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Self Managed Super Fund (SMSF) Article
Shop or motel not a super idea for self managed super

By Tony Negline.

This article may be out of date.

24th June 2009

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This column regularly gets questions about super funds investing in small businesses.

Investors would like to use their super fund assets for these activities because it is often an easier source of funds than a third party investor or lender, the investments can sometimes produce great returns which will be good for retirement income purposes and, perhaps most importantly, the superannuation tax concessions are a powerful beacon.

Typically investors want to structure their business investments in one of three ways.  The super fund might be called on to own and run a business.  Alternatively, the super fund might own shares in a company or units in a unit trust or be a beneficiary in a discretionary trust or the super fund and the other parties might enter into a joint venture arrangement through a formal arrangement.

These three different structures – owing and operating a business, business investor or joint venture partner – represent very different transactions and each has unique issues that don’t apply to the other two structures.  Equally each structure has advantages and disadvantages compared to the other arrangements.

In this article we will concentrate on super funds actually owning and running a business.  Some people want to run their retail shop, motel, farm, property development or service business through their Self Managed Super Fund.  Other investors want to know if their super fund investment activities might qualify their fund as an investment business such as a share trader.

There is a lot of controversy about the ability of a super fund to own and operate any business.  Investors who want to do this type of transaction can’t see anything wrong with the structure.  One reader told me, “Why can’t we do this?  We will run the business until retirement when we will sell it hopefully for a good profit.  If we run the business through a company, the sale proceeds would end up funding part of our retirement anyway.  We’re making the structure simpler and cheaper over the long term.”

The Australian Taxation Office has said, without qualification, that the super laws do not allow super funds to run a business.  In the superseded publication Roles and Responsibilities of Trustees the ATO said, “if a superannuation fund is conducting a business, [the super fund] is not administered for the sole purpose of providing benefits for the members and beneficiaries of the fund.”  In a newer publication Running a Self-Managed Super Fund the ATO simply say, "Money belonging to your SMSF can’t be used for personal or business purposes under any circumstances."

Some investors who want their small super funds to own and run their business also intend that the business will employ the fund members and their relatives.  Structurally this is a much more complicated arrangement than would occur under a company with the owners being active employees.

So what is the ATO’s view if the fund members and their relatives are not involved in the business?

In Interpretative Decision 2003/524 the ATO says that a super fund cannot claim a tax deduction for some expenses incurred is setting up a business structure if the business is designed to earn income subject to tax.  Effectively the ATO believe that even if a super fund could run a business, it would be denied tax concessions available to other taxpayers.

Further this same document points out that the super laws prohibit a super fund from borrowing except in limited circumstances.

This is perhaps the most important point made by the ATO.  All businesses have to borrow at some point in their trading activities.  Clearly any borrowings made by a super fund to assist with business trading may be a breach of the super law borrowing restriction.

This Interpretative Decision doesn't apply to expenditures that occur after June 2005 because the tax legislation that it referred to was replaced from 1 July 2005 onwards.  Presumably its references to super laws that have not changed for many years continue to apply.

In 2005 the ATO told trustees that if their super fund’s regulatory return shows that the fund is claiming for ‘salary and wages’ then the fund is probably running a business and is more likely to be targeted for an ATO audit.

A super fund therefore needs to be careful that it's never seen to be running a business.

But what about being a share trader?  The benefits of a super fund being a share trader are attractive.  Share traders treat their shares as trading stock and they can claim deductions for the costs of buying and selling this stock.  Gains must be fully declared as income but all losses can be used to offset other income.

A non-share trader treats gains under the Capital Gains Tax rules and can only offset losses against capital gains.  The costs of buying and selling shares are not tax deductible but are used to alter the cost of shares for CGT purposes.

To work out if a fund is a share trader, it is necessary to look at the volume, frequency and scale of activities.  It is also important to know if the trustee uses a systematic course of buying and selling in order to produce profits.  The intention of the trustee is also an issue.

In a newsletter issued in July 2003, the ATO said that in its view it would be doubtful if a Small Super Fund could satisfy both the share trader requirements and all fiduciary responsibilities.  Any trustee who is unsure of their share trading status might want to wait for a Draft Tax Determination which is expected to be released before the end of 2009.

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