We all spend a lot of time worrying about when an SMSF investment might involve a related party. But sometimes we overthink it. Let’s walk through some common scenarios where there’s actually no related party problem.
The most common scenarios I encounter in practice are situations where two individuals might have strong business ties but are not actually related parties.
For example, Hannah and Shrey are both directors of their business (HS Coffee Pty Ltd). They are also shareholders. They don’t have any family relationships connecting them or any other financial dealings. The fact that they “feel” very closely tied doesn’t make them related parties.
That means Hannah’s SMSF could, for example, invest in a separate business owned by Shrey or his family.
One or both of their SMSFs may even be able to invest in HS Coffee Pty Ltd but that will depend on the way in which that company is controlled.
Let’s say, for example, that control of HS Coffee really is exactly evenly divided – they have equal shares, both are directors, neither has a casting vote or any abnormal influence over the way the board behaves etc. Then it’s likely HS Coffee isn’t a related party and any investment in it would not be an in-house asset for their super funds.
The same would apply if (say) Hannah’s SMSF owned an industrial coffee machine which it leased to the business. Normally we think of SMSFs leasing anything to a member’s business (unless it’s business real property) as a problem. But that’s because if a fund leases an asset to a related party, it’s an in-house asset (and we need to keep it under 5% of the fund). But it wouldn’t be a problem in this case because HS Coffee isn’t a related party.
It would also mean that if HS Coffee leased a property owned by Hannah’s SMSF, they wouldn’t need to be sure it was business real property. For example, it might fail the definition because it’s a building that has both retail space and a residential unit upstairs. Normally that’s a problem but again, not in this case because the business isn’t a related party.
(Of course, all the usual – very important – rules around the sole purpose test, arm’s length dealings, etc would still apply. And we would also need to think differently if Hannah’s SMSF was initially going to buy the property from Hannah personally. For that transaction, we’d then need to consider an entirely different set of rules : the acquisition of assets rules. The property would need to be business real property for this to work, no matter who it’s being leased to once the SMSF owns it.)
What if instead, Hannah controlled HS Coffee? She (either personally or via family or entities she controls) owns the majority of the shares and Shrey is a minority shareholder? That definitely means an investment in HS Coffee by Hannah’s SMSF would be an in-house asset. But actually it doesn’t change anything for Shrey – his SMSF could hold shares.
It also doesn’t change anything when it comes to whether they two of them are related parties of each other. They’re not. So (for example) if she really wanted to, Hannah’s SMSF could still invest in Shrey’s Beans Pty Ltd - an entity controlled by Shrey.
And don’t forget, we don’t have to keep digging forever. What if HS Coffee and Shrey’s Beans each had a 50/50 share of the units in the HS Coffee Distributors Trust which is starting to build up a portfolio of other coffee businesses? The trust has a corporate trustee that they control equally.
Unless there’s more to this than we know, HS Coffee Distributors isn’t controlled by Hannah and her related parties. Instead, she – via HS Coffee – shares control of the trust with Shrey’s Beans and Shrey’s Beans isn’t controlled by related parties of Hannah’s SMSF.
What might change all this? Four main things.
A change in ownership
In our first example, HS Coffee was controlled equally by Hannah and Shrey and so it wasn’t a related party of Hannah’s SMSF. But as soon as the ownership changed (and Hannah controlled it), its related party status changed. The same would apply if HS Coffee took up a larger stake in HS Coffee Distributors. If HS Coffee ends up controlling that trust, it will be a related party of Hannah’s SMSF.
A (new) family relationship
If Shrey married Hannah’s sister all of this falls apart.
At that point, Shrey is a related party of Hannah’s and vice versa. That would change everything for both of them – any company or entity controlled by one of them is a related party for both the SMSFs and anything they control together is too.
And the couple doesn’t have to be married for this to happen – being de facto spouses has the same impact.
Owning assets jointly
If Hannah and Shrey owned their business premises jointly (rather than via a structure like a company) that makes them “partners” in a tax sense – ie receiving joint income. Partners are related parties of each other. The same would apply if the property was owned jointly by their respective family trusts and the trusts had individual trustees. That’s because technically, the individual trustees are partners of each other. This is one of the many reasons all trusts, not just SMSFs, should generally have a corporate trustee.
Joining the same SMSF
All members of an SMSF are related parties of each other so if Hannah and Shrey belonged to the same SMSF things change. For example, it would mean HS Coffee Pty Ltd was a related party no matter how the holdings were divided between them. It would also mean that even if Shrey also had his own SMSF and wanted to use money in that to buy shares in HS Coffee Pty Ltd (that is controlled by Hannah), he couldn’t. Hannah might as well be his sister – they are related parties.
Whether or not an investment involves a related party can be simpler than you think – but it’s worth understanding the rules as simple changes in your client’s circumstances can make a big difference to the outcome.
My colleague Lyn Formica explains all of this far better than I do – and fortunately a lot of her wisdom is captured in a new module in our Super Extension series: 'Super Extension – Investments'. If you haven’t already started our Extension program, now might be the time to start. And you can begin with any topic area so if this article has piqued your interest, start with 'Investments'.