Keeghan Silcock, senior associate with Cooper Grace Ward Lawyers, said in a recent webinar that although there are restrictions on an SMSF lending money, it may be possible for the fund to set up a loan to a related entity as long as strict protocols are followed.
“There are restrictions on an SMSF lending money. The first is that an SMSF cannot lend money to a member or a relative of a member such as a spouse, children, or parents,” Ms Silcock said.
“There is a blanket prohibition against that, and you cannot do it in any circumstance because it would amount to a breach of the prohibition against financially assisting a member or their relatives under Section 65 of the SIS Act.”
However, Ms Silcock said there are several ways an SMSF can lend money to a related entity if you consider the loan to be an in-house asset.
“It would be important that the amount of that loan is less than five per cent of the market value of the total assets of the self-managed super fund, otherwise, the loan would be in breach of the in-house asset rules,” she said.
She said a loan can also be made by the SMSF to a completely unrelated third party where there is no need to worry about the in-house asset rules or the five per cent limitation.
“But there are general requirements with which the SMSF would have to comply, both in respect of a loan to a related entity or to a third party,” she said.
“This includes that the loan must be on a commercial arm’s length term, particularly where you have a loan to a related entity.”
However, in this scenario, Ms Silcock warned that the fund must ensure there is written evidence from an independent party supporting that the terms of the loan are arm’s length and the contract includes the interest rate, repayment terms, duration of the loan, to ensure they are consistent with an arm’s length dealing.
“It’s important that the loan is documented in writing as well as any security that might be offered for the loan. Whether it’s a mortgage over real property, guarantees, security over other assets, that all needs to be documented in writing and registered appropriately,” she said.
Additionally, once the documentation is completed and the loan given, the parties need to comply with the terms of the loan. If the SMSF finds that the borrower hasn’t complied, it needs to take appropriate action.
“It’s not just sufficient that the loan was documented and put in place properly at the beginning.”
“This is a continuing arm’s length arrangement that needs to be enforced appropriately by the SMSF. The other rule that you should be wary of when an SMSF is making a loan is that the sole purpose test applies. It’s just the same as any other investment that an SMSF is making.”
She added the loan needs to be to provide retirement benefits for the members and can’t be because the borrower is a related business and needs money.
“The real purpose needs to be for the retirement benefits of the members. You also need to carefully check the terms of the SMSF trust deed and the SMSF’s investment strategy, and make sure that this type of investment is permitted for the SMSF,” she said.
If your SMSF is intent on lending money privately, then make sure it is at arms length. If it is a large unsecured loan, a higher interest rate does not necessarily compensate for and justify the risk.
e.g. find a bank that will lend the same amount as an unsecured loan. You probably can’t without security.
That is your arms-length benchmark. Regardless of the interest rate, if an arms length lender would not lend that amount of money unsecured, nor should the SMSF.