Several years ago two clients came to me and asked advice about whether their SMSFs could invest in a business. The business was being started from scratch and would not only involve my two clients but a number of other people that would have equity.
At the time the business was being set up, it was thought that a bank overdraft might need to be put in place. There was a concern that if the ownership by the two SMSFs was not done correctly, future problems could be encountered with the rules concerning related party unit trusts.
The strategy devised at that time was to set up a unit trust where each SMSF had no more than 50 per cent of the units. As a result, neither of the trusts could be regarded as being in control and therefore the investment could proceed without the threat of restrictions associated with related unit trusts applying.
The unit trust ended up being the partner in three different businesses where the other partners were family trusts. As the two SMSFs were in pension phase, and therefore no tax was payable on the share of the business income earned or eventual capital gain when the business was sold, it was felt by having a partnership the other owners could maximise their potential capital gains tax relief using the small business concessions.
The business ventures proved very successful, resulting in large profits being earned by the SMSFs through the unit trust distributions. In each of the SMSFs, there were still members in accumulation phase and, despite the increased accounting costs, the assets of the funds were segregated so that the unit trust holding was allocated to the members in pension phase.
There has been some debate over the years as to whether an SMSF can carry on a business. The fact of the matter is as long as the various superannuation regulations are met there is nothing really stopping an SMSF operating a business.
SUB: Hurdles not necessarily obstacles
The first hurdle to get over is to make sure that the trust deed of the SMSF allows it to carry on a business. This in itself, if the trust deed of an SMSF currently does not permit the carrying on of a business, does not mean the end of the matter. In this situation the deed would need to be amended so that the SMSF could carry on a business.
The next biggest hurdle is to make sure that the investment will pass the sole purpose test. The ATO, rather than setting out the factors that it considers where the sole purpose test will be passed, instead gives examples of where the test would not be passed.
The ATO states, “cases that would attract our attention include those where:
- the trustee employs a family member (we would look at, among other things, the stated rationale for employing the family member and the level of salary or wages paid)
- the ‘business’ is an activity that is commonly carried out as a hobby or pastime
- the business carried on by the fund has links to associated trading entities
- there are indications that the fund’s business assets are available for the private use and benefit of the trustee or related parties”.
This means that SMSFs can carry on a business as long as the trust deed allows it; the sole purpose test is met; and other investment rules are met, such as the investment strategy including the running of a business, assets are not acquired from related parties, there are no borrowings, and that all operations of the business are conducted on an arm’s length basis.
