Johnson responded to a question regarding members of an SMSF, aged 71 and 72, who have a personal unsecured loan of $300,000, lent to themselves and used to run a farming business. The farming business is in their personal names and they are charging eight per cent interest. The loan is about 8.62 per cent of the total fund assets.
“The question is whether this would be an in-house asset and therefore have to be kept below five per cent? Now that it is over five per cent of the fund’s assets do they just have to get it below that threshold or is it a case that they now have to repay the whole amount as it’s a breach of the fund’s in-house asset limit?” Johnson said.
“The loan on the SMSF balance sheet was shown as a business real property loan to what was thought to be a company until a copy of the loan doc was requested and which the client wasn’t able to produce.”
Johnson said in this example, there is a $300,000 loan from the fund to the members, and Section 65 states you can’t lend to a member or a relative of a member.
“To be a relative, you’ve got to be an individual, and there’s two separate definitions of relative in the SIS Act. There is the overall definition, and then there’s another one inside of Section 17A which extends to cousins. This is certainly a member, and you can’t lend to a member, so it is a straight out breach of section 65,” he said.
“Yes, it is still an in-house asset, because it’s a lease or a loan to a related party of the fund. So, it’s an in-house asset. You’ve breached Section 65 you’ve lent to a member and it is an in-house asset, so you’ve got to get rid of it from both and they have to pay the whole thing back.”
Johnson said as the members are over 65, a solution would be just to give them to money.
“I’d suggest in this example, there might also have a Part 4A problem because they are trying to get an interest deduction for the members and pay no tax in the fund,” he said.
“The best thing to do is get written advice which will probably say something along the lines of, you have to have an entity, you have got to set your farming up through a trust or a company, lend the money to the company, no more than five per cent of the assets of the fund.
“Now, if eight per cent is not an appropriate interest rate, then the fund will be paying 45 per cent tax on the earnings as well. I would imagine that these clients are actually doing quite well, and so maybe eight per cent is actually too much interest to be charging if you’ve got a $300,000 loan, that is only just over five per cent of the assets of the fund. I can’t comment on an arm’s length interest rate, but I can say that this is all a breach.”
