SMALL SUPER FUNDS – INVESTMENT RULES
The Superannuation Industry (Supervision) Act 1993 (the SIS Act) contains a number of rules governing the investment activities by superannuation funds that are designed to limit the risks associated with investing that money and to ensure that superannuation savings are preserved until retirement and not accessed for current use.
However, investment options were reduced for new investments made after 11 August 1999 by small superannuation funds. The investment rules in the existing legislation (ignoring any transitional rules) that applies to a small superannuation fund limit or prohibits some investment activities between related parties of the fund and permit others. The main rules relate to the following items.
5% Limit On In-House Assets
The fund cannot hold more than 5% of market value of fund assets in the form of in-house assets. An in-house asset is defined as a loan to, or an investment in, a related party or a lease or lease arrangement with a related party. This rule limits superannuation savings from being invested in an employer-sponsor or associate of the employer or the member. Fund trustees need to ensure that they do not exceed the in-house asset limits.
Applying The 5% Limit
Where the fund trustee enters into a lease or lease arrangement for property other than business real property with a related party, which involved part of the property, or part of the income year the 5% limit applies in the following ways:
Part of a property – The in-house asset is the part of the property that is leased to the related party.
Example – A fund owns a block of flats and leases one flat to a related party. The flat lease the related party is an in-house asset that is subject to the 5% limit, not the entire block of flats.
Part of the income year – The full value is an in-house asset for that period that it is leased or subject to a lease arrangement with a related party.
Example – A fund owns a holiday house, and leases it to a member for two months of the year. The full market value of the beach house is included in the in-house asset ratio of the fund during that two-month period.
Loans To Members And Relatives
As the fund is prohibited from lending or providing other financial assistance to members and their relatives and this strategy cannot be used to create wealth. The underlying reason for this is to prevent the use of superannuation savings as a means of providing financial support to members before they retire. Also note that this rule takes precedence over the in-house asset rule.
Applying This Rule With The In-House Asset Rule
A fund can make a loan to a related party who is not the member or a relative of the member where the loan, together with any other in-house assets, does not exceed the 5% in-house asset limit at that time.
Investments To Be Made On Arm’s Length Terms
There is a general requirement in the SIS Act that investments are made by a superannuation fund on arm’s length terms. What this means is that investments should be entered into, and continued, on commercial terms. This rule is designed to limit non-arm’s length transactions actually being used to give early access to superannuation savings for non-retirement purposes.
Investments In Related Companies And Unit Trusts
Except for transitional investment rules, the general rule is that superannuation funds cannot make investments in related companies and unit trusts.
However, small superannuation funds can invest in certain related companies and unit trusts 9but only whilst they continue to have four or less members and satisfy strict rules specified in SIS regulations 13.22A to 13.22D).
These stringent regulations do allow full ownership or joint ownership of business real property by small superannuation funds and their related parties via an ungeared company or trust. The company or trust may also own other assets that are not specifically excluded by the regulations.
Such investments by small superannuation funds are not in-house assets, only where all of the specified requirements are met. If a requirement is breached the exception ceases and any investments made by the small fund that exist at that time become in-house assets and so subject to the 5% of market value limit.
Another alternative is to make an investment as tenants in common with a related party. In simple terms tenancy in common is where two or more entities own undivided property, but each can dispose of its share to an entity other than the other tenant/s in common (this contrasted with joint tenancy where there is a right of survivorship).
Peter Townsend BS, LLB, FAICD
Peter Townsend Business Lawyers
The Clarence Street Professional Group
222 Clarence Street
SYDNEY NSW 2000