Highlights

  • SMSFs can legally carry on a business but face complex obligations under the SIS Act and related legislation.
  • The sole purpose test requires that all fund activities are directed at providing retirement benefits to members.
  • In-house assets must not exceed 5% of total fund assets, and non-arm's length income is taxed at 45%.
  • Entities controlled by the SMSF must comply with SIS regulation 13.22C to avoid related party restrictions.

Phil Broderick of Sladen Legal confirms that SMSFs can legally carry on a business, but the compliance architecture surrounding business activities inside an SMSF is complex. Multiple SIS Act provisions interact to constrain how the fund can operate, hold assets, and deal with related parties.

The Sole Purpose Test

The sole purpose test in section 62 of the SIS Act requires that an SMSF be maintained for the purpose of providing retirement benefits to its members, or death benefits to their dependants. Any business carried on by the fund must be consistent with this purpose. A business that provides current day benefits to members or trustees rather than retirement benefits risks breaching the sole purpose test, which carries severe consequences including loss of concessional tax treatment.

Related Party Restrictions and Borrowing

SMSFs face strict restrictions on acquiring assets from related parties and on in-house asset exposures. The in-house asset limit caps related party investments at no more than 5% of total fund assets. Entities that the SMSF controls or partially controls must comply with SIS regulation 13.22C to avoid being treated as related party entities that push exposures above the limit.

Borrowing by the fund to fund business activities is banned under the general borrowing prohibition in the SIS Act, except through compliant limited recourse borrowing arrangements. The fund also cannot charge its assets as security for any borrowing, which limits the financing options available to a business-operating SMSF.

Non-Arm's Length Income

Non-arm's length income provisions in the ITAA 1997 tax any income that the fund derives under arrangements not on arm's length terms at 45%, rather than the standard 15% fund tax rate. Where a business involves transactions with related parties, trustees must ensure all dealings are on commercial terms to avoid NALI exposure. This significantly increases the risk of an adverse tax outcome if business dealings are not properly structured.