As SMSF trustees, we are aware that the objective of running our fund is to accumulate funds for our retirement and to pay out death benefits to our beneficiaries in the future.

While running an SMSF is so flexible that it is only limited by our imagination, your SMSF must still meet some criteria:

• At a legislative level, it complies with the Superannuation Industry Supervision Act (SISA);

• At a fund level, it adheres to your trust deed;

• At an operational level, it is for the sole purpose of providing retirement benefits for fund members.

One important consideration is to meet the sole purpose test (SISA s62). This test requires you to maintain your SMSF solely for at least one core purpose or at least one core purpose and for one or more ancillary purposes.

The "core purposes" are to provide benefits on or after the member's retirement, reaching age 65 or death, and the "ancillary purposes" are to provide benefits due to ill health, reversionary benefits, and other approved benefits on or after an appropriate condition is met.

The sole purpose test therefore has the only objective of benefiting the member, and if the member dies, the benefit be distributed to the beneficiary. Any other purpose is a breach.

You may risk breaching 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.

Your fund may breach the sole purpose test if your SMSF:

• Employs a family member, especially at a salary higher than an arm's length rate;

• Engages in activity that is commonly carried out as a hobby or pastime;

• Has links to associated trading entities;

• Has its assets available for the private use and benefit of the trustee or related parties.

Given our love of bricks and mortar, let's use properties as an example.
As the holiday season is coming, you may stay at your own properties. If you intend to invest in holiday properties and use them, make sure your use is merely an incidental benefit to pass the sole purpose test.

Examples are:

• Benefit inherent in investment: staying at the property whose shares the SMSF owns. You pay at market rate but are given a free upgrade because the SMSF owns it and this offer is part of the investment that cannot be separated;

• Maintenance of asset: staying at the property for a few days to conduct maintenance and repair while it is vacant; and

• Benefit to related party at market value: having accommodation at the property at market rate while travelling for work. The stopover, however, is incidental to the work route.

Anything more than an incidental benefit will risk breaching the sole purpose test. Examples are:

• Separately negotiated benefit: requesting a free stay in return for lower dividends to the SMSF and a free stay is not part of the investment offer;

• Benefit assigned to unrelated party at market value: investing in golf club shares with membership attached for personal enjoyment by swapping membership rights to gain access, with the knowledge of little capital growth.

These are sole purpose test examples in SMSF Ruling 2008/2 issued by the Australian Taxation Office (ATO).

When you operate your fund, you may also deal with fellow SMSF members or people around you, such as your family and business partners. They usually fall within the definition of related parties. Another ATO ruling to watch out for is SMSF Ruling 2009/4, which describes the meaning of "asset," "loan," "investment in," "lease" and "lease arrangement" in the definition of an "in-house asset" under SISA.

The significance of "in-house assets" is that you are restricted from lending to, investing in or leasing to a related party for investments totalling more than 5 per cent of the SMSF assets.

"In-house asset" is defined as "an asset of the fund that is a loan to, or an investment in, a related party of the fund, an investment in a related trust of the fund, or an asset of the fund subject to a lease or lease arrangement between a trustee of the fund and a related party of the fund".

The term "asset" is quite broad. It can be any form of property and may include every type of right, interest, or thing of value that is legally capable of ownership.

You may want to lend money or other assets to your family or business partners in times of need through making a loan. "Loan" is defined as the provision of credit or any other form of financial accommodation.

"Loan" also covers arrangements where there is no intention of gaining interest, income, profit, or gain, for example, an interest-free loan.

If you lend an asset, there will be a "lease arrangement". It means any agreement, arrangement, or understanding in the nature of a lease (other than a lease) between a trustee of a superannuation fund and another person, under which the other person is to use, or control the use of, property owned by the fund.

In meeting the definition of a "loan" or a "lease," it is regardless whether the agreement, arrangement or understanding is enforceable, or intended to be enforceable, by legal proceedings. In other words, it is regardless of whether you can, will, or want to get your money or asset back by suing the borrower.

Upon hearing this, you may figure calling it differently, say, to "invest" instead. To "invest" means to: (a) apply assets in any way; or (b) make a contract; for the purpose of gaining interest, income, profit, or gain.

Care must be taken because your fund cannot acquire an asset from a related party unless it is acquired at market value and is:

• A listed security (for example, listed shares, units, or bonds at an approved stock exchange);

• Business real property;

• An in-house asset, provided the market value of your fund's in-house assets does not exceed 5 per cent of the total market value of your fund's assets;

• An asset specifically excluded from being an in-house asset.

The significance of "market value" is that an SMSF must transact on an arm's length basis, which means the purchase and sale price of fund assets should always reflect the true market value for the asset.

If you acquire your asset at a premium (paying more than market value), you are not dealing at arm's length and therefore this is a sole purpose breach.

If you acquire your asset at a discount (paying less than market value), the difference between the market value and the amount paid by the SMSF should be recorded as a contribution. You will risk breaching the recipient's contribution caps.

As you can see, while there are many ways to operate your SMSF with a great deal of flexibility, certain rules still apply. Talk with your financial planner to ensure your investment strategies are compliant before you bring your ideas to life.

More from Morningstar

• Aussie grocers weather Amazon storm

• 13 simple rules for better fund investing

• Make better investment decisions with Morningstar Premium | Free 4-week trial

 

Victoria Kuok is an SMSF specialist advisor at the SMSF Association. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.