Many small business owners like to run self managed super funds (SMSF), but there are also some super funds that like to operate a business.
While carrying on a business within an SMSF is not forbidden, there are strict regulatory provisions in place that can make running a business in super difficult. These provisions may prevent trustees from conducting business activities without breaking SMSF law.
The rules
As with any SMSF activity, the SMSF trust deed must reflect its ability to carry on a business. If the deed allows this, then the Australian Tax Office (ATO) will consider the activities of the trustee when determining compliance rather than whether or not a business is being conducted.
The backbone to the SMSF provisions is whether any activity carried out by the SMSF trustees is done in accordance with the sole purpose test. Briefly, this means that the SMSF must be maintained for the ‘sole purpose’ of providing retirement or death benefits for its members or their dependents if they die before retirement. In order to determine if business activities breach the sole purpose test, the ATO will look at whether the carrying on of the business, instead of providing retirement benefits, is the sole purpose of the fund. In particular, the ATO will pay close attention to whether:
- the trustee employs a family member, their rationale for employment and the amount of remuneration;
- the business activity is commonly carried out as a hobby or pastime;
- the business activity has links to associated trading entities; and whether
- the assets of the fund are made available for the private use and benefit of the trustee and related parties.
Business limitations
SMSF law has robust provisions that enhance the sole purpose test and provide further framework for SMSF activities. An important provision in respect of carrying on a business is the prohibition of borrowing, subject to limited exceptions.
Businesses outside of super often use lines of credit or overdraft facilities to bridge short-term cash flow deficiencies or to grow and expand. Even though borrowing may be a normal trading activity for a business, these borrowing tools are strictly prohibited within an SMSF.
While a business may only intend to borrow for a short period, pay market rates of interest and repay the borrowing on time and in full, this would contravene the super borrowing provisions, irrespective of the counterparty.
Likewise, mortgaging an asset owned by the fund would breach the charge over assets restrictions. Therefore the business would solely have to rely on funds accumulated within the SMSF and any contributions made by the members, subject to contribution caps, to carry on the business.
More restrictions
Further restrictions involve:
• SMSF trustees are prohibited from lending money or providing financial assistance using the resources of the fund to a member or their relatives. This disallows members or relatives from acquiring an asset, product or service for less than its market value from the business within the SMSF, or selling to the SMSF at greater-than-market value. While traditional business owners may take advantage of discounted goods and services in the ordinary course of business, these practices from a business within an SMSF will deem the SMSF non-complying.
• All dealings with the SMSF must be conducted on an arm’s-length basis. This provision ties in with the financial assistance restriction discussed above, and also covers salary payments above market value.
• Acquiring assets from related parties is prohibited, subject to limited exceptions. If the business within the SMSF wishes to purchase equipment or assets from a related party, either as a one-off acquisition or supply contract, this would breach SMSF law. Therefore any purchases, regardless of value, must be from independent parties that are not considered related under super law. The related party definition is far reaching, including trusts controlled by members or relatives and companies that are sufficiently influenced by, or majority voting rights held by members or relatives.
Consequences of getting it wrong
Any breach of the super law provisions could have serious tax and legal implications for both the trustees and the SMSF, including civil penalties or criminal charges in severe cases. The SMSF may lose its complying status and therefore it’s tax concessions.
Understand each course of action
Every action undertaken in the course of running the business will need to be checked against all SMSF laws at every stage. Each case is taken on its own merits and therefore there is no blanket answer as to whether carrying on a business complies with all the SMSF provisions.
It is imperative that the trustees of the super fund fully understand the limitations of an SMSF as well as the needs of the business to assess whether it is possible to successfully run the business in the SMSF. This includes funding requirements, asset acquisitions, necessary connections with related parties and seeking legal advice where appropriate.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should, before acting, consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek professional advice.
