Answer this week provided by Liam Shorte, a SMSF specialist advisor and financial planner with Genesys Wealth Advisers.

I get this question regularly from business clients with SMSFs. The technical answer is yes, subject to complying with the regulatory provisions of SIS Act.

In reality the answer is most likely no, as there are so many ways you can breach one or more of the rules governing this area. Let’s look at some of those rules.

Firstly, it is a requirement that a SMSF and any assets it considers purchasing must meet the sole purpose test.

Sole purpose test

Section 62: trustee must ensure fund is maintained solely for core purposes, such as benefits to members upon retirement and ancillary purposes.

Other relevant issues include:

Formulating investment strategy

Section 52: trustee must formulate and give effect to investment strategy that has regard to whole of circumstances including:

• Risk involved in making, holding and realising, and likely return from investments having regard to objectives and expected cash flow requirements.
• Lending to members, relatives and financial assistance:
• Section 65: A trustee must not lend fund money or provide financial assistance to:
• Member of fund OR relative of a member
• "Financial assistance” has no technical meaning and their frame of reference is language of ordinary commerce ... one must examine commercial realities of transaction and decide whether it can properly be described as giving of financial assistance (Charterhouse Investment Trust Ltd v Tempest Diesels Ltd [1986] BCLC 1, 10)

In-house asset rules:

An in-house asset is:

• Loan to related party
• Investment in related party
• Investment in a related trust
• Asset subject to lease between trustee and a related party (this is the one that matters in your case)

However a SMSF can have up to 5% of fund’s assets in invested “in-house” assets without breaching the rule so if the vehicle’s value were less than 5% of the fund’s total value then you would not be in breach of this rule. But remember, the other rules hold equal importance. Also it is important that this rule is met on an ongoing basis so if stock markets drop or cash is taken out of the fund for pensions you need to revisit the value of the in-house asset.

Arm’s length requirements:

Section 109(1): A trustee must not invest unless:

• The trustee and the other party are dealing with each other at arm’s length OR
• The terms and conditions are no more favourable to the other party than if they were at arm’s length.
• Section 109(1A): If trustee invests and is required to deal with investment with another party not at arm’s length, must deal as if were at arm’s length.
• The term “at arm's length” is not defined in the SIS Act so open to interpretation.
• Implies dealing that is carried out on commercial terms again subject to interpretation.
• Useful test to apply is whether prudent person, acting with due regard to own commercial interests, would have made the investment (APRA v Derstepanian (2005) 60 ATR 518, 524).

So example of how this works:

Let’s say you have $600,000 in your SMSF and you want to purchase a vehicle for $25,000 to lease to your own business.

1. The SMSF trustees do their research and minuted how they calculate a lease rate that takes into account market return on their investments, allows for the depreciation of the asset and insists on the insurance of the vehicle with its interest noted on the policy to protect its investment. They are satisfied that this provides a decent return for the fund not correlated to the other assets of the funds invested in shares and term deposits: sole purpose, S62 and S52 satisfied.
2. They ascertain that the business could be approved to obtain finance for the vehicle from a third party on similar terms: Section 65 met as clear finance available elsewhere and that this is not the reason why the arrangement is being entered into.
3. As the value of the vehicle ($25,000) is less than 5% of the fund it does not breach the in house asset rule. This needs to be monitored annually.
4. They arrange for a written commercial lease agreement comparable with the standard lease available in the market to be entered into by all parties: S109(1) satisfied.

So in summary, yes it can be done but in reality there are so many ways you can trip up that it is really not worth the hassle and raising the eye of the ATO or challenging your auditor’s patience. Your first step is to engage your accountant and a SMSF specialist before considering these types of strategies.

For more from Liam Shorte, Authorised Representative of Genesys Wealth Advisers and SMSF specialist advisor. Visit www.nextgenwealth.com.au and www.smsfcoaching.com.au or for the latest in SMSF related news. Follow him on Twitter @smsfcoach.  

Any advice given is general only and has not taken into account your objectives, financial situation or needs. Because of this, before acting on any advice, you should consult a financial planner to consider how appropriate the advice is to your objectives, financial situation and needs.

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