Arms Length Rule
Along with the flexibility of managing your own superannuation comes a greater responsibility to act in the best interests of the SMSF, over and above the interests of other parties with whom the SMSF may deal.
Members of an SMSF are typically the same individuals that manage the investments and ongoing administration of the fund. There is therefore an increased likelihood that an advantage or benefit may be provided to a related party, which is not appropriate in the superannuation environment, either inadvertently or wilfully.
In order to comply with the objectives of the Superannuation Industry Supervision Act 1993 (SIS Act) and prevent the abuse of the superannuation system concessions, all transactions in an SMSF must be conducted on an arm’s length rule (commercial) basis. Understandably there may be many transactions which are not conducted ‘at arm’s length’ due to the close relationship the fund’s members will share with the trustee/s of the fund and the ability of the fund to have dealings with related parties (in some circumstances). Regardless of this non-arm’s length relationship, all dealings must be conducted in the same way as if both parties were actually unrelated and operating in a normal commercial relationship.
It is essential when a transaction occurs between the fund and another party, that “the terms and conditions of the transaction are no more favourable to the other party than those which it is reasonable to expect would apply if the trustee or investment manager, as the case may be, were dealing with the other party at arm’s length in the same circumstances” (Section 109(1)(b) SIS Act 1993).
Of particular note:
- Purchases and sales of the assets of an SMSF should always be conducted at the appropriate market value.
- Income from assets owned by the fund should always be indicative of the ‘going rate’ in an open market and should also be paid in a timely manner.
- Where the SMSF is disadvantaged in any way, it is expected that appropriate action will be taken to protect the interests of the fund.
Conversely, transactions in the fund could potentially be biased toward the SMSF, resulting in the undermining of various superannuation policies, such as the imposition of contribution caps, and leading to the income of the fund being treated as non-arm’s length income (previously known as special income) and taxed at 45%. It is therefore important to ensure that the income received by your SMSF is not more than would be expected under a normal commercial arrangement.
The penalties for contravention of the arms length rule include civil and criminal charges, so it is well worth discussing your situation with your accountant or lawyer if you are in any doubt regarding this requirement.