How does the Sufficient influence test work for In House Assets?
The sufficient influence test in relation to determining if a self-managed super fund (SMSF) has an in-house asset (INHA) can be tricky.
An in-house asset is all about SMSFs and transactions with related parties. Specifically, loans to related parties, leases to related parties, investments in related party companies or an investment in a related trust. There are some well-known exceptions such as acquiring business real property from a related part or leasing a business property from their SMSF. A fund is also allowed to own up to 5% of INHAs at the time the asset is acquired or as at 30th June.
The consequences of breaching the INHA rules can be catastrophic for an SMSF and can include the forced sale of a property, imposition of monetary penalties and even end up with a trustee being jailed or removing a trustee for severe breaches (but jailing or removing a trustee is rare).
Who is a related party?
A related party includes all members of an SMSF and a standard employer sponsor (unlikely with a modern trust deed or update but was commonly named as party to deeds dating back before the year 2000). In addition, a related party includes Part 8 Associates of the fund’s members or a standard employer sponsor.
Who is a Part 8 Associate?
The Part 8 Associates of a fund member include a relative of a member such as a parent, grandparent, child, brother, sister, aunt & uncle, niece & nephew but excludes cousins. Part 8 Associates also include other members of the SMSF, the partnership of a member, a partner of a member in that partnership and the partners spouse and children.
Where an SMSF has a single member, the other individual trustees or if the trustee is a company each director of the company is a Part 8 Associate.
A company in which a member, together with their Part 8 Associates (group), control the voting interest, more than 50%, or can sufficiently influence the company will be a Part 8 Associate. A trust in which a member together with their Part 8 Associates (group) can control or remove the trustee of a trust will also be a Part 8 Associate or alternatively the group has a fixed entitlement to more than 50% of the capital or income of the trust.
Why is understanding the sufficient influence test crucial?
The sufficient influence test matters when assessing related party status for companies or trusts. Control is central and isn’t just about the number of shares or units held by members and their Part 8 Associates.
The benefits of ensuring the sufficient influence test does not change an otherwise unrelated party to a related party can be significant. An unrelated unit trust or company can borrow and use a property as security for a loan and is not restricted by the requirements of related unit trusts.
Casting vote
Often, a company constitution gives a director a casting vote when there is a tie.
Example – Two unrelated SMSFs acquire 50% of the units in a unit trust
Dr Horn and Dr Smith are unrelated, each with their own SMSFs, jointly establish a unit trust to buy a medical building, with each fund holding 50% of the units. Both are directors of the corporate trustee, so neither controls the trust initially.
Years later, Dr Horn wishes to retire and sell the property, while Dr Smith prefers to retain it. The constitution gives Dr Horn the casting vote, which he uses to decide on selling. By exercising this vote, Dr Horn gains effective control over the trust, making it a related trust to his SMSF. Dr Smith does not control the trust, so it is not related to his SMSF.
If the related unit trust can meet the requirements under regulation 13.22C(often referred to as “ungeared unit trust”) it may not be an INHA of Dr Horn’s SMSF but if there are any borrowings in the trust or holdings in another entity it will fail and breaches the INHA rules due to the size and nature of the investment as it is likely more than 5% of the fund’s total assets.
Director Influence
Example – Two unrelated SMSFs acquire 50% of shares in a new investment company
Lisa Mortin and Anthony Smith are not related parties, and each operate their own SMSF. Their funds jointly incorporate a new company, with both individuals appointed as directors and each fund holding a 50% ownership stake. The company actively engages in investment activities across equities, cryptocurrencies, and exchange traded funds (ETFs). Lisa, an accomplished wealth fund manager, assumes responsibility for all investment decisions on behalf of the company. Conversely, Anthony participates as a passive investor due to his limited financial expertise.
Given Lisa’s dual role as an SMSF member and her effective control over the company, she is deemed to exert sufficient influence such that the shares held by her fund constitute a related party interest for her SMSF. In contrast, Anthony’s SMSF maintains its interest in an unrelated company, as neither he nor his Part 8 Associates exercise control over the entity.
The distinction between substance and form plays a critical role in assessing whether “sufficient influence” exists, as the determination is inherently subjective and reliant upon the particular facts of each case.
Control of a Company –Sufficient influence is defined by the Superannuation Industry (Supervision) Act 1993 (SIS) – Sect 70 E (1) as:
“ (a) a company is sufficiently influenced by an entity or entities if the company, or a majority of its directors, is accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the entity or entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts)”
Control of a trust – One of the tests to determine control of a trust includes whether a trustee is sufficiently influenced by a group – The Superannuation Industry (Supervision) Act 1993 (SIS) – Sect 70 E (2)(b):
“(b) the trustee of the trust, or a majority of the trustees of the trust, is accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of a group in relation to the entity (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts”