SMSFs: Complying with investment rules

Don't be caught out: recent rule changes apply to all new artwork and collectibles owned by an SMSF.

Before your fund buys an asset, confirm that the trust deed and superannuation laws allow it.

Your Australian superannuation fund can own assets as long as the ownership of these assets falls in line with what your fund’s trust deed states and what superannuation laws allow.

In simple terms, your trust deed has to give you the necessary power to perform any action involved in the running of your fund.

In addition, Australian superannuation laws impose several restrictions on asset purchase and management. Many of these rules deal with your fund’s related parties. Related parties mean all the members of your fund, all the relatives of all the members, and any entity – for example, a company, a trust or a partnership that the members (or their relatives) control, or the law deems that they control.

Furthermore, there are restrictions on some assets your super fund can buy from you or from a related party of the fund. Importantly, these restrictions don’t apply to shares listed on most Australian and overseas exchanges. They also don’t apply to property used wholly and exclusively in the running of a business (commercial property).

There are some exemptions to these rules regarding investments in related businesses.

Typically, your super fund can’t loan money to its related parties, even if your fund charges a good rate of return. And there are restrictions on renting or leasing your super fund’s assets to its related parties.

It is important to know that, in most cases, your super fund can’t borrow money to make any investments. A super fund can, however, enter into a special transaction called a Limited Recourse Borrowing Arrangement.

And finally there is the arm’s length rule, discussed further below, and rules regarding collectibles and artwork, which are also discussed in more detail below.

The arm’s length rule

The arm’s length rule says that a super fund must deal with every other party on an arm’s length basis.

However, an extension of this rule applies if the other party is related to your super fund. This rule says that if the other party is related to the super fund, then the transaction can’t be more favourable to this related other party.

How might transactions be more favourable to a related other party? Let’s say your super fund buys an asset you personally own. If your super fund agrees to buy that asset for 100 per cent more than a genuine arm’s length price, then clearly that might appear to be good for you personally. Such a transaction wouldn’t comply with the arm’s length rule.

The arm’s length rule for related parties allows the two parties to deal in such a way that the super fund gets a great deal. For example, your super fund might take possession of one of your assets but not pay anything for it.

On the face of it, the super fund now has an asset for nothing. This is okay from an arm’s length perspective because the super fund has “won”.

However, Tax Ruling 2010/1 says that when a super fund acquires an asset for less than market value, then the difference between the market value and actual purchase price is deemed to be a super contribution, which has to be reported and assessed for excess contributions tax purposes.

Capital gains tax and stamp duty will also be charged, assuming the asset has changed hands at the prevailing market value.

What about purchasing collectibles and artwork in a self-managed super fund?

Artworks means photographs, drawings, paintings, engravings, sculptures or reproductions of any of these items.

Collectibles includes postage stamps or first-day covers, rare folios, jewellery, manuscripts or books, antiques, artefacts, coins, bank notes, medallions, memorabilia, wine, motor vehicles, recreational boats, memberships of sporting or social clubs and anything, other than land, kept for personal use or enjoyment.

There are two potential types of returns available from these investments – income and capital. The principal source of return is capital gains over the medium- to long-term. Your super fund would receive income if it leases its artwork or collectibles to someone, such as an art gallery.

There is an important rule to note here. You can’t lease any artwork or collectible to a related party of your fund, that is you and your relatives. It also includes most employers who contribute to your super fund, as well as any entity that fund members, your relatives or employer sponsors control or are deemed by the super laws to control.

It is also important for your self-managed super fund (SMSF) to keep this rule: SMSF artwork and collectibles can’t be stored at the “private residence” of any related party, which means the primary residence of an individual. It doesn’t mean any other location, such as a place of business or specially constructed storage facility.

You must document why you stored the investment at a particular location. This documentation must be kept on file for at least 10 years.

There’s a specific exclusion from super fund-related parties using any recreational boat, car, jewellery, or membership of a sporting or social club. The purpose here appears to be that the government doesn’t want these assets to lose value due to regular use. If your fund owns a sporting or social club membership, it must be because they’re good investments and not for fund members to use for personal purposes.

The regulations insist that the investments are insured. This insurance must be in the name of your super fund and must be in place within seven days after the fund purchased the asset. Some commentators have been arguing that many trustees will find it difficult to get this insurance. However, it is expected that, in time, general insurers will come to the party. Sensibly, this rule doesn’t apply to sporting or social club memberships.

The final part of these new regulations says that when a super fund sells any piece of artwork or collectible to a related party then the super fund must get an independent valuation on the item and the agreed sale price can’t be less than that valuation.

If an SMSF fails to abide by these rules, then the trustee can be fined. These penalties are “strict liabilities”, which mean that if the breach can be proved then a court can immediately impose a penalty and there is no need to examine why the trustee breached the rules.

These new rules apply to all new artwork and collectible investments made after June 2011. For such investments held by a super fund before July 2011, the new rules won’t have to be complied with until after June 2016 – that is, about five years after commencement.

October 2021
October 2021

Read the October 2021 issue of INTHEBLACK magazine.

Each month we select the must-reads from the current issue of INTHEBLACK. Read more now.