The economy continues to be turbulent. Everyone’s perspective of the economy is different depending on what state you live in and depending on what sector you are involved in. The mining sector (and associated states) are doing well while the retail sector is struggling.   Many small to medium businesses have been doing it tough for a considerable period of time. As a result, these businesses are looking to source finance, however finance can be difficult to obtain. If the traditional sources of finance are not available where do businesses turn?

Borrowing from your SMSF

One source that business owners may consider is their self-managed superannuation fund. The idea might seem perfect at the time however the rules are complex and there can be serious consequences if you get it wrong. The issues surrounding the use of your self-managed superannuation as a source of finance were reinforced by the Administrative Appeals Tribunal (AAT) in a recent decision.

A recent case

The facts of the case appear to read like a script from the ‘Perfect Storm’. The husband (business manager and proprietor) was seriously ill, the business premises had sustained damage during a cyclone, the cyclone resulted in a general downturn in trading conditions, suppliers started to withdraw credit and the business’s usual banker refused further finance. It was at this point that the business borrowed significant funds from the self-managed superannuation fund for which the husband and wife were trustees. The funds borrowed exceeded 95% of the superannuation fund’s total assets, well in excess of the in-house limit.

As a result of the borrowings, the auditor of the self-managed superannuation fund lodged a contravention report with the Australian Taxation Office advising that the fund had contravened the in-house asset rules. The Commissioner then issued a non-compliance notice in July 2008.  The trustees of the superannuation fund appealed against the decision however the appeal was rejected by the Tribunal, who said the husband's health issues and the impact of cyclones in North Queensland were only relevant considerations up to a certain point.

Penalties for breaches

Once a self-managed superannuation fund is found to be non-compliant the penalties are harsh. The fund no longer is given concessional tax treatment and the taxable income of the fund is assessed at the top marginal rate (currently 45%). However the real sting in the tail is the fact that the year the fund becomes non-complying, its assessable income includes the assets of the fund less any undeducted contributions. This has the effect of recouping all previously allowed tax concessions. This is a particularly frightening prospect for funds with significant balances and with members close to retirement.

What are the rules?

It should be remembered that the sole purpose of a superannuation fund is to provide benefits for members in retirement. It is a breach of regulations to invest in related parties above the 5% in-house asset limit. If a breach occurs then urgent action should be taken to rectify the situation.

A breach of the in-house assets rule does not automatically render a self-managed superannuation fund non-compliant. The Commissioner has the power to treat a fund as complying even though it may have contravened the law, however, this is on a case by case basis. Practice Statement PS LA 2006/19 has been released by the ATO and this outlines the factors the Commissioner will consider in determining whether a fund will be given non-compliance status.

A self-managed superannuation fund can bring significant benefits to members however the trustees must be fully aware of the rules governing the fund and the consequences of breaching these rules.