SMSF Loan Mistakes: Costly Penalties Ahead!

Highlighting common SMSF loan mistakes to help trustees avoid costly penalties and secure their investments.

Loaning money from an SMSF to fund members or relatives is against the super laws and can land trustees with big fines, so it’s important to know the rules and not use SMSF savings for anything other than retirement purposes.

New ATO estimates show that, in 2020 and 2021, SMSF trustees entered into more than $200 million in prohibited loans to members or related parties. This was in addition to more than $600 million illegally withdrawn.

The huge amounts explain the ATO’s concern, with deputy commissioner Emma Rosenzweig telling a recent SMSF conference the regulator considered it essential to ensure “SMSFs aren’t seen as a vehicle to access super illegally or to provide short-term finance”.i

She says newly established SMSFs are more likely to make prohibited loans, with the key drivers being lack of knowledge and attitudes towards super. Trustees also tend to dip into their super when facing financial stress or personal issues.

The rules for providing a loan or other direct or indirect financial assistance from your SMSF to fund members, family or other related parties are simple.ii

It’s illegal, even if the loan is repaid with interest.

Your SMSF’s assets are solely to provide for members’ retirements and cannot be used for other purposes.

If you think you won’t get caught, the ATO is actively looking for trustees making prohibited loans by identifying individuals with outstanding personal lodgement applications, overdue tax debts and applications for early access prior to setting up a SMSF.

Tough penalties

If you breach the lending provision by making a loan to fund members or relatives, significant sanctions can be imposed. The penalty for each fund trustee can be almost $19,000. And penalties must be paid personally, not from SMSF assets.iii

Lending to members could also lead to civil and criminal penalties.

Serious breaches of your trustee obligations can lead to disqualification, which means you can never be a SMSF trustee again and your name is on the public record forever.

The biggest risk is your SMSF could be deemed non-complying and unable to take advantage of the 15 per cent tax rates applying within the super system. In the year a SMSF is deemed non-complying, it’s hit with the highest margin tax rate on its income and a fine equal to almost half its assets.

If your fund has made a prohibited loan, it must be repaid as soon as possible. It’s important to talk to us early, so we can help you work out the next steps.

The ATO’s SMSF early engagement and voluntary disclosure service allows trustees or their accountant to voluntarily report non-compliance issues.

Early disclosure is encouraged by the ATO and generally the regulator will not audit the SMSF if non-compliance is resolved this way.

Legal ways to make a loan

While making a loan to a member or related party is illegal, it’s possible to make a loan to certain businesses from your SMSF.

These loans must be in the best interests of members and comply with the fund’s documented investment strategy.

They must not exceed 5 per cent of the SMSF’s total assets and if the loan exceeds this limit at 30 June, trustees must prepare a plan to meet that limit by the end of the following financial year.

Loans can only be made to a company or trust with a corporate trustee (not a sole trader or partnership), be on arm’s-length commercial terms, and must not breach the sole purpose test.

If you’re thinking about entering into a loan arrangement, talk to us first so we can help ensure it’s structured appropriately to comply with super law.

If you need help with your SMSF or business financing and loans, call our office today.

i https://www.ato.gov.au/media-centre/levelling-up-smsf-compliance-the-regulators-update
ii https://www.ato.gov.au/individuals-and-families/super-for-individuals-and-families/self-managed-super-funds-smsf/investing/restrictions-on-investments/related-parties-and-relatives
iii https://www.ato.gov.au/individuals-and-families/super-for-individuals-and-families/self-managed-super-funds-smsf/administering-and-reporting/how-we-help-and-regulate-smsfs/how-we-deal-with-non-compliance

This article is intended as an information source only and to provide general information only. The comments, examples, words and extracts from legislation and other sources in this publication do not constitute legal advice, financial or tax advice and should not be relied upon as such. All readers should seek advice from a professional adviser regarding the application of any of the comments in this article to their particular situation.