SMSFs and ‘business-like’ activities

MLC’s Peter Hogan explains what ‘business-like’ activities an SMSF may be able to undertake and outlines the related ATO guidance.

A frequently asked question is can a self-managed super fund (SMSF) carry on a business or enter into ‘business-like’ transactions and activities?

From a compliance perspective, the answer depends on the nature and circumstances of the activity.

What’s acceptable?

It is clear that the regular arm’s-length trading of assets such as shares, units in unit trusts and other similar passive investments in unrelated entities is generally viewed as acceptable by the regulators.

It could also be argued that the purchase and sale of real property would usually not breach the Superannuation Industry Supervision Act (SISA) requirements.

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This is supported by comments made by the Australian Tax Office (ATO) in SMSFR 2009/1.

Here it is stated that it would be unusual for an SMSF to meet the business indicators to such a degree as to distinguish the activities of a fund of investing in property from the normal investment activities of a trustee.

There are, however, many business-like activities that would need to be assessed on a case-by-case basis to determine whether they would or wouldn’t be acceptable from a compliance perspective.

The sole purpose test

A key area of concern is those activities that breach the sole purpose test.

In a document titled ‘Carrying on a business in a self managed superannuation fund’, the ATO states that if the trustee of an SMSF carries on a business, it would examine the activities closely to ensure that the sole purpose test is not breached.

Activities which would attract the ATO’s attention are listed and comprise those where:

• The trustee employs a family member (where they would look at, among other things, the stated rationale for employing the family member and the level of salary or wages paid)
• The trustee carries on a business that relates to an activity that is commonly carried out as a hobby or pastime
• The business carried on by the fund has links to associated trading entities; and
• There are indications that super fund assets are available for the private use and benefit of the trustees or related parties.

This is very much in line with the views expressed in SMSFR 2008/2, which sets out the ATO’s view on the application of the sole purpose test to SMSF trustee activities.

Assessing whether a retirement purpose exists rather than a current benefit being sought for the benefit of trustees or related parties will determine whether the sole purpose test has been met.

To do this, the ATO will look to the use to which SMSF assets are put and the actions of trustees, and assess those actions against the trustee responsibilities and duties as set out in the covenants in sub section 52(2) of SISA.

Failure by trustees to act in accordance with those covenants will raise questions as to the genuine nature of the retirement purpose for which the SMSF has been set up.

Other ATO guidance

In SMSFR 2009/1, the ATO details its interpretation of the definition of business real property for the purposes of SISA. In that ruling, it examines what it means to be carrying on a business.

In particular, in paragraph 123, it is stated that a trustee cannot carry on a business unless expressly authorised to do so by the trustee instrument or by statute, and the activities required in order to carry on the business are not prohibited by relevant trust law, including SISA.

This statement highlights two very important issues.

Firstly, the governing rules of the SMSF must expressly authorise the trustees to carry on a business or enter into business-like activities.

This will vary from fund to fund. It also suggests that carrying on a business or business-like activities per se is not the problem.

Secondly, and more importantly, it is other provisions of SISA which must also be considered when trustees commence business activities. These would include such things as:

• Assets owned being in accordance with the investment strategy of the SMSF
• More broadly, trustees will need to deal with the assets of the SMSF in accordance with the covenants generally
• Assets are not acquired from related parties, unless within the listed exceptions
• All transactions and dealings are undertaken on an arm’s-length basis
• Borrowings are not allowed unless within the limited recourse borrowing arrangement rules
• Assets are not used as security for borrowings
• Loans cannot be made by the SMSF to members or relatives
• Transactions entered into cannot provide financial assistance either directly or indirectly to members or relatives, and
• Related party investments and loans are limited to 5 per cent market value of the SMSF in accordance with the in-house asset rules.

In other words, apart from the sole purpose test, where the ATO will investigate whether a genuine retirement purpose is evidenced by the activities of the trustees, the investment standards contained in SISA will be applied against all business activities undertaken by the trustees.

Failure to comply with any or all of these standards repeatedly and systematically in the course of carrying on a business will go towards throwing doubt on the genuineness of the retirement purpose of the SMSF.

This can be helpful in distinguishing why something like share trading is an acceptable business-like activity, whereas property development can be more problematic.

The very nature of the activities that need to be undertaken in order to carry out a property development, especially where related parties are directly or indirectly involved, could easily breach one or more of the above investment standards.

In other words, it is the activities of a business which are the problem, rather than the idea of carrying on a business per se in a super fund.

It is therefore necessary to distinguish between activities which have a business-like look to them but don’t breach the investment standards and covenants in SISA, and those activities which fail to meet these requirements.

Peter Hogan is a senior technical manager at MLC Technical Services.