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. It gives you simple control over how you invest your super. This article looks at the potential benefits and key considerations. We focus on running a business within an SMSF or investing SMSF monies into another business.
Running a Business in an SMSF.
The act does not technically forbid operating a business in an SMSF. However, this arrangement creates too many complications to name within this article’s scope. The simple answer is clear: we do not advise running a business under your SMSF itself.
You may consider investing SMSF monies into someone else’s business. In this case, your SMSF could own equity in that business. Strict rules apply to such arrangements. If you meet these rules, the investment may be acceptable. But as SMSF auditors, we see red flags everywhere when an SMSF runs a business. If an SMSF accountant approached us to audit such a fund, we would identify many problems.
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 draw a salary from the business or pay yourself an allowance, you are deemed to have paid yourself a benefit. Section 65 of the SIS Act covers this rule.
- You must also test any business borrowings under Sections 67, 67A, and 67B of the SIS Act.
- Section 82 of the SIS Act addresses related party transactions within an SMSF business.
- Related party acquisitions fall under Section 83 of the SIS Act.
- Your investments in in-house related party assets must not exceed 5% of the fund value. Section 84 stipulates this limit.
- Section 85 prohibits schemes with third parties that circumvent the in-house asset rules.
- You must minute all financial decisions for the business within an SMSF. Failure to do so may breach Section 104.
- Section 105 and Regulations 5.03 and 5.08 cover Member’s Statements preparation. You must also apportion members’ balances from business profits. This results in taxable profits for the SMSF.
- An independent valuer must value the business at market value. This could cost a few thousand dollars each year. Regulation 8.02B requires this valuation.
Despite the risks mentioned above, you can still run a business in an SMSF. You must avoid contravening any of the above provisions. However, this approach puts you on a very tight rope. The major issue is the flexibility you need to run a business. Simply put, that flexibility will not be available to you. This is because the business operates 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.