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22 December 2024

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Mistakes in SMSFs on related party loans

There are a significant number of professionals giving out some seriously wrong advice on related party lending. Some believe that an SMSF can lend up to 5% of the value of its assets to fund its members or the members’ relatives.

Loans to members or their relatives are prohibited by the superannuation law and you can get into trouble with the Tax Office for going down this path.

Why are professionals getting this wrong?

The reason for the mistake is that superannuation law does allow lending of up to 5% to a ‘related party’ of an SMSF, but there is a qualification people miss. The law is referred to as ‘in-house asset’ and is covered by section 71 in Part 8 of the superannuation law.

I prefer to write in plain English and I don’t normally quote sections of legislations when I write, but bear with me and you will soon understand why I need to do so in this article.

Another area of the superannuation law prohibits a trustee of an SMSF from lending or giving financial assistance to members and relatives. This law appears at section 65 of the superannuation law.

Reading on to subsection 65 (7) of the law states, “Nothing in Part 8 limits the operation of this section”. Essentially, this means that section 65 overrides section 71 which is in Part 8 of the superannuation law. SMSFs can never lend to their members or members’ relatives, not even under the 5% in-house asset limit, regardless of what is allowed under section 71.

Can an SMSF lend to a party who is not a member or a relative of a member of an SMSF?

The good news is it can. An SMSF can lend up to 5% of the total value of its assets to a related entity such as a related company or a related unit trust. It can also lend an unlimited amount to a member’s cousin or their former spouse (who are not members of their SMSF) because they are not considered related parties.

The reason an SMSF can lend to a cousin or a former spouse is because the definition of a ‘relative’ under the general definition in section 10 of the superannuation law does not include a cousin and former spouse. However, just to keep us on our toes, the definition of a relative under section 17A does include a cousin and a former spouse.

The section 17A definition covers the legal structure of an SMSF. It determines which individuals can be in an SMSF together. The section 10 definition, on the other hand, covers investment transactions involving related parties.

So, if your cousin or your former spouse is not a member of your SMSF, then you can lend to them. But if they are members of your SMSF, then your SMSF cannot lend to them.

The superannuation law can be complex as it has various twists. The fact that professionals can get it wrong suggests that if you receive advice that seems too good to be true, get a second opinion. It helps to have a good working knowledge of the law in spotting advice that is not up to the mark.

 

Monica Rule is an SMSF Specialist and author of The Self Managed Super Handbook – Superannuation Law for SMSFs in plain English. See www.monicarule.com.au.

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