Key Highlights

•  No rule in the SIS Act prohibits an SMSF from carrying on a business, but restrictions on borrowing, charges and related-party dealings make it very difficult.

•  The ATO says the business must be operated to provide retirement benefits and look closely at family employment and private use of assets.

•  A fund owning business real property and leasing it to a business on arm's length terms is a more workable arrangement.

Some SMSF trustees, particularly those with farming, small manufacturing or hospitality backgrounds, wonder whether their fund could own and operate a business directly. It is a reasonable question. Superannuation law does not contain a blanket prohibition on an SMSF carrying on a business. Yet experienced practitioners say the practical answer is usually no.

At The Tax Institute's National Superannuation Conference in Melbourne, Sladen Legal business law principal Phil Broderick said that while SMSFs can legally run a business, he would advise against it, even for a small private production business on farmland.

Why it is legal but difficult

Broderick noted that no rule in the SIS Act prohibits an SMSF from carrying on a business, but said the Act's restrictions make operating one very difficult. He pointed to limits on related-party dealings, restrictions on borrowing in most circumstances and the inability of an SMSF to charge its assets. He added that where a fund uses an entity it controls, that entity must generally be structured as a trust meeting regulation 13.22C of the SIS Regulations, which carries further restrictions.

Each of these rules goes to the heart of how most businesses operate:

  • Borrowing. Businesses commonly rely on overdrafts, equipment finance and working-capital loans. The ATO's guidance on carrying on a business in an SMSF warns that overdrafts or margin lending used to fund the business may breach the borrowing restrictions.
  • Charges over assets. Lenders frequently take security. The same ATO guidance says borrowing with a mortgage over an asset breaches both the borrowing rules and the rules against charging fund assets.
  • Related parties. Family members often work in, supply or buy from a small business. The ATO says the business must not sell fund assets to members or relatives below market value, buy from them above market value, pay inflated prices for their services, buy plant or equipment from them in breach of the related-party acquisition rules, or pay a member or relative more than an arm's length salary.
  • The sole purpose test. The ATO says the business must be operated to provide retirement benefits for members, and that it looks closely at family employment, hobby-style activities, links with associated trading entities and private use of business assets.

The ATO also says the trust deed must permit the business and that the nature of the business, and how it is run, must be consistent with the fund's investment strategy.

Where SMSFs fit better

Broderick said SMSFs remain well suited to conventional investments such as shares, real estate, commercial property and cash. He also noted the concessional tax treatment of super, particularly for members below the $3 million and $10 million total super balance thresholds that now apply for Division 296.

Business owners can still use an SMSF in ways that complement their business. A common example is a fund owning business real property and leasing it to the owner's business on arm's length terms, which superannuation law specifically accommodates. Such arrangements still require careful documentation, market-rate rent and regular review.

Practical considerations for trustees

Trustees considering any business-like activity inside the fund should ask a few direct questions:

  • Will the activity require borrowing, credit terms or security that the fund cannot give?
  • Will any member or relative work in, supply or benefit from the activity?
  • Does the trust deed permit it, and does the investment strategy explain how it serves retirement objectives?
  • How would the activity be valued each year, and how would the auditor verify income and expenses?
  • What happens if a member needs to be paid out, or the fund needs to be wound up?

If the honest answers raise doubt, it may be more appropriate to hold the business outside super and to use the fund for investments that sit comfortably within the rules.

Hypothetical example

A hypothetical couple consider having their SMSF buy and run a small olive grove. The grove would need a seasonal equipment loan, the couple's son would manage harvests and the family would take some oil for personal use. Each of those features raises a separate compliance issue: borrowing, related-party dealings and a possible current-day benefit. By contrast, the fund buying the land and leasing it at market rent to a family business could be more workable, subject to the property qualifying as business real property and the lease being on arm's length terms.

Takeaway

An SMSF running a business is legally possible but practically fraught. Trustees attracted to the idea should seek specialist legal and tax advice first and consider whether holding the business outside the fund, and using the SMSF for conventional investments, better serves members' retirement.