By Monica Rule

In my opinion, the two terms in the superannuation law which cause the most confusion amongst Self Managed Superannuation Fund (SMSF) Trustees and professionals are “relative” and “related party”.  These terms are used in various areas of the superannuation law and have different meanings depending on the context of how they are used. 

The common meaning of the term “relative” is someone whom is related to a person by blood – such as a mother, father, sibling and grandparent.  It can also be someone related to a person by marriage – such as a spouse, brother-in-law, and mother-in-law.  Since 2008, same sex couples living together as partners are also recognised as spouses under various laws, including the superannuation law.      

Within the superannuation law, the term “relative” is used as a defining term in two separate areas.  In one area of the law, which for simplicity’s sake I shall just refer to as section 17A, it is used to determine which individuals can be in an SMSF together.  Section 17A relates to the legal structure of an SMSF. It states that a member of an SMSF can establish an SMSF with a relative.  Here, the definition of a “relative” is a parent, child, grandparent, grandchild, sibling, aunt, uncle, great aunt, great uncle, niece, nephew, first cousin or second cousin of the individual or of his or her spouse or former spouse; or, a spouse or former spouse of the individual, or of any other individual referred to previously.

A different area of the superannuation law, which I will simply refer to as section 65, prohibits SMSF members from providing financial assistance to members and relatives of the members.   However, under section 65, the definition of a “relative” of an individual, is a  parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the individual or of his or her spouse; or, a spouse of the individual or of any other individual referred previously.

Notice that the section 65 definition of a relative does not include a cousin and a former spouse.  This means, an SMSF trustee is not prohibited from providing financial assistance to their cousins and former spouses as long as the financial agreement is at arm’s length and it is in accordance with their SMSF’s investment strategy. Therefore, the loan must be documented so that it is enforceable by the SMSF trustee and interest on the loan must be charged at the market rate. 

As long as none of the members of an SMSF is a child of a cousin or of a former spouse; and, none of the members of the SMSF is directly related to the cousins such as being the spouse of the cousin or being a parent of the cousin, the SMSF would not be prohibited from providing financial assistance to these people.

Now, another area of the superannuation law, which I’ll refer to as section 71, allows an SMSF trustee to lend money to a related party of up to five per cent of the total value of the SMSF’s assets. Under this area of the law, the definition of a related party includes other members of the SMSF, relatives of members of the SMSF, individuals that are in partnership relationships with the members of the SMSF, and entities such as companies and trusts that the SMSF members and/or their relatives control.

So, if two individuals, let’s say an SMSF member and his cousin, purchase real estate together, then the cousin will actually fall within the definition of a related party due to the existence of a partnership relationship. What this means is the financial assistance provided by the SMSF member to his cousin must be limited to five per cent of the total value of the assets in the member’s SMSF.  Otherwise the arrangement will contravene the superannuation law.

Now just because section 71 of the superannuation law allows SMSF trustees to provide loans of up to five per cent of total value of their SMSF’s assets to related parties, does not mean SMSF trustees can provide financial assistance to people who fall within the section 65 definition of a relative of an SMSF member.   This is because section 65 overrides section 71.  Therefore, although an SMSF can provide financial assistance, of up to five per cent of the total value of the assets in the member’s SMSF, to an entity (e.g. a related company or related trust) that is controlled by an SMSF member and/or their relatives, it can never provide financial assistance to people who are caught under the definition of a relative under section 65.   

I love working with the superannuation law, but when important defining terms can include one relationship under one area of the law and exclude it in another, I can understand why many people find it frustrating.   It has always seemed odd to me that there are these inconsistencies with some of the defining terms in the superannuation law, so it does make things tricky for the average SMSF investor.  The important thing to remember here is that it’s always best to talk to an SMSF specialist before proceeding with any related party transactions.

Monica Rule is an SMSF Specialist and author www.monicarule.com.au

Gold and Platinum Members please read on for real life examples or “related party” cases actioned by Monica Rule while working as a compliance officer in the Australian Taxation Office.

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