMSF
- Selling an SMSF asset to a member or relative of a member for less than its market value
- Acquiring services from a member or a relative of a member on terms that are not considered as arm’s length. For example, paying for unnecessary services, or paying an amount for services above an arm's length amount.
Acquiring assets from related parties
An SMSF cannot buy the asset from a related party unless the asset is acquired at market value and under proper commercial terms, and unless the asset is a listed security, real estate property or in-house asset. Make sure that the in-house assets do not exceed 5% of the total cost of the SMSF assets.
Please note that there are exceptions while acquiring assets other than shares, real estate property and certain in-house assets. Merging of certain assets from members is allowed only under specialised determinations.
Trustees and members are not allowed to borrow money on behalf of the fund except in certain limited circumstances as mentioned below:
- Limited recourse borrowing arrangements — these are investments with borrowing under stringent rules. Lenders must only hold a charge over the investment asset for which the borrowing has incurred, and the asset must be held in a trust arrangement. Strict regulations exist for this type of lending. However, this type of arrangement enables SMSFs to borrow for shares or real estate.
- Benefit payments — borrowing to fund a benefit payment until the funds are available. This type of borrowing addresses the short-term cash flow issues. The borrowing must not exceed 90 days or represent more than 10% of the fund's assets.
- Settlement of securities — buying shares when the transaction relates to short-term cash flow issues. The borrowing must not exceed seven days or represent more than 10% of the fund's assets.
It is worth noting that when a member pays an expense on behalf of the SMSF, this action is generally not deemed to be "borrowing".
If the SMSF undertakes a prohibited borrowing, all trustees will be subject to penalties.
Seeking advice from an appropriately-qualified independent source will improve your ability to remain objective in your decision making. Additionally, you can refer to the relevant ATO webpage for further information. The independent annual SMSF audit ensures you becoming aware of conformance to the investment restrictions.