What is the penalty for living in an SMSF property?
An SMSF trustee may incur penalties where a SMSF member or relative lives in or leases a residential property or holiday unit owned by the member’s SMSF, unless the property qualifies as business real property such as a farmhouse.
Under SISA the ATO have the following available penalty options:
impose administrative penalties- make rectification directions or enforceable undertakings
- disqualify a trustee
- make an educational directive
- impose civil and criminal penalties
- make the fund non-complying
The ATO may remit penalties, in part or in full, based on the seriousness of the breach, the compliance history of the fund, whether the breach has been rectified or a plan entered into to rectify it, the value of the breach, whether the ATO believe the results were unintended or unjust, whether the SMSF trustee made a voluntary disclosure and multiple provisions breached based on one event.
Example – In-house asset (INHA)
Paul’s SMSF owns a residential holiday unit on the Gold Coast. The market value of the unit is $950,000. Paul is staying in the unit and leased it at market value for a week while he attended to personal business. He satisfies the sole purpose test as he is paying market rate. However, the total value of the fund’s assets at that time was $1.5million and thus the INHA ratio exceeded the 5% allowable threshold by 58.33%.
The fund breached section 83 of the SIS Act which prohibits the acquisition of a new inha which exceeds 5% of the fund’s assets at that time. The value of the breach is based on the property value, not the rent paid. The fund did not exceed the inha 5% threshold at the 30th June as the lease with a member of the fund was not in place at that time. Given the fund’s good compliance history and the trustee’s belief they were complying with SISA, the penalty imposed is not likely to be as severe as disqualifying a trustee or imposing civil or criminal penalties. Paul has confirmed he will not stay at the unit in the future.
The ATO may impose an educational directive on the trustees/directors so they are better informed about SISA compliance issues and no administrative penalty as section 83 is not one of the provisions that an administrative penalty applies to. It is unlikely any other severe penalties would be imposed.
Administration Penalties
An administration penalty is a monetary penalty which can range from 5 to 60 penalty units per breach. A penalty unit is currently $330. A maximum of 60 penalty units is $19,800 for a single breach of the following:
- borrowing standards
- failing to enter into a plan to reduce INHA back under the 5% threshold by the following 30th June
- lending money or providing financial assistance to a member or a relative of a member
- failure to notify the ATO in writing of an occurrence of an event having a significant adverse effect on the financial position of the fund
Administrative penalties of a lesser amount can be applied to breaches of SISA provision such as failing to:
- retain records
- keep minutes and records
- preparing a statement of financial position and operating statement
- to complete an education directive within the specified time frame
- retaining records of changes of trustees
An event which breaches more than one SISA provision can result in multiple penalties.
Administrative penalties are levied per trustee
One of the advantages of having a corporate trustee is that an administrative penalty is only levied on the corporate trustee and not on each director. All directors are jointly and severally liable but only in relation to that single penalty. Whereas an administrative penalty is levied on each individual trustee. A SMSF with 6 individual trustees could be hit with 6 times the penalty a corporate trustee is liable for. The penalty must be paid by the trustees or the directors of the corporate trustee and cannot be reimbursed or paid by the fund.
Penalties are most commonly applied to related party property transactions
A related party includes SMSF members, trustees, directors of the trustee, their relatives, partners, and other entities controlled by SMSF members and their associates. The ATO are particularly concerned about members or related parties obtaining a present-day benefit from the fund. To receive tax concessions, the fund must solely provide retirement benefits to members and death benefits to the members beneficiaries.
SISA prohibit the following dealings in relation to related parties:
- in-house assets (INHA) are prohibited such as making loans to a related party, investments in a related party and leasing assets to related parties with some limited exceptions such as a 5% INHA threshold, non-geared unit trust and business real property
- acquiring residential property from a member or related party unless an exception applies such as the property being business real property i.e.a primary production property
- prohibition on providing financial assistance to a member or a relative of a member
- borrowing is prohibited with limited exceptions such as a limited recourse borrowing arrangement (LRBA)
An SMSF member and their family can live in a residential property under specific circumstances. A fund owning land used wholly in a primary production business which includes a residential home that does not exceed 2 hectares is exempt from being an INHA. The SMSF member is required to pay market value rent for the use of the residence.
Otherwise, an SMSF member is prohibited from living in a residential property owned by their SMSF.
Common mistakes SMSF trustees make in relation to related party leases
- leasing the fund’s property at reduced rates or even rent free
- not having a formal executed lease agreement
- terms and conditions of the lease not at market value
- no evidence to support the market value of the lease