SMSFs investing in unlisted companies

My client wants their SMSF to buy shares in an unlisted company. My client won’t control the company so the in-house asset rules aren’t a problem but what else do they need to consider?

Most SMSFs invest in fairly mainstream assets such as cash, term deposits, listed securities, managed funds and property.  Ensuring the trustee satisfies the super law with these sorts of investment is relatively straightforward. However, some SMSF trustees want to hold less conventional investments including shares in unlisted companies. In these situations it can be harder to know where the problem areas might lie but to follow is a summary of some of the issues to check. 

Check #1 – In-house asset rules 

As you have indicated, one of the first things to check is the in-house asset rules. Funds are restricted to holding no more than 5% of their assets in in-house assets. Shares in an unlisted company will be an in-house asset if the company is controlled by the fund members or their related parties. 

Check #2 – From whom is the fund buying the shares? 

If the shares are currently owned by the members of the fund or related parties of the members, the fund will be prohibited from acquiring the shares unless: 

• the company is controlled by the fund members or their related parties (in which case the shares will be an in-house asset), or
• the company meets the rules of SIS Regulations 13.22C & D (ie. it is exempt from the in-house asset rules).

 Check #3 – Why is the trustee wanting to invest in the company? 

The cornerstone of the super law is the sole purpose test – making sure the fund is maintained only for the purpose of providing benefits to members on their retirement. Does the trustee’s reason for investing in the company align with the sole purpose test? Or is there some other purpose driving the investment decision? 

Similarly, is the proposed investment in the best financial interests of the members? 

Check #4 – Is the price to be paid “arm’s length”? 

If the fund trustee is being offered a discounted price, why? If the price paid is not considered “arm’s length”: 

• there is a risk all of the fund’s income from the shares (including capital gains) will be non-arm’s length income and taxed at 45%, and
• if the fund is acquiring the shares from a related party, it will be an illegal acquisition. 

 Check #5 – Will the fund members or related parties be providing services to the company? 

Where services are to be provided to the company by the members or related parties, they must be paid an arm’s length amount for those services and the trustee must have evidence to support the amount. Too little could cause a non-arm’s length income issue for the fund. Too much could cause a super law compliance issue. 

Check #6 - Investment strategy 

Does the proposed investment align with the trustee’s investment strategy? Is there adequate justification in the strategy of any diversification or liquidity issues? 

Check #7 – Will the trustee have access to sufficient information to determine the market value of the shares each 30 June? 

When preparing their annual financial statements, SMSF trustees are required to value the fund’s assets at market value. Ideally an updated valuation of the unlisted shares would be obtained each year. It is unlikely the shares would be considered a prudent investment if the trustee did not have access to the information necessary to value the shares on a regular basis. 

To stay informed on changes to rules and legislation subscribe to our Super Companion. It's our go-to online resource and knowledge centre – we use it internally to support our staff as they navigate SMSF accounting and compliance for our clients. It's so good that we've opened it up for all – find out more and sign up here.