A superannuation fund is a trust in which money and other assets are accumulated and managed on behalf of its members; for the specific purpose of providing retirement benefits in the future.

Types of Superannuation Funds

A large proportion of Superannuation Funds currently in existence in Australia are Self Managed Funds.  The SIS legislation recognises and encourages this type of fund which is referred to as a Self Managed Superannuation Fund (SMSF). Such funds are termed Self-Managed as they are excluded from many of the reporting and other requirements imposed on larger funds.  To qualify as “Excluded” a fund must have a maximum of four members, and all members are trustees or Directors of the trustee company.  Funds that have more than two members must ensure that each member is a partner, director or trustee of the employer, sponsor or family relatives.  The remainder of this paper relates to this type of fund.

Statutory Controls and Requirements

The Government has introduced progressively a range of legislative framework laws and regulations with the following goals:-

• To provide protection for members assets as they accumulate in SMSF’s.
• To provide a framework to Trustees for administering SMSF’s.
• To provide regular information to members about their SMSF’s.
• To ensure members funds are retained for their intended purposes.
• To prevent abuses and exploitation of the significant Income Tax Concessions available to Superannuation Funds.
• To reduce future Government outlays and reliance by retirees on the Aged Pension.

The Need to Comply

The trustees of a SMSF are responsible for administering the fund.  One of the principal responsibilities is to ensure the fund complies with both the Income Tax Act and SIS Regulations.  This is an ongoing requirement, i.e. the Fund must ensure that at all times it retains its “Complying” Status. To fail this ongoing test can have a dramatic effect on the Fund, including loss of the income tax concessions (i.e. rate of tax increase from 15% to 45%).  All funds must confirm their “Complying” status to the ATO annually by submitting a Return which includes Statements by both the Trustees and Independent Auditor to that effect.  Trustees of SMSF’s must therefore have a good working knowledge of their duties, obligations and powers as set out in both SIS and the Funds own Trust Deed document.

What Rules do Trustees have to follow?

Under SIS there are some basic rules which are deemed to be included in every Fund trust deed.  These are called covenants and in simple terms they require trustees (amongst other requirements:

• act honestly in all matters concerning the fund;
• apply the same care, skill and diligence as an ordinary prudent person would if entrusted with the property of another:
• always act in the best interest of the fund members;
• keep the assets of the fund separate from trustees’ personal assets, and separate from any assets of the employer (or associates of the employer);
• not enter into any contract, or other arrangement, that would prevent or hinder them from performing their functions and using their powers properly;
• have the fund and its records audited each year by an independent auditor;
• formulate and implement an Investment Strategy for the fund which has regard to liabilities, risk/return, diversification and liquidity (this is explained further below);
• allow a member or a beneficiary access to relevant information or documents;

If a trustee breaks any of the above covenants, he or she may be sued by adversely affected fund members. 

Information to Be Provided To Members

“Excluded” fund trustees must provide to their members any and all information which the members would reasonable require to understand their entitlements and the management investment performance and financial condition of the fund at the appropriate times including:-

• when a person joins a fund;
• when a significant event occurs that a member would reasonably expect to be informed about;
• when a member leaves the fund;
• annually; and
• when a member or recent member specifically requests documentation which would help them understand their entitlements and the main features of the fund.

Investment Rules Which Apply to Self Managed Funds

Investment Strategy

All SMSF’s must have a suitable Investment Strategy.  This may include setting the trustee’s target rate of return and plan for achieving it (e.g. returns of 2% above the rate of inflation through investment in a “balanced” portfolio of property, shares, bonds and cash).

In formulating an investment strategy, the trustee is required to take account of:-

• the likely risks and returns of different investment classes;
• the need to spread risk by having an appropriate range or diversity of investment classes; and
• the fund continuing to be in a position to pay benefits to members as they fall due (liquidity of assets).

Investment Restrictions

The general requirement is that, in making investment decisions, the trustee must do so in the best interests of all members, and having regard to the whole of the circumstances of the fund.

SMSF’s are permitted to hold no more than 5% of total fund assets (based on market value) in certain assets including:

• investments in associated parties (such as trusts);
• investments involving associated parties e.g. leasing of assets to members or employer sponsors with an exception for business real property.

Lending To Members

Trustees and investment managers of all regulated funds (excluded and non excluded) must not lend fund money to members or relatives of former members.

Acquisition of Assets From Members or Relatives (Generally Prohibited) - exceptions for listed shares & business real property

Trustees and investment managers must not acquire assets other than listed securities (e.g. shares) from fund members or relatives of members.  Another significant exception allows for a SMSF’s to acquire business real property (freehold or leasehold property used exclusively in their business) from fund members or their relatives. For further information on business real property see our article “Adding Value to your SMSF with Business Premises”.

Borrowing by Superannuation Funds- possible from September 2007

Prior to September 2007 SMSF’s were generally prohibited from borrowing for investment purposes, or pledging or permitting any fund assets being used as security for borrowing  within the fund or by any other parties. Funds however, can borrow for short-term cash flow purposes. (e.g. for up to 90 days) .

New legislation was passed in September 2007 which permits superannuation funds to now effectively borrow money for approved investment purposes.

Investments To Be On An “Arms Length” Basis

Investments made by all superannuation funds must be at “arms length”.  That is, investments must be entered into and maintained on a fully commercial basis.  The purchase or sale price of an investment should be at full market value and the income received from the investment should also reflect a true market rate of return.

Residential property and holiday homes- members & relatives use banned

An SMSF may acquire residential property (including a holiday home) provided the following limitations are followed:

• purchase only at Arms Length: Under no circumstances can an SMSF acquire a residential property from a member or an associate of a member.
• arms length Tenants only- Under no circumstances can a residential property be tenanted to or made available for use by Members or relatives. (limited exceptions apply to pre August 1999 arrangements).

Sole Purpose Test and Investments

The sole purpose test referred to earlier requires that an SMSF is operated for retirement purposes.  Potential contravention of the sole purpose test may arise when the nature of investments suggests a non-retirement purpose behind the investments.  The provision of retirement benefits for members must be the overriding consideration behind all investment decision.