Investing in Unlisted Shares within Your SMSF

Investing in Unlisted Shares within Your SMSF

Unlisted SharesIn this article we are considering the acquisition of shares in unlisted companies (refer to ‘What is the difference between Listed and Unlisted Shares’ below for further details).  

Unlisted shares can play a role in diversification of the fund’s investment portfolio and are often used to invest into assets which have a higher risk profile than mainstream investments which generally include listed securities, managed funds, cash, term deposits and property. 

Under certain circumstances it may be possible to invest into a company which is carrying on a business, developing a property or using a company to pool cash from various related or unrelated sources to invest into risky mining ventures, start-up tech companies or lending money to other entities to undertake risky ventures. Of course, there are a number of compliance issues which need to be adhered to and are discussed below. 

It is crucial to understand if the company is a related or an unrelated company which is a significant factor in determining if the acquisition of the shares will be an in-house asset (INHA) of the fund and prohibited from acquiring the shares.

Compliance with Superannuation Laws when Investing into Unlisted Shares 

Acquiring shares in an unlisted company can cover a very wide range of activities.  SMSFs should go through a checklist, as per below, to ensure the fund meets legal and compliance requirements. 

Any proposed investment into an unlisted company should be considered after consultation with a SMSF specialist or Licensed Financial Adviser.

Is the unlisted company an in-house asset (INHA)?

An INHA includes a loan, an investment in a related party or an asset leased to a related party of the SMSF and excludes such things as a widely held trust and a lease by a related party of business real property. An SMSF can have up to 5% of its assets as INHA.

Controlled by a member and their related parties

An unlisted company which is acquired by a SMSF and is collectively controlled by the fund members and their related parties is an INHA and is generally prohibited from being acquired by the SMSF.

An SMSF is prohibited from having more than five per cent of the fund’s assets in INHA.  Control typically includes the following:

  • 50% or more of the shares are owned by members and their related parties; or
  • majority of the company directors are fund members and their related parties

Example – Fred is the sole member and director of the corporate trustee for the Flinstone SMSF. Fred and Barney are brothers and Harry and Jo are friends of Barney but not related to him. Fred, Barney, Harry and Jo decide to establish a new private company, Newco, to pool their personal funds and the cash reserves from the Flinstone SMSF for the purpose of lending monies to start up tech companies. The shareholders are going to be Flinstone SMSF, Barney, Harry and Jo. Flinstone SMSF and Barney will own 30% each and Harry and Jo will own 20% each. The directors of Newco will be Fred and Barney.

Newco would be an INHA of the fund as Fred and Barney are related parties and control Newco as they collectively own 60% of the shares and are also the directors of Newco.  However, if the value of Newco was under the 5% INHA threshold it could be an allowable investment.

Controlled by unrelated parties

The SMSF can purchase unlisted shares if the company is controlled by unrelated parties.  Potentially, an unrelated company is able do things which are prohibited if the SMSF owned the asset directly or owned the asset in a related party company.  An example of this is the unrelated company is able to borrow and use the assets as security. Of course, the super laws require the transactions undertaken by the company are made at arms length and the company shares are valued at market value at the end of each financial year.

An exception to the in-house asset rules

Unlisted shares or units that satisfy the 13.22C SIS regulations can be acquired from a fund member and their related parties without breaching the INHA rules.  The eligibility requirements are very strict and if the rules are breached there is no fix.  The auditor will breach the fund and the shares or units have to be sold. 

The significant rules include:

  • the company or unit trust cannot borrow
  •  the company or unit trust   is unable to hold an interest in another entity – it cannot hold shares in another company or units in a unit trust
  •  the assets of the company or unit trust   cannot have a charge over them
  • the assets cannot include a loan to another entity, unless it is a bank account (as defined by the Banking Act 1959)
  • the company or unit trust cannot lease property to a member or their related parties unless it is business real property   

Generally, this exception was legislated to allow small business owners to pool cash with their SMSF, other related entities and relatives of fund members to purchase business premises.  

Furthermore, provided ungeared residential property is not purchased from a member or their related parties an ungeared company or unit trust is able to purchase residential property.  Whilst a company can be used to hold property a unit trust is usually a more tax effective vehicle to do this. A company is not eligible for the CGT discount when a property is held longer than 12 months which is a disincentive to hold property in a company structure. 

Can the SMSF borrow to purchase the shares?

The SMSF has the option to utilise a limited recourse borrowing arrangement in order to acquire unlisted shares. However, this may pose challenges as the single acquirable asset is the shares and not the underlying assets owned by the company.  Most lending institutions are hesitant to provide loans for the purchase of unlisted shares, as they cannot use the company’s assets as security. However, engaging an independent third-party lender is the recommended course of action to ensure adherence to super laws.

While a related party of the SMSF may provide a loan for the acquisition of shares, it is extremely challenging to obtain evidence that demonstrates the loan meets the requirements of an arms length transaction. The ATO may approve a related party loan if the SMSF follows their safe harbour guidelines, but unfortunately this does not apply to unlisted shares. As a result, the trustee must gather sufficient evidence on their own. This involves more than just obtaining general loan terms from a lending institution’s website. Ironically, the most convincing evidence would come from a third-party lender willing to lend to the SMSF for the specific purpose of purchasing the unlisted shares.

 Has the sole purpose test been considered?

The SMSF must be managed solely for the purpose of supporting a member’s retirement. If the fund purchases unlisted shares from a member, it must be done with the intention of benefiting the member’s retirement rather than accessing cash from the fund. It is essential to record the trustee’s rationale in a written record and ensure that the acquisition aligns with the fund’s investment goals. Acquiring the shares at their market value and ensuring the return on the investment is appropriate with the level of risk involved is crucial when aligning with the sole purpose test.

Is the purchase price of the shares at market value?

It is critical to obtain evidence to support the market valuation of the shares being acquired from a member of the fund.  The supporting evidence will depend on the underlying assets owned by the company and any significant liabilities.  Where the acquisition of shares is from an unrelated party an auditor may accept correspondence from a director showing the value of the last independently traded shares or if a newly established company the cost of acquiring the shares may be appropriate evidence in its first year of operation. 

Has the investment strategy been reviewed and updated?

Consider diversification of the fund’s portfolio, expected returns on the investment and cashflow requirements which are key to ensuring the acquisition of the shares aligns with the trustee’s investment strategy and the retirement requirements of the members as well as adherence to the superannuation laws and regulations. The SMSF trustees need to ensure the reasons to acquire the shares are clearly documented in the fund’s investment strategy and to regularly review the strategy and the performance of the shares.

Can the SMSF trustees determine the market valuation of the shares at 30 June?

The trustees need to consider any issues with the timing of obtaining an annual market valuation of the company’s underlying assets.  The fund’s financial statements are required to be audited and evidence of the market value of the underlying assets is required. In circumstances where the SMSF trustee has no control over the directors who will not provide current market valuation of the company assets the trustee needs to consider if the investment is appropriate for the fund to continue to hold. 

Will the trustees, members or other related parties be providing services to the company?

Non arms length income (NALI) is taxed at 45 %.  Expenses which are provided by a member or trustee at nil or lower than market can result in the related income being taxed as NALI.  This can also include the capital gain on sale of the asset. The trustee must ensure any services provided by a member or trustee of the fund to the unlisted company is provided at commercial terms and conditions.  Furthermore, the trustee cannot be remunerated for services unless they are qualified to provide those services to the public.  It is best practice to ensure services are contracted to unrelated parties.

What is the Difference between Listed and Unlisted Shares

Listed shares such as BHP, Commonwealth Bank and National Australia Bank are listed on the Australian Securities Exchange (ASX). Listed shares are highly regulated and available to the public and traded publicly.  The share price is easily identified and share registries maintain detailed records of the shareholders and when dividends are due and payable.

Unlisted or private shares are not listed shares.  

An unlisted company can be a public company which is open to the public for investment but is not listed on a public stock exchange. An unlisted company is used to raise equity directly from the public by issuing shares. large amounts of capital for a specific purpose and must provide a prospectus to possible buyers. An unlisted public company is subject to more regulatory controls and reporting requirements than a private company.

A private company is a private limited company, with a maximum of 50 shareholders, which is not open to the public and is not listed on a public stock exchange. 

Market Valuation of Unlisted Investments

 Market valuation of an unrelated company may be provided by the directors of the company where they can provide confirmation of the latest independent trades.  Regardless if the unlisted company is related or not if the company holds property it must be valued at market value.  A formal valuation is always best but other acceptable evidence can be obtained from on-line service providers or a real estate agent.  The evidence must be supportable which means it cannot be a one-line statement from a real estate agent but should contain recent comparative sales of similar properties or an explanation as to how the market value was derived. 

The value of the shares would be expected to reflect the value of the underlying assets owned by the company. However, the valuation is not required to be reflected in the financials of the company.  It is only required to be included in the financial statements of the SMSF.

Can My Super Fund (SMSF) buy Unlisted Shares from Me?

The shares are in an unrelated company and may list in the future so getting in early could potentially give my SMSF a big gain in the near future. 

Let’s have a look at this.  

Are the shares listed on an Australian stock exchange?         No

Are the shares an in-house asset (INHA)? No

 The shares in an unrelated company are not an INHA and therefore the 5% threshold of INHA allowed is not available. As the shares are not listed on a stock exchange the SMSF is unable to purchase the shares. However, if the shares do list successfully the fund is able to purchase the shares at that time and not limited to the 5% INHA threshold.

If the unlisted shares are in my related company my SMSF could purchase up to the 5% INHA threshold provided there are no existing INHA as the fund cannot purchase an INHA which causes the total 5% threshold to be exceeded.

Can My SMSF Sell Unlisted Shares to Me?

Yes.  The shares must be valued at market value.  It is best practice to obtain an independent valuation as supporting evidence.

The Key Takeaways

  • The fund can acquire shares in unlisted companies
  • Unlisted companies can be private or public but not listed on a stock exchange
  • Purchasing shares in an unlisted company can provide a more diverse portfolio 
  • Shares in an unlisted company owned by a member can be purchased by an SMSF if the company is a related company subject to 5% threshold
  • Shares in an unlisted company owned by a member can be purchased by an SMSF if the company meets the exception under SIS regulation 13.22C 
  • Shares in an unlisted company which is an unrelated company can be acquired by an SMSF
  • An unrelated company is able to borrow and use the assets as security without breaching the borrowing prohibitions
  • Market valuation of the company or it’s underlying assets need to be considered annually
  • Market valuation of the company is required when shares are being purchased from a member or related party 
  • Market valuation of the company is required when shares are being sold to a member or related party 
  • Ensure expenses of the company are at arms length to avoid NALI

Do you need help with understand Investing in Unlisted Shares through your SMSF?

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Do you need help with understand Investing in Unlisted Shares through your SMSF?

Give us a call on 1300 392 544 or fill in the form above

Contact Us

If you’re interested in learning more about investing in Unlisted Shares, please reach out for a confidential quote. Simply submit your details and one of our friendly team will be in touch as soon as possible.

Contact Us

Name(Required)