Business in an SMSF: Pros & Cons
Self-managed superannuation funds, or SMSFs for short, are simply do-it-yourself superannuation funds. Owning an SMSF is a popular way to save for retirement because it gives you simple control over how your super is invested. We’ll look at the potential and things to think about before considering running a business within an SMSF and/or investing SMSF monies into another business.
Running a Business in an SMSF.
Operating a business in an SMSF technically is not forbidden under the act so far; but it creates too many complications to even name all within the scope of this article. The simple answer is it is not advisable to run a business under your SMSF itself. Investing SMSF monies into someone else’s business whereby the SMSF could own equity in that business could potentially be subject to strict rules, but if met this may be acceptable. However, as SMSF auditors, if an SMSF accountant were to approach us to get a fund audited that is running a business in an SMSF, there would probably be red flags everywhere we’d see.
Such an investment strategy could typically contravene the below provisions and extend to even contravene more provisions of this act and this is the reason it is strictly not advisable. Given the complication of running a business within an SMSF; the chances are that 90% of the time you’d end up contravening more than one provision mentioned below, some of the provisions below are reportable and could involve heavy penalties from the taxation office.
- Contribution limits.
- NALI – NALE provisions of the SMSF. S.109 pf the SIS act.
- Sole Purpose test. s.62 SIS Act.
- Income tax avoidance. Part IV A of the ITAA Act
- If you drew out a salary from the business or paid yourself an allowance, you are deemed to have paid yourself a benefit. S.65 of the SIS Act
- Any borrowings by the business would need to be tested under S.67, S.67A & S.67B of the sis act.
- Related Party Transactions within a business in an SMSF. S.82 of the SIS act
- Related party acquisitions S.83 of the sis act.
- Investments in in-house related party assets should not exceed 5% of the fund value S.84
- Schemes used with third parties to circumvent the in-house asset rules S.85
- If financial decisions for the business within an SMSF are not minuted, you may be in breach of S.104
- Member’s Statements preparation and apportionment of their balances from the profits of the business resulting in taxable profits for the SMSF. S. 105 & Reg. 5.03, Reg 5.08
- The business would need to be valued at market value by an independent valuer which could cost a few thousand dollars each year. Reg 8.02B.
Given the risks mentioned above, it is still possible to run a business in an SMSF by not contravening any of the above provisions but that would be on a very tight rope and the major issue is the flexibility needed to run a business will simply not be available to your business. This is because it is being run under an SMSF.
It is worthwhile to note the risks first because the risks easily outweigh the benefits by a considerable margin, however, there may be safer ways to invest in a business without contravening the provisions of the SIS Act. Let us first consider the advantages of investing in commercial activities before delving into what options you actually have before you can invest in a business using your SMSF funds.
The Advantages of investing in business operations within an SMSF.
1. Diversification: Investing in a business from your SMSF can enhance diversity by complementing conventional investment assets like stocks and real estate. By providing an extra source of income, business income may strengthen a portfolio and reduce dependency on other investment streams.
2. Control and Flexibility: Investment control and the greater options that SMSF members have over industrial and retail super funds, including being able to invest in a business. With this degree of independence, trustees can maximize returns and growth potential by coordinating business operations with the fund’s investment goals and risk tolerance.
3. Tax Efficiency: SMSF’s are concessional taxed on income. If the income stream from the business is taxed at the concessional tax rate of 15%, that would mean a world of difference to the retirement savings.
4. Estate Planning: A foundation for legacy planning and intergenerational wealth transfer may be established by holding equity within the SMSF and then having a binding nomination prepared transferring business equity to the beneficiaries.
So what is the best way to invest in a business from the SMSF funds?
The answer is best dressed by a financial advisor, and we are not financial advisors so this article and the contents are general in nature. The best way to hold business interests within an SMSF is to invest in other people’s businesses by becoming equity partners on an arm’s length basis. For example, becoming angel investors who typically own equity (Units or Shares) or fixed interest entitlements. This way you have distanced yourself from the day-to-day running of the business and hence the risks we mentioned earlier no longer apply to you.
The other option you have is to invest in a commercial property where you run a business, this is an exception to the rule within the SMSF and is completely legal. Business owners are allowed to purchase a commercial property from their SMSF funds and run a business from occupying such a property.
Disclaimer:
No aspect, part or content of this article should be considered as any kind of advice. This article is general in nature and based on general SMSF concepts. A One Accountants is not in the business of providing financial advice and is neither licensed to provide financial advice. A One Accountants does not guarantee or warrant the accuracy of the content of this article and readers are required to make their own enquiries and not rely on the content of this article and make any decisions. For a full copy of our website terms and conditions page click here.