By Andrew Zbik – Published in Canstar on 24th April 2023.
Australia has one of the-largest pools of retirement savings in the world. These retirement savings are held within the superannuation system, which is largely governed by the Superannuation Industry (Supervision) Act (the SIS Act).
The SIS Act for short applies in the same way for industry superannuation funds, retail superannuation funds and Self-Managed Super Funds (SMSFs)
Superannuation is highly regulated. Most Australians who have their retirement savings and investments within the superannuation system can benefit from a lower tax rate on that money, compared to savings and investments held in their own name.
You are not the actual ‘owner’ of your superannuation while it’s being held by your fund. You are the ‘beneficiary’ of your superannuation. This means your retirement savings and investments are owned by a ‘trustee’, who manages it on your behalf.
That is why your superannuation is regulated and controlled, and you can’t simply do whatever you like with it.
Most people in Australia have a super fund as their trustee, but the SIS Act also allows you to establish your own superannuation fund, appropriately named a Self-Managed Super Fund (SMSF).
Below is a breakdown of the general structure of an SMSF. Note that SMSFs can contain up to six members and not all SMSFs necessarily have a trustee company, with the members acting as trustees instead.
The structure of a Self-Managed Super Fund (Corporate Trustee)
Source: Andrew Zbik
Setting up and managing an SMSF can be a lot of work, and there are a number of rules and restrictions on how they can legally work. Below are the main sections of the SIS Act that guide how SMSFs operate.
Section 62 – the sole purpose test
This is a legal test that outlines how retirement savings and investments must be managed to be compliant with the SIS Act and benefit from the concessional tax treatment of the superannuation environment.
Any savings or investments within superannuation need to be managed with the ‘sole objective’ to provide each member with:
benefits for retirement (i.e. income to cover living expenses)
benefits after death (i.e. a benefit for that member’s dependents)
The best example I give of the ‘sole purpose’ test is where an SMSF may purchase an investment property. If that property is leased to a tenant at arm’s length (i.e. the members of the SMSF do not know the tenant personally and the rent is in line with the market rate), the ‘sole purpose’ test is likely to be met.
If the property is leased to a person who is related to a member of the SMSF by blood, marriage or business association, the ‘sole purpose’ test is breached, as another benefit (i.e. enjoyment of that property) is received.
The SIS Act outlines that any member of an SMSF, along with anyone who is related to a member by blood, marriage or business association, is deemed to be a ‘related party’ of the SMSF.
Section 66 – Acquisitions of certain assets from members of regulated superannuation funds prohibited
An SMSF generally cannot purchase an asset that is owned by a member of the SMSF in their own name.
But due to the complexity of managing this provisions, all industry superannuation funds to my knowledge will only accept cash as a form of contribution to a member’s superannuation account.
Quite a number of retail superannuation funds will permit members to transfer assets such as Australian shares into their account via what is called an ‘in-specie’ transfer.
This is a fancy name for transferring the ownership of your shares from your own name into your superannuation account.
But most retail funds do not permit you to transfer these shares back to yourself as an ‘in-specie’ transfer.
SMSFs have the most flexibility. Shares can be both ‘in-specie’ transferred into a SMSF as a form of contribution. SMSFs can also transfer shares via an ‘in-specie’ transfer back to a member as a form of pension payment.
In limited and special circumstances, some types of real property such as commercial property and industrial property can be transferred ‘in-specie’ or sold to a SMSF.
In limited and special circumstances a SMSF can then sell or ‘in-specie’ transfer commercial property, industrial property and residential property back to a member of that fund.
There are some exceptions to this rule. Examples of assets that can be purchased from a member of an SMSF are:
Business real property (This is commercial or industrial property. Residential property is not permitted).
Listed securities (This refers to any shares listed on a public share exchange, such as the Australian Stock Exchange).
Certain in-house assets. These are assets that may include widely held unit trusts, or shares in a private company and cannot be greater than 5% of the fund’s total assets. This is quite a specialist area and is covered in subsection 71(1) of the SIS Act. It would be wise to seek professional advice when considering purchasing an in-house asset.
Key obligations when purchasing assets from a member of the SMSF are:
The asset must be purchased at its fair market value.
The transaction must be conducted on commercial terms.
The transaction needs to be properly recorded.
Section 67A – Limited recourse borrowing arrangements
Prior to 2007, SMSFs could not borrow money for the purpose of purchasing assets.
SMSFs since 2007 can borrow money to purchase a ‘single acquirable asset’.
A ‘single acquirable asset’ is something such as a parcel of shares (e.g. 100 identical shares in a public listed company. The shares could not then be sold in tranches, only as a parcel of 100 shares) or a title in a single property (i.e. an SMSF cannot borrow money to own two separate properties, or to own 50% of a property as tenants-in-common with another owner).
A key aspect of SMSF borrowing is that it must be of a ‘limited recourse nature’. This means the lender of the money used to purchase the asset can only claim security over the assets that the borrowed monies were used to purchase. The lender cannot have any claim over any other assets owned by the SMSF.
This is another example of where the SIS Act applies equally to industry superannuation funds, retail superannuation funds and Self-Managed Superannuation Funds (SMSFs).
But the administrative requirements are quite complex. Therefore, industry superannuation funds and retail superannuation funds simply do not provide this option to their members.
Hence, most people will need to determine if it is appropriate for them to establish a SMSF for the purposes of borrowing money to invest in certain assets.
Summary on super
All superannuation funds in Australia, including both industry and retail super funds as well as SMSFs, are governed by the Superannuation Industry (Supervision) Act.
But Australians who are members of an SMSF can utilise aspects of the SIS Act, such as Sections 66 and 67A summarised above, to use their super in ways which are not usually available to members of industry or retail superannuation funds.
Bear in mind that managing an SMSF can be costly and time-consuming, and that there are legal and financial risks involved. This is also a fairly complex area of Australia’s super laws, meaning it could be wise to seek professional advice from a qualified adviser before you decide to set up an SMSF or make any significant investment decisions.