Self-Managed Superannuation Funds (SMSFs) operate under strict regulations to ensure that fund assets are used solely for retirement benefits. One critical restriction under the Superannuation Industry (Supervision) Act 1993 (SIS Act) is the prohibition on related party loans and financial assistance to members or their relatives. Understanding these rules is essential to maintain fund compliance and avoid serious penalties.
Prohibited Loans and Financial Assistance
Under Section 65 of the SIS Act, an SMSF trustee must not:
- Lend money to a member or a relative of a member.
- Provide any other financial assistance using fund resources to a member or their relative.
Breaching these rules is one of the most common compliance failures in SMSFs, as reported by the ATO.
Who is Considered a Relative?
The SIS Act defines a relative as:
- A parent, grandparent, sibling, uncle, aunt, nephew, niece, lineal descendant, or adopted child of the member or their spouse.
- The spouse of the member or any of the above individuals.
Loans to any of these individuals will breach the SIS Act and result in compliance penalties.
Exceptions and Allowable Loans
While loans to members and their relatives are prohibited, an SMSF can lend money to a related party that is not a member or relative. However, these loans are treated as in-house assets and must comply with:
- The 5% in-house asset limit.
- The sole purpose test, ensuring the investment benefits fund members in retirement.
- Arm’s length terms, meaning the loan must be on commercial terms, including interest rates and repayment conditions.
Case Study: Prohibited Loan to a Relative
Scenario
Mary, as trustee of her SMSF, lends $15,000 to her brother John at a commercial interest rate. Despite being on commercial terms, this loan is prohibited because John is a relative of a fund member.
Outcome
- The loan breaches Section 65 of the SIS Act.
- The SMSF risks loss of compliance status and severe penalties.
Case Study: Allowable Loan to a Related Party
Scenario
Margaret and Jack’s SMSF lends $10,000 to their business, M & J Carpets Pty Ltd. The business is a related party, but it is not a member or a relative.
Outcome
- The loan is not prohibited, but it is classified as an in-house asset.
- The loan must not exceed 5% of the fund’s total assets and must comply with arm’s length rules.
Providing Indirect Financial Assistance
SMSFs must also avoid indirectly providing financial assistance to members or their relatives. Examples include:
- Selling an SMSF asset below market value to a member.
- Purchasing an asset above market value from a member.
- Forgiving a debt owed by a member.
- Delaying recovery of a loan owed to the SMSF by a member.
- Providing a personal guarantee using SMSF assets.
Even if these transactions are not direct loans, they still breach Section 65 and may result in penalties.
Case Study: Indirect Financial Assistance Breach
Scenario
Gwen and Marg’s SMSF lends $250,000 to their company, CleanPipes Pty Ltd. Soon after, CleanPipes Pty Ltd lends $250,000 to Gwen and Marg personally for an investment property.
Outcome
- Even though the SMSF did not directly lend to Gwen and Marg, it indirectly facilitated the loan.
- This breaches Section 65 and risks serious penalties.
Penalties for Breaching Related Party Loan Rules
If an SMSF breaches Section 65, the ATO may impose significant penalties, including:
- Administrative penalties (up to $18,780 per trustee, as of 2023-24).
- Fund disqualification, resulting in loss of concessional tax benefits.
- Civil and criminal penalties for serious breaches.
Trustees must ensure strict compliance to avoid these consequences.
Final Thoughts
Loans and financial assistance involving SMSF members and their relatives are strictly prohibited under Section 65 of the SIS Act. While certain loans to related parties may be permitted, they must comply with the in-house asset rules, the sole purpose test, and arm’s length requirements. Seeking professional financial advice is essential to ensure SMSF compliance and avoid costly penalties.