SMSFs: Investing in related trusts and companies

On this page

In-house assets and exceptions
Who and what are related parties?
Other regulations and guidelines
The bottom line

Have you ever been curious about using your SMSF to invest in a related company? How about investing in a related unit trust?

It may come as a surprise that, in certain situations, these related party investments could be allowed and occur more frequently than you might think.

It may be that you want your SMSF to invest in a related trust or company to fund the purchase of an asset with other family members or even with a business partner. This can be achieved where investors, including your SMSF, purchase shares in a company or units in a unit trust and the company or unit trust then uses those investment proceeds to acquire an asset.

This enables multiple related investors to come together to buy assets, in most cases to acquire property.

In other scenarios, SMSF trustees may want to invest in a related company where they see a good investment opportunity. In these situations, there are a number of compliance issues that must be addressed.

Example 1: Joining forces to buy property

Matt is looking to buy a residential property together with his siblings Nick and Penny. They all want to use their retirement savings held in their respective SMSFs.

They decide to use a related unit trust to acquire the property, so each of their SMSFs buys units in the related trust using cash.

The trustee of the unit trust then uses this cash to fund the property purchase and any associated expenses with the purchase. Once the purchase completes, the legal owner of the property is the trustee of the related unit trust.

Financial accounts will need to be prepared for the trust each year and, where relevant, each of the unit holders (the three SMSFs) will receive a distribution from the trust consistent with the interest they hold in the trust.

As the trust is a related trust of each of the three SMSFs, there are rules and restrictions that must be met at all times so the SMSF’s investment in the trust is not caught as an in-house asset.

Using this structure allowed the three funds to combine their resources to purchase the desired asset.

In-house assets and exceptions

The main compliance issues relevant for SMSFs when entering a related party investment are the in-house asset rules.

An in-house asset includes:

Investments that an SMSF has in a related party (including related trusts and companies)
Loans made by an SMSF to a related party
An SMSF asset that is leased to a related party (but does not include business real property leased on arm’s-length terms).

There is a 5% limit imposed on the total value of all in-house assets held. That is, an SMSF can hold no more than 5% of its assets as in-house assets. Breaching this limit will result in compliance issues and often results in penalties being applied.

Read more about SMSFs and in-house assets.

However, there is an exception to the in-house asset rules for certain SMSF investments in related trusts and related companies, where those trusts and companies adhere to specific requirements.

This exception is often referred to as the related ungeared trust exception and it requires all of the following to be met at all times:

There can be no borrowings taken out by the related trust or company. The related entity must be ‘ungeared’.
The related trust or company cannot lend any money to anyone.
The assets of the related trust or company cannot be used as security; no charges over these assets are allowed.
The trust or company cannot lease any of its assets to related parties (with the exception of business real property).
The trust or company must not carry on a business.
The trust or company cannot invest in any other entity (not even listed shares).

Example 2: Investing in a related company

Toby runs a successful marketing business through a company structure and he is the only shareholder.

To help expand his business, Toby wants additional shareholders to take up an investment in his company and he wants his SMSF to purchase shares.

As this is a related company, any investment made by Toby’s SMSF will be caught as an in-house.

As Toby’s company is carrying on a marketing business, the general in-house asset exception would NOT apply.

Any investment made by Toby’s SMSF into the related company would need to fall within the overall 5% in-house asset limit. Significant SMSF compliance issues will result if this limit is not adhered to.

Also keep in mind that the 5% limit will continue to apply in future. So, if the value of these shares results in the level of in-house assets exceeding the 5% limit at the end of any financial year, Toby’s SMSF will need to sell enough of these shares to get back within the overall 5% limit.

To understand when a company or trust is deemed a related entity requires an understanding of who the related parties of an SMSF actually are.

This is important as an entity will be deemed to be a related party and hence trigger the in-house asset rules where it is controlled by a related party.

For a company, it is where the SMSF alone or together with any related party controls the company. Essentially where:

A majority of the directors are “accustomed or under an obligation” to do what other people direct them to do. So where they are making decisions regarding the company based on other people’s wishes; or
The SMSF alone or together with related parties can cast more than 50% of the votes at a general meeting of the company.

For a trust, it is where the SMSF alone or together with any related party controls the trust, where:

The SMSF alone or together with related parties has a fixed entitlement to more than 50% of the capital or income of the trust; or
The trustees are “accustomed or under an obligation” to do what other people direct them to do. So where they are making decisions regarding the company based on other people’s wishes; or
Where the SMSF and/or related parties can appoint or remove the trustee of that trust

The term ‘related party’ has a very specific definition under the superannuation law and includes:

A member of the fund: So all of the individual SMSF members.
A standard employer-sponsor: This includes any employer who contributes to a super fund under an agreement between the fund trustee and the employer. This is rarely, as contributions to an SMSF are in almost all cases made under an agreement between the employer and the fund member, not in the member’s capacity as a trustee.
A Part 8 associate of a member of the fund or a standard employer sponsor. Part 8 associates include:
- Fund members and their relatives, directors of the corporate trustee or all individual trustees, partnerships in which the member is a partner (including the individual partners, their spouse or child and the partnership itself), a trust where the member and their Part 8 associates control the trust and a company if a member and their Part 8 associates control the company.

Read more about related parties and relatives.

Other regulations and guidelines

If you are considering using your SMSF to invest in a related unit trust or company, there are other regulations and guidelines you need to consider, including the following:

Your SMSF investment strategy

All SMSF investments need to be acquired and maintained in accordance with the funds overall investment strategy.

You need to consider the need for diversification within the fund’s investment portfolio in order to manage risk effectively.

Make sure your SMSF investment strategy covers any related party investment and, where appropriate, detail how any associated risk will be managed.

Your SMSF trust deed and its wording

Refer to your SMSF trust deed for any fund specific rule or restriction relevant to related party investments.

There may be specific processes or restrictions imposed by your trust deed. Having a clear understanding of these is important.

Where required, update or amend your trust deed prior to any investment taking place.

There are strict rules regarding transactions between SMSFs and related parties, which would include investments held in related trusts or companies.

These rules require all transactions to be entered into and then maintained on an arm’s-length basis. This essentially requires the terms of the investment and all dealings between parties to be carried out as if the parties were not related.

Sole purpose test

The sole purpose of a super fund is to provide retirement benefits to the members of the fund or to their dependents on the member’s death. The sole purpose test is used as the basis for determining whether the fund is being maintained appropriately.

All transactions entered into by the SMSF and all investment decisions made by the fund trustees must be made with the sole purpose of the members retirement in mind.

The SMSF regulator makes the following comment regarding the sole purpose test:

“It’s likely your fund will not meet the sole purpose test if you or anyone else, directly or indirectly, obtains a financial benefit when making investment decisions and arrangements (other than increasing the return to your fund).”

Therefore, if your SMSF makes an investment into a related entity, that investment must be made with the intention of providing retirement benefits and not for the direct or indirect financial benefit of the members or related parties.

Read more about the sole purpose test and how it works.

The bottom line

As you can see, it is possible for your SMSF to invest in related companies and trusts, but you will need to have a good understanding of the relevant compliance requirements relating to the initial investment and those relevant on an ongoing basis.

If this is an area that you want to explore further, it may be a good idea to seek professional advice.

The information contained in this article is general in nature. Your personal position has not been taken into consideration. You should seek personal advice before taking any action.