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SMSF investments – What Could You Invest In With SMSF?

SMSF investments – What Could You Invest In With SMSF?

I. Possible SMSF investments and the Sole Purpose Test

Most common SMSF investments include shares, listed and unlisted property trusts, fixed interest securities, government or corporate bonds, management funds, direct property and cash. Other investments that SMSF are allowed to investment, but are not so common include art, precious metals like gold or silver, derivatives, forex or commodities trading.

The main purpose of SMSF is to provide and generate benefits for members and not provide current day benefits.

Sole Purpose Test

The sole purpose test is a test used to see if the SMSF remain for the purpose of providing benefits to members when they retire or to their dependents if the member dies before retirement. Trustees should comply with this test to become eligible for tax concessions given to compliant superannuation funds.

The sole purpose test has a core and ancillary purpose. A regulated fund should be maintained for at least one core purpose or one core and one or more ancillary purposes. It cannot however be maintained for one or more ancillary purposes only.

  • The Core Purpose

The core purpose of an SMSF is to pay benefits to members when they retire from gainful employment. Another core purpose is to pay benefit to members when they have reached their prescribed age or pay benefits to a member’s beneficiaries or dependents on the member’s death.

  • The Ancillary Purpose

These are for the provision of benefits to members in circumstances such as: termination of a member’s employment, with an employer who had made contributions to the fund for the benefit of the member, end of employment because of ill-health (physical or mental), death of the member after retirement and when benefits are given to the his or her dependents or legal representative, death of a member after reaching a prescribed age and benefits are paid to his or her dependents or legal representative and other ancillary purpose approved in writing by the Australian Prudential Regulation Authority which include provision of benefits when the member is experiencing financial hardship or on compassionate grounds.

Contravention of the Sole Purpose Test

Looking at the character and purpose of the fund’s investments can show if the SMSF has breached the sole purpose test. If members gain current benefit from its investments, the sole purpose test is breached. Like if the funds own a beach house and members or related parties use this for their vacation, this is a breach of the test. Each fund transaction should be examined to ensure that the fund remains compliant and will benefit from concessions available to SMSFs.

II. SMSF Investment Restrictions

Breaching the laws of SMSF investments can turn into disastrous financial consequences and trustees will be fined and lose its compliant status. Even if the superannuation law does not say exactly what a fund can invest in or not, it restricts a number of investment practices.

This includes:

Investment on an arm’s length basis. Buying and selling assets must always reflect the assets’ true market value. Income from these assets should also reflect their true market rate of return.

Borrowing. Borrowing money from the SMFS is not allowed, except for limited circumstances. This exceptions include borrowing, for not more than 90 days and not exceed 10% of total assets, to pay for member benefits or surcharge liability.  To settle security transactions, borrowing may be allowed for not more than 7 days, as long as it was not foreseen as needed at the initial time of the transaction. For investment purposes, ‘limited recourse borrowing arrangement’ can be availed.

Loans to members or their relatives. Providing assistance or loans to members of the fund and their relatives is strictly prohibited. Properties of the fund or any assets cannot be used a guarantee to secure personal loans for a member or his or her relatives.

Acquiring assets from related parties. Trustees buying assets from related parties are strictly prohibited. The exception to this rule include assets acquired or purchased at market value if: it is an ‘in-house asset’, the asset is a listed security like shares, units, or bonds listed in the stock exchange, the asset is a business real property. Trustees of SMSF are allowed to purchase up to 100% of the fund’s total asset as business real property.

In-house assets. These are asset investments in a loan to or leases with a related party of the fund. Trustees cannot have more than 5% of the fund’s assets in this way. Business real property subject to a lease between a fund and a related party is an exception. SMSF may invest in unit trust or a company if certain conditions are met this include: it does not borrow, has no assets with a charge over them, does not loan money to persons and other entities, does not purchase an asset from a related party other than business real property at market value, does not directly or indirectly lease assets to related parties other than business real property, does not conduct business and process transactions at arm’s length basis.

Related Party. This includes all members of the fund and their associates, employer sponsors, and other associates or employer sponsor’s associates or their relatives, business partners and any companies or trusts they control.

Derivatives. These are allowed in SMSFs. Derivatives risk statement is needed if an asset of the fund is held as margin on your derivatives.

Sole Purpose Test. This test basically ensures that members are provided benefits from the fund when they retire or to their dependents if they die before retirement. If you have made an investment and you are gaining current benefits from it at present time, you are breaching the sole purpose test.

III. SMSF investments in Art and Collectibles

Yes, works of art are possible SMSF investments, but there are conditions that trustees have to comply with to meet their obligations. The conditions that apply to the investment on art include that it is an allowable investment according to the terms of the SMSF’s trust deed. That the SMSF has an effective investment strategy for the fund which includes the art investments and provide for the member’s retirement. Expert advice is needed to seek information on how to generate potential income or capital growth from the art investments; or to easily sell them and include any costs involved. The costs involved in the storage and insurance of the art is also important to the overall investment strategy. Understanding these will help in compliance with ATO provisions.

Restrictions on Using Art Work. SMSF investments in artwork should not breach the sole purpose test. They should not be displayed in the residence belonging to a member or associate at no cost. Breaching the sole purpose test may incur penalties and loss of compliant status. It may also cause the loss of tax concessions for the super fund.

Other collectibles that SMSF can invest in include: jewellery, antiques, artefacts, coins or medallions, postage stamps, rare folios, manuscripts or books, memorabilia, wine, cars, recreational boats, membership of sporting or social clubs, and particular kind of assets that are ordinarily used.

Restrictions that the government has set on these assets include: not lease that asset to related parties, not store them in a private residence of a related party, not permit related party to use the asset, document the reasons for deciding on their storage, insure the asset, and obtain valuation from an independent valuer if the fund would later transfer the asset to a related party.

IV. Derivatives

Derivatives are financial assets or liability value or derived from other assets, liabilities or indices. Derivative contract means an option contract or futures contract relating to any right, liability or thing.

Derivatives are legitimate and allowable SMSF investments but full compliance needs: that the trust deed includes derivative contracts as allowable investments, that there should be a derivatives risk management statement if margin or collateral is needed, a written investment strategy that includes derivatives and ensures that derivative contracts are opened, exposure is calculated and allocated to relevant assets. They should also be within the funds’ asset class parameters stated in the investment strategy.

V. Can the SMSF invest in Contracts for Difference or CFD?

CFDs are synthetic financial products that allow members access the movement in the price of shares and other instruments like stock indices, commodities, currencies and futures contracts without owning the product. Opening a CFD requires you to deposit into a CFDs bank account for the initial margin requirements. Later you may be required to make additional margin payments for moving losses on open positions. Large gains or losses may result in the exposure with relatively small deposits.

VI. Is Investing In Shares With Discount Cards Allowed?

ATO allows SMSF to purchase publicly listed discount card shares given that the investment is in according to the fund’s investment strategy and that the SMSF does not take part in a discount plan where the trustees would agree to a regular debit on their dividend payments.

Regular debit of dividend payments is not allowed. When the shareholder obtain discounts on purchases from certain stores, this cannot be viewed as an incidental benefit because dividend payments resulting from the holding of shares are reduced to pay for discount shareholder plan. The direct use of the fund’s income to pay for current benefit breaches the sole purpose test.

If you have more questions about possible SMSF investments or if you’re looking for a trusted and approved SMSF auditor, talk to us and we will do our best to help you.

Kingston Knight Audit are the Auditor Melbourne experts to contact when dealing with your trust account audit, SMSF Audit, financial statement audit,  and internal audit requirements. Contact us today, Kingston & Knight Audit offers a free telephone consultation to establish how we can best help you achieve the assurance and compliance you require.

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