Can an SMSF run a business?
It’s tempting for an SMSF trustee to try to offset capital losses from share sales against other income by becoming a share trading business. It’s not easy to satisfy the provisions of superannuation law.
I am often asked whether an SMSF can run a business. The usual reason for this question is not because the SMSF trustees are thinking of starting a conventional business, but because they are attracted to their SMSF running a share trading business. I’ll explain why later.
While the superannuation law does not specifically disallow an SMSF from conducting a business, the activities of the SMSF trustee must not contravene super law provisions, including:
The sole purpose test. The purpose of an SMSF is to provide retirement benefits or retirement related benefits for its members and their dependants. So, if an SMSF is conducting a business, it could be perceived that the money in the fund is being used to provide a current-day benefit to its members instead of it being there for their retirement.
Investment strategy. An SMSF trustee must formulate and give effect to an investment strategy. This means the nature of the business activities and the manner in which they are conducted must be in accordance with the investment strategy of the SMSF.
Lending. An SMSF trustee is prohibited from lending money or providing financial assistance to members and relatives. Therefore, the business activities must not involve selling an asset of the SMSF for less than its market value; purchasing an asset for greater than its market value; acquiring services in excess of what is required; or paying an inflated price for services acquired from members or relatives.
Borrowing. An SMSF must not draw upon a bank overdraft or margin lending product to fund its business activities nor can it borrow money for the business by taking out a mortgage over the SMSF’s assets.
Arm’s length investments. An SMSF must not employ a member or a relative in the business at a salary higher than the going rate.
Of course, many of these contraventions now come with steep penalties imposed by the regulator.
A share trading business in an SMSF
If a person is an ordinary share holder then the cost of purchasing shares is not an allowable deduction, and the losses from sales of shares cannot be offset against the income of the SMSF but is instead offset against capital gains received from the sale of those shares. On the other hand if a person is a share trader, they can treat the shares as trading stock and claim deductions for costs incurred in buying and selling shares.
The Australian Taxation Office will determine which category a person belongs to on a case-by-case basis. The general rule is that a share trader is classed as someone who is undertaking business activities for the purpose of earning an income from buying and selling shares. It is the volume and frequency of transactions that is important and not necessarily the amount of capital invested. Other important factors would include things such as evidence of a business plan and keeping records in a business-like manner.
Nevertheless, what people need to be aware of is that a law was introduced in June 2012 that abolished trading stock exceptions for SMSFs. This law limits the ability of SMSFs to pass gains and losses from certain assets (e.g. shares, units, land) through the revenue account. Gains and losses are treated in accordance with the capital gains tax provisions. However, if an SMSF did hold assets as trading stock prior to 10 May 2011 then it can continue to be taxed on revenue account.
So whether an SMSF is conducting a share trading business or not, all share trading activities of the SMSF will now be treated as an investment and the capital gains tax provisions will apply. If you were thinking of a share trading business solely as a way of avoiding capital gains tax then you will need to rethink your plans.
Monica Rule worked for the ATO for 28 years and is the author of the book titled “The Self Managed Super Handbook – Superannuation Law for Self Managed Super Funds in plain English” www.monicarule.com.au
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