Peter Johnson, director of Advisers Digest, said section 65 stipulates that a fund cannot 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,” Johnson said.
“In the SIS Act, there is the overall definition, and then there’s another one inside of section 17A which extends to cousins. Therefore, you can’t lend to a member as that is a straight-out breach of section 65, and any property that may have been purchased with the loan is an in-house asset as it’s a lease with, or a loan to, a related party of the fund.”
Johnson gave an example of a couple that has a personal, unsecured loan to themselves, which is used to run a farming business.
The farming business is in the couple’s personal names. The loan is $300,000 and the couple is charging eight per cent on the loan. The members are aged 71 and 72.
According to the clients they received written advice from a global accounting firm advising that this arrangement was compliant but cannot produce that written advice.
The loan on the SMSF balance sheet was shown as a business real property loan to what was assumed was a company, but the company was also not able to produce the loan document.
“This would be an in-house asset as they have breached section 65 by lending to a member,” Johnson said.
“It is also a breach of section 71 and it means the couple will have to get rid of both the asset and the loan. I’d suggest there also might be a problem because they are trying to get an interest deduction for the members and pay no tax in the fund.”
Johnson continued that in this instance, the arrangement is probably part of a scheme, and the written advice that was allegedly provided would have stated that the couple should set-up their farming through a company trust and lend the money to the company at no more than five per cent of the assets of the fund.
“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 can’t comment on what is an appropriate interest rate. I would imagine that the 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,” he said.
“I also can’t comment on an arm’s length interest rate, but I can’t say that this situation is all a breach.”
