Is Your SMSF Carrying on a Business?
Investing in an SMSF provides a number of benefits, not least of which is the tax free income available upon retirement. It also allows assets to be pooled, costs to be controlled, and the trustee can employ a number of tax strategies to reduce the tax burden. This last point in particular attracts the attention of the Australian Tax Office (ATO), for it understands the temptation of carrying on a business within an SMSF structure and thus avoiding a chunk of tax.
For many, the distinction between carrying on a business and investing in a business is a grey area; but if the ATO believes your SMSF is carrying on a business it will put the entire SMSF under the microscope. It is also easy for an SMSF to mistakenly carry on a business, so a trustee needs to understand the way in which the ATO determines whether an SMSF is carrying on a business to avoid raising the ire of the ATO.
The four determinants of carrying on a business in an SMSF
When deciding whether an SMSF is carrying on a business, the ATO will be most concerned in four areas:
- 1. The sole purpose test
The SMSF must be operated with the sole purpose of providing benefits upon retirement (or death). Running a business as part of an investment strategy and remunerating members and beneficiaries of the fund is a clear indication that this rule has been broken.
- 2. Arm’s length requirements
Any transactions undertaken by the SMSF must be made ‘at arm’s length’. Doing so ensures that conflicts of interest are avoided. Property should be independently valued before purchase or sale, and the overriding test is to decide if “a prudent person acting with due regard to their own commercial interests would have made such a transaction.”
- 3. Trustee remuneration
Section S17A of the Superannuation Industry Supervision Act states that a trustee cannot receive any remuneration from the SMSF for any duties performed as the trustee. However, the trustee can charge for their services if the trustee:
- usually provides the services paid for, and
- holds all necessary qualifications, and
- usually provides the services in the course of their work, and
- the amount paid is not higher than would have been paid on an arm’s length transaction
- 4. Charges over assets
This is, perhaps, the ATO’s main area of concern when determining whether the SMSF is carrying on a business. Generally, the SMSF must not give a charge over any of its assets to at third party. However, during building work and property development it is common for contracts to give a charge over the property, and if contracts are not fully inspected and amended accordingly the SMSF could be in breach of the ATO’s guidance on carrying on a business.On top of this requirement, SMSF rules also state that any borrowing must be made by way of a Limited Recourse Borrowing Arrangement (LRBA), and this can only be made for a single asset – read more about borrowing to fund the purchase of property within and SMSF here.
Check your SMSF at regular intervals
Make sure your SMSF isn’t in breach of the ATO guidance on carrying on a business in an SMSF by checking for compliance at regular intervals, and especially prior to any property investment or maintenance program. Remember, too, that it is the trustee who will be held as ultimately responsible for compliance: it’s an important job governed by many rules and regulations.
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