SMSF lending money: “Neither a lender nor borrower be” – ATO lectures SMSFs
The ATO cannot stop an SMSF lending money. This is assuming it is in the best interest of the SMSF to lend money. Your SMSF may even lend money to a ‘related party’.
But the ATO wants you to treat your SMSF as a special delicate creature. It does not want you to see your SMSF as a racy business structure. We agree with the ATO.
Can a Self-Managed Superannuation Fund lend money?
Your SMSF invests and seeks to grow wealth. Lending money can achieve this. But tick these boxes before you lend the money:
- SMSF investment strategy. Does the Investment Strategy allow the SMSF to lend money? If not update it here.
- SMSF Trust Deed. Does the SMSF Deed allow lending? If not update your SMSF Deed here.
- SMSF compliant Loan Deed: build and sign the SIS compliance Loan Deed BEFORE your super fund lends the money
1. SMSF lending money to ‘unrelated’ third party?
It is possible for an SMSF to lend money to an unrelated third party. But, there are strict rules. Speak to your accountant before you do so:
- Is lending money part of your SMSF’s investment strategy?
- Does the lending meet with the SMSF sole purpose test? SMSFs are for the sole purpose of providing benefits to members upon their retirement. If lending does not meet this requirement, then your SMSF is non-compliant.
- Is the SMSF Loan on an ‘arm’s length basis’? Is it on fair market rates? Is the interest rate and repayments ‘commercial’?
- Is the loan on a commercial basis?
- Are the interest rate and repayments reflecting what a normal unrelated lender requires? (No ‘mates rates’.)
- Is the SMSF loan in the best interest of the SMSF?
Requirements of an SMSF Loan
The SMSF Loan agreement contains:
- How much is being borrowed
- The interest rate, or how the interest rate is set
- The length of the loan
- Minimum repayment amount
- Repayment frequency
- The security for the loan, if any
- Guarantors (if applicable)
Check with your advisor and accountant that your loan agreement complies with your fund’s:
If not, update your SMSF Deed.
2. Lending to ‘related parties’ — the SMSF prohibition – in house asset
There are additional rules when lending to a ‘related party’. Speak to your accountant first.
Your SMSF cannot lend money to members or their ‘relatives’. See Section 65 Superannuation Industry (Supervision) Act 1993. Section 65 prohibits your SMSF providing financial assistance, such as a loan, to members or your relatives. See the ATO’s SMSFR 2008/1.
Can an SMSF lend money to members?
The Australian Tax Office (ATO) restricts SMSFs from lending money to a ‘related party’ of your fund. This includes any members of the fund, relatives and spouses of members, and business partners and employers of members.
The ATO prohibits any financial assistance of any kind from an SMSF to a related party. There are both monetary and criminal sanctions if you break this law.
So, if you get into financial strife, your SMSF can not bail you out with a loan.
Can an SMSF lend money to a ‘relative’?
A ‘relative’ of an SMSF member includes:
- a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant
- adopted child of the member or their spouse
- a spouse of any individual stated above
‘In house asset’ when an SMSF lends money
However, SMSF trustees can lend to some ‘related parties’ of the SMSF. This is subject to the ‘in-house asset’ rules. The SIS Act limits investments in ‘in-house’ assets. ‘In house’ asset include loans to related parties. The limit is 5% of the total assets of the SMSF. But this is based on SMSF’s on going day to day current market value. Market values change all the time. Be careful.
So we now know that the ATO restricts SMSFs from lending money to a ‘related party’ of your SMSF fund. This includes any members of the fund, relatives and spouses of members, and business partners and employers of members.
The ATO prohibits any financial assistance of any kind from an SMSF to a related party. If you breach the rule you lose half of your super in penalties and face criminal penalties.
Can a “Loan” be an ‘in house’ asset?
The ATO defines a loan from an SMSF to a related party as an ‘in-house asset’. Other in-house assets include an investment in a related trust of your fund and an asset of your fund that is leased to a related party.
In-house assets cannot make up more than 5% of your SMSF’s total assets. Let’s say you have $2m in your SMSF. Most of it is in listed shares. You may be able to lend up to $100k to a related party. But if the following day the stock market crashes to 50% then you have lent 10% of your SMSF. You are in breach.
Can an SMSF lend money to your Family Trust or Unit Trust?
You may be able to lend money to a related party where:
While you can lend money to a related company or a family trust with a corporate trustee, you can never lend to a member’s:
- sole trader business
- trust where the trustee is a human (rather than a company)
e.g. Freida Jones as trustee for (ATF) Jones Family Trust
Can the SMSF ‘related party’ be a family trust with a human trustee?
- a company as its trustee.
For example, Xono Pty Ltd as trustee of the Kyle Family Trust; or
- a human as a trustee.
For example, David James Kyle as trustee for the Kyle Family Trust
There is nothing wrong with having a human being as a trustee of a trust. But, your SMSF should not lend money to a family trust which has a human as a trustee. And that trustee is a member or related to a member.
- Mary and John are the members of the Smith Super Fund. (It makes no difference who the trustee of the Smith Super Fund is.)
- John personally (not a company) is the trustee of the Happy Family Trust. E.g. John atf Happy Family Trust
- The Smith Super Fund should not lend to their family trust
- This is because the Happy Family Trust has John (a member of the SMSF) as the trustee of the family trust
- John now updates his Family Trust Deed and replaces himself with a new corporate trustee company E.g. NewCo Pty Ltd atf Happy Family Trust
- the Smith Super Fund can now lend money to the Happy Family Trust
Is Legal Consolidated’s position on SMSF Loans to ‘related party’ conservative?
Your accountant, adviser and lawyer may feel Legal Consolidated is being overly conservative. But we like our clients to sleep at night.
For example, the ATO’s SMSFR 2008/1 strangely states:
Arrangements or transactions that do not contravene paragraph 65(1)(b)
Investing on commercial terms
217. If an SMSF invests on commercial terms in an unrelated entity and that unrelated entity, independently of the SMSF and in its own right and from its own resources, gives financial assistance to a member or a relative of a member the investment by the SMSF in that unrelated entity does not result in a contravention of paragraph 65(1)(b).
We are of the view that the ATO is wrong and reckless in this comment. We think there is a real risk that if the matter went to the Court, the Court would look at this as a breach of the law. The Courts care little with the ATO’s views of the world. The Court only considers what the law states. The Court does not consider what the ATO thinks the law means.
What is an SMSF Loan Agreement?
A Self-Managed Superannuation Loan Agreement is an agreement between a Lender (your SMSF) and a Borrower. This SMSF Loan Agreement is a formal way of setting out the terms and conditions of the loan.
The SMSF Loan Agreement addresses what the rights are of the parties, including:
1. the initial amount being borrowed
2. how it is repaid
3. any interest payable
5. right to use the loan to support mortgages, debentures, charges and Personal Property Securities Register (PPSR) registrations.
An SMSF operates through the SMSF trustee. The lender is the trustee of your SMSF. The lender may be a human or a company. For example:
Colin and Karen’s SMSF lending money to their Family Trust:
- Colin Roberts and Karen Jane Roberts are the trustees of their SMSF. Their SMSF is called the Roberts Super Fund ABN 28383738373. Therefore the Lender is:
- Lender One: Colin Roberts [Tick yes to the trustee question and type in Roberts Super Fund ABN `28383738373]
- Lender Two: Karen Jane Roberts [Tick yes to the trustee question and type in Roberts Super Fund ABN 28383738373]
- Colin and Karen at trustees of their SMSF are lending to their Family Trust. KJ Robert Pty Ltd is the trustee of their Family Trust. Their Family Trust is called the C & K Robert Family Trust ABN 483838383. Therefore the Borrower is:
- Borrower: KJ Robert Pty Ltd [Tick yes to the trustee question and type in C & K Robert Family Trust ABN 483838383.
Smith Pty Ltd as trustee for the Smith Super Fund lends to the Smith Family Trust
- Smith Pty Ltd is the trustee for the Smith Super Fund ABN 23838383338. Therefore, the Lender is:
- Smith Pty Ltd [Tick yes to the trustee question and type in Smith Super Fund ABN 23838383338]
- Smith Pty Ltd as trustee for the Smith Super Fund is lending money to Jenkins Nominees Pty Ltd who is the trustee of the Jenkins Family Trust ABN 38838383993. Therefore, the Borrowers is:
- Jenkins Nominees Pty Ltd [Tick yes to the trustee question and type in Jenkins Family Trust ABN 38838383993]
SMSF lending money with security – Mortgages, debentures, charges and PPSR
The SMSF Loan Agreement allows you to lodge caveats, mortgages, PPSR, fixed & floating charges, debentures and encumbrances over the Borrower’s assets.
The SMSF as the Lender is authorised to direct the Borrower to sign all documents required to charge and register all the Borrower’s interest in:
a) land the Borrower owns or controls from time to time (this includes the right to lodge mortgages, equitable mortgages, Mortgages, caveats and other encumbrances of any nature whatsoever); and
b) other assets, fixtures, chooses in action and chattels owned or controlled by the Borrower including by way of debentures, fixed & floating charges, mortgages, equitable mortgages, caveats, Personal Property Securities Register (PPSR) and share capital
Add Guarantors to an SMSF Loan Agreement?
A Guarantor promises to answer for the debt. This is if the Lender defaults on the Loan. If the Lender cannot or will not fulfil the obligations of the Loan (such as not pay the money) then the Guarantor is contractually obliged to fulfil the obligations. This is under the SMSF Loan Agreement.
For example, the SMSF is going to lend money to Smith Stix Pty Ltd. The SMSF feels the company does not have many assets so it increases the interest rate and makes the director of the company be a Guarantor. If Smith Stix Pty Ltd fails to make good on the loan then the SMSF has recourse to the Guarantor.
If the trustee of the SMSF (as Lender) wishes, the Lender adds additional persons to guarantee the repayment of the loan.
Is the SMSF a professional lender of money?
There are two types of Lenders:
- Professional lenders: Example: banks such the Commonwealth Bank of Australia and ANZ, other lending institutions such as AMP; pawnbrokers and shop owners providing laybys.
- Non-professional lenders: other people such as mum and dad lending money to a child; a person lending money to a friend; a person or company lending money not as part of their business or as a one of transaction
This SMSF Loan Agreement is for non-professional lenders.
Can I just do an SMSF Loan Agreement on the back of an envelope?
In the movies, IOUs are often handwritten on a piece of paper. Sometimes instead of an SMSF Loan Agreement, someone does a ‘minute’. Both approaches fail. In Rowntree v FCT  FCA 182 shows the additional care required to document even simple related-party transactions, such as loans. In this case, the taxpayer, a practising NSW lawyer, claimed he borrowed over $4m from his group of private companies. The Court said:
‘Mr Rowntree has not deliberately chosen to ignore the law. His evidence presented to the Tribunal suggests that he genuinely believed that there were arguments to support his view that a loan was in existence.’
He failed. Only a legally prepared Loan Agreement satisfies the ATO, Bankruptcy Courts and Family Court. Only a legally prepared Loan Agreement supports mortgages and debentures.
The SMSF must be commercial
What is the correct interest rate an SMSF should charge?
The interest rate must be ‘commercial’. What would a bank charge? A bank ‘lends’ money through its credit card at say 17%. This is because it is unsecured. And there are no guarantors. But the same bank will lend the money at a lower interest rate if it is secured by real estate or a guarantor.
You need to talk with your financial planner and accountant as to what a ‘fair’ or ‘commercial’ interest rate should be.
Can I capitalise the loan being given by an SMSF?
Again the answer is ‘yes’ if that is commercial and usual. Banks often provide capital only loans. But they may charge a higher interest rate. Or they may charge a lower interest rate. They may be more likely to require a guarantor.
Are you acting in the best interests of the SMSF? Is capitalising the loan normal and commercial?
Speak to your financial planner and accountant.
What does the SMSF Loan contain?
1. Our letter of advice for your SMSF Auditor
2. SMSF Loan Agreement
Press the ‘Sample’ button above to see a full sample of the SMSF Loan Agreement.
Why prepare my SMSF Loan Agreement on a law firm’s website?
You are dealing directly with a law firm website, therefore you:
1. retain legal professional privilege
2. Legal Consolidated, is an Australian law firm, it is responsible for the SMSF Loan Agreement
3. receive legal advice from us
Help in building the SMSF Loan Agreement
You are building your SMSF Loan Agreement on an Australian legal practice’s website. Start building, for free, your SMSF Loan Agreement. Read the hints. Answer as many questions as you can. Telephone us if you need a hand answering the questions. But, start the free building process first. The building process is designed to educate you and answer most common questions.
These are some sample hints that you can read as you build the SMSF Loan Agreement:
Who is the Borrower?
The Borrower is the entity (human or company) who is going to receive the capital (e.g. money) from the SMSF lender.
How do I describe my SMSF as the Lender?
The SMSF Lender is the entity (human or company trustee) who is passing the capital (e.g. money) to the Borrower.
In this SMSF Loan Agreement, the person who is the Lender is lending the money. The person who is the Borrower is the person borrowing the money.
What does the SMSF Loan Agreement kit include?
Why is it better to prepare SMSF Loan Agreement on a legal practice website?
You are dealing directly with a lawyer website, therefore you:
- we are responsible for the legal document
- hints and videos for every question
- full document sample before you start building
- law firm letter confirms we authored the Loan Agreement
- legal professional privilege
How do I build the SMSF Loan Agreement?
- Answer the questions on our website
- Read the Summary page
- Lock and Build the SMSF Loan Agreement
- Type in your Credit Card details
- The SMSF Loan Agreement, our covering letter and Tax Invoice are emailed to you
- Print and sign the SMSF Loan Agreement
I do not know how much I’m lending.
Sometimes you do not know the amount that you are lending. If you do not know you can leave it as the default answer; “as lent from time to time”.
If you do know but are paying it in instalments, then put it all in as one figure.
Otherwise, just put in the total figure. Remember to put in the dollar sign.
What if I do not have a payment date?
Sometimes you might not want to set a specific date in the agreement. You can leave it as the default answer; “payable on demand as demanded by the Lender”.
If you want it all paid back on the one date, just enter that date.
If the SMSF is being paid back in instalments, you can word it how you like. For example:
- “Payable in instalments of 10% per calendar month”
- “Half to be paid on 21 September 2030, and the remainder to be paid on 21 September”
- “$100 to be repaid weekly for 10 weeks starting from 4 July”
What do I put in as the interest rate?
There are five ways you can answer this question depending on how you’d like to do it:
- If you are charging no interest, put the word ‘Nil’ – this would not be correct for an SMSF.
- If you are not sure what the interest rate is yet, leave it as the default. This is ‘as demanded from the lender from time to time’.
- You can put in a flat rate. For example, ‘5%’ (do not forget to put the % sign in).
- Keep it variable, for example, ‘2% above the Commonwealth Bank interest rate’.
- You can also use the inflation rate. You could word it something like ‘calculated according to the percentage increase in the Consumer Price Index (all groups) for the average of the capital cities of the Commonwealth of Australia. (As published by the Australian Bureau of Statistics or body that takes over that function.)’.
But, always get sign off by both your accountant and you Auditor.