Client Background (SMSF Loan to a Friend)
We recently received an inquiry from one of our Self-Managed Superannuation Fund (SMSF) clients. This client had a surplus of $500,000 in cash within their SMSF, in addition to their investments in shares and property. The client’s friend had approached them with a request to lend money to their friend’s cousin and cousin’s wife. The client was interested in exploring the possibility of lending the money to their friend using funds from the SMSF, specifically considering an SMSF Loan. Importantly, the friend was not a family member, nor were any of their family members related to our client’s family.
Challenges: The primary challenge in this scenario was to determine whether the proposed loan would fall under the related party rule and whether it could potentially breach the in-house asset rule, both of which are crucial considerations for SMSFs.
Our Response: We provided the following guidance to address the client’s inquiry:
- Related Party Rule and In-House Asset Rule:
- The related party rule and in-house asset rule are essential components of the Superannuation Industry (Supervision) Act 1993 (SISA) that govern SMSF investments.
- An in-house asset is an investment in a related party or a related trust of the SMSF, and it should not exceed 5% of the total market value of the fund’s assets.
- In this case, if the individuals to whom the SMSF intends to loan the money are not related parties or Part 8 associates, the loan would not be classified as an in-house asset.
- Related Party Determination:
- Based on the information provided, it appears that the cousin and his wife (the client’s friend) are not related parties or Part 8 associates as per section 70B of SISA.
- SMSF Compliance and Commercial Terms:
- Provided that the SMSF’s trust deed and investment strategy allow for such investments, the SMSF can proceed with making this loan.
- It’s essential to ensure that the loan is structured on commercial terms to comply with section 109 of SISA.
- We recommend the establishment of a written loan agreement with clearly defined terms, including regular repayments and the application of a commercial interest rate.
Conclusion: In this case, our SMSF client was interested in lending money to a friend, who was not a related party, using funds from the SMSF. Our assessment indicated that this loan would not be considered an in-house asset as the borrower did not fall under the related party rule.
While the client is free to proceed with the loan, it is crucial to adhere to commercial terms, maintain proper documentation, and ensure compliance with all relevant SMSF regulations. In addition to addressing compliance and tax issues, we have also recommended that the client considers this as part of their broader investment plan for the SMSF. We suggest they consult a financial planner to assess its alignment with their investment strategy and overall retirement plan.