SMSFs cautioned on ‘strict conditions’ with SMSF lending
Where SMSFs are planning to lend money there are some important conditions to be aware of including who the money is lent to and the reason for the loan.
In a recent online article, Heffron managing director Meg Heffron said while its not particularly common for SMSFs to lend out money to earn interest as a fund investment, it may be permissible under the rules depending on who the money is lent to and what it is for.
“To start with, SMSFs can’t lend money to members or their relatives under any circumstances. Ever. It doesn’t matter that the arrangement might be a good retirement investment and might be entirely above board in terms of being on commercial terms. It’s just not allowed,” Ms Heffron cautioned.
“In fact, an SMSF can’t even give financial assistance to members or relatives. For example, my SMSF couldn’t lend money to say my friend on the condition that my friend then lent the same amount to me.”
However, Ms Heffron explained that an SMSF could lend money to a person or business completely unrelated to the SMSF members.
“In fact, SMSFs can even lend money to related parties. There is a long definition of exactly what a related party is but as a general rule, its people and entities (for example, companies) that are closely linked to the members and their relatives,” she noted.
“For example, a company or trust controlled by a member or even a member and their family would be a related party. Hence, an SMSF could lend money to a member’s family trust or their company.”
Ms Heffron explained that a loan to a related party is what is known as an in-house asset.
“In house assets are allowed but they are limited – any given fund can only have 5 per cent of its assets (by value) classified as in-house assets. So an SMSF that lends $100,000 to a member’s family trust could only do that if the fund was worth more than $2 million,” she said.
“If the loan was to a person or business completely unrelated to the SMSF members, this 5 per cent limit doesn’t apply.”
Regardless of who the money is lent to, its always important to make sure that the terms are entirely commercial, she added.
“This is especially important when there’s a close relationship between the SMSF members and the borrower – whether they are a related party or not,” she noted.
“For example, the arrangement should be put in writing, the interest rate should be commercial, the repayment period should be comparable to other lenders and the terms of the contract should be honoured.”
Ms Heffron said in some circumstances it may be appropriate for the SMSF to take assets or guarantees as security or charge the borrower more interest if the loan is unsecured.
“For example, if a bank lending to a family business would normally require directors’ guarantees, it would be appropriate for the SMSF to get the same. And if the loan fails, the SMSF trustee should pursue those guarantees just like a bank would,” she explained.
“The loan needs to comply with the sole purpose test. Regardless of who the money is lent to, the reason or motivation behind the loan must be to provide for the members’ retirement. Any other purpose, such as supporting a struggling business, will fall foul of the rules.”
27 December 2022