The laws relating to self-managed superannuation funds (SMSFs) include two anti-avoidance provisions, namely:
- a prohibition on schemes to circumvent the prohibition on acquiring SMSF assets from related parties; and
- a prohibition on schemes to reduce the apparent market value of SMSF assets and thereby avoid any compliance rule.
Anti-avoidance: related party acquisitions
Ordinarily, the prohibition on related party acquisitions prevents SMSFs from acquiring assets from related parties of the fund, with limited exceptions.
The reason for an anti-avoidance provision for this particular prohibition (while there is none, for instance, for the prohibition on borrowing) is clearly because the Government foresaw the likelihood that this particular prohibition is vulnerable to schemes.
Contravention is an offence
Note that contravention of this anti-avoidance provision is an offence punishable by imprisonment for 1 year. This contrasts with the SMSF market value anti-avoidance provision, whose contravention is merely subject to civil penalties. The contrast underscores the Government’s great concern about schemes circumventing the related party rule.
Example: Scheme circumventing the related party rule
Members of a certain group of entities have fallen into the habit of providing goods and services between members of the group through an unusual barter system known as a “trade exchange”. Under the trade exchange, member entities can provide goods and services to each other in exchange for “trade dollars”, a kind of cashless credit only of value within the group.
One member of the group is X Trust, a non-listed unit trust which has invested in real property located in Australia. It permits other members of the group to buy units in itself to receive returns on the investment in trade dollars.
Another member of the group is Y Co, a large employer. One of its employees has an SMSF which is interested in investing in X Trust units.
However, the SMSF and Y Co are related entities, since some of the SMSF members have majority voting interests in Y Co. This means that Y Co is prohibited from providing any assets to the SMSF. The SMSF and X Trust are not related.
The entities enter into the following arrangement:
- Y Co purchases 1,000 units in X Trust for 400 trade dollars;
- Y Co then makes a contribution of the Australian currency equivalent of 400 trade dollars into the SMSF and claims a deduction for this contribution;
- the SMSF then uses the Australian dollars to buy 1,000 units in X Trust itself; and
- mysteriously, Y Co then returns its own 1,000 units in X Trust back to X Trust, and X Trust pays for this in the Australian currency equivalent of 400 trade dollars.
Note that “trade dollars” of this sort are generally regarded as assets, not money, under superannuation law. Therefore, as Y Co and the SMSF are related parties:
- the contribution of trade dollars from Y Co to the SMSF direct would have contravened the prohibition on related party acquisition; and
- the sale of the X Trust units from Y Co to the SMSF direct would also have breached this prohibition.
The ultimate outcome of the scheme was that Y Co funded the SMSF’s acquisition of the X Trust units without breaching the prohibition on related party acquisitions. The scheme was plainly designed for this end.
Therefore this scheme falls foul of the anti-avoidance provisions and all the participants in the scheme may be prosecuted for an offence and at risk of imprisonment or criminal penalties.
If you have concerns over the anti-avoidance provisions applicable to SMSFs, call LAC Lawyers and we can provide advice and assistance.