Under the current SIS Act rules, an investment in a related trust or company is included in the definition of an in-house asset and is subject to the 5% in-house asset rule.

“A related company or trust is effectively a company or a trust that the member of the fund controls. A member will be considered to control a company or trust where they and/or their associates own more than 50% of the shares or units in thew company or trust, or they have effective control. “Effective control is when you've got dummy directors/trustees in place, and you tell those directors what to do.

If a company or trust is considered to be related, weirdly enough, a fund is permitted to actually invest into it by acquiring shares or units.

“But that initial investment must not cause the fund to exceed the five per cent in house asset limit which is based on the market value of the asset compared to the fund’s assets at that time.

Mr Day said it is not only the acquisition that needs to be considered in regard to the five per cent limit, but also at the end of each financial year, the fund must measure the value of its in-house assets and ensure they do not exceed the five per cent limit.

“If they do exceed that limit, maybe because the value of the funds of the in-house assets have gone up you've got to identify the amount of the excess and enter into a to sell down the excess within the next 12 months.”

Mr Day said prior to August 1999, there used to be no restrictions on SMSF investing in such related companies or trusts, and as a result of that a common strategy for SMSFs was to invest via a related company or trust to get around the superannuation investment rules such as the ban on super funds borrowing.

“What the members of an SMSF would do is simply go and set up something like a unit trust, which they would then invest 100% of the fund’s assets in.” he said.

“That trust, which wasn't subject to the superannuation investment rules and restrictions, would then go and borrow to acquire asset effectively getting around the ban on superfund gearing.”

However, about 12 months after the rule change the government introduced new rules, which would allow an SMSF to invest up to 100% of its assets in one of these related companies or trusts, without those in-house asset rules applying, appearing to contradict the previous rule changes.

“What we think happened is the government acknowledged that when it shut down these related company and trust investments by introducing this five per cent in-house asset rule, it had an unintended impact of shutting down a range of other legitimate uses of such structures,” he said.

“So what they did is relax the law to allow such related-party investments, but at the same time, it did include a bunch of additional conditions to ensure these entities couldn't be used to circumvent those superannuation investment rules.”

So yes, you can do this but not in the way that you used to use them to get around those rules.

“In summary, they said you can invest in a related company or trust, but only where that company or trust doesn't go and enter into arrangements that the fund would be prohibited from undertaking itself.”

There are rules for these companies and trusts which are referred to as 13.22C trusts and companies, he said.

“These rules basically say, an SMSFs investment in a related company or trust will not be an in house asset, and therefore not subject to that five per cent in-house asset limit.”

There are conditions to these rules, however, including the company or trustee of the unit trust must not lease an asset of the fund to a related party, including by an interposed arrangement, unless the lease relates to business real property.

As well, the company or the trustee, the unit trust must not have any outstanding borrowings.

In addition, the assets of the company or trust must also not include an interest in another entity and that includes a share in a company or a unit in another trust, a loan to another entity other than an Australian bank account, an asset over or in relation to which there is a charge, and an asset other than money or a business real property that was acquired from a related party of the fund after 11 August 1999 – this also includes where the asset had, at any time, been owned by a related party in the previous 3 years. In addition, Regulation 13.22D also specifies a number of things that will cause a company or trust to fail the 1322C requirements. “This includes where the number of members in the SMSF increases to more than six, or the company or trust undertakes transactions on a non-arm’s length basis or conducts a business.

Where the company or trust complies with all these requirements it will be exempt from the in-house asset rules and an SMSF can invest up to 100% of its assets into the entity. However, should the company or trust fail any of these requirements in future, the in-house asset exemption will cease to apply which will then require the whole arrangement to be unwound, potentially at significant cost and expense. So it will be important for clients to understand the rules and comply with them at all times.