SMSF Investment Restrictions

Self-Managed Super Funds (SMSFs) provide trustees with significant flexibility and control over retirement investments. However, with this flexibility comes a substantial level of responsibility. SMSFs are governed by strict legislative requirements under the Superannuation Industry (Supervision) Act 1993 (SISA) and the Superannuation Industry (Supervision) Regulations (SISR). These rules are designed to ensure that superannuation savings are used solely for retirement purposes and are managed prudently in the best interests of members.

The investment restrictions imposed under the SIS legislation are fundamental to maintaining the integrity of the superannuation system. Trustees who fail to comply with these obligations may expose the SMSF to severe consequences, including administrative penalties, disqualification as trustees, taxation penalties, or even the loss of the fund’s complying status. In addition, advisers, accountants, lawyers and other professionals involved in facilitating breaches may also face regulatory consequences.

Understanding SMSF investment restrictions is therefore essential for trustees when making investment decisions and managing the ongoing operations of the fund.

2. Arm's Length Investment Rules

Section 109 of the SIS Act requires SMSF investments to be conducted and maintained on an arm’s length basis. This means transactions must occur on commercial terms as if the parties were independent and unrelated.

The arm’s length rules apply to all investments and dealings involving the SMSF, including:

• Property acquisitions
• Lease agreements
• Loans
• Service arrangements
• Related party transactions

The rules do not prohibit transactions with related parties. However, trustees must ensure that related party dealings are conducted on genuine commercial terms.

Examples of arm’s length practices include:

• Purchasing assets at market value
• Charging market rent
• Using formal written agreements
• Applying commercial interest rates
• Obtaining independent valuations where appropriate

The objective of the arm’s length rules is to protect SMSF assets from being manipulated for personal or tax advantages.

Where transactions are not conducted on arm’s length terms, the fund may also be subject to Non-Arm’s Length Income (NALI) provisions. NALI can result in income being taxed at the highest marginal tax rate of 45%, even where the SMSF would otherwise qualify for concessional tax treatment.

Trustees should therefore ensure all transactions are properly documented and commercially justifiable.

Prohibition on Lending and Financial Assistance

Section 65 of the SIS Act prohibits SMSFs from lending money or providing financial assistance to members or their relatives.

This is a strict rule designed to prevent trustees from accessing superannuation savings before retirement or using fund assets for personal purposes.

The prohibition extends beyond direct loans and includes a broad range of financial assistance arrangements. Examples include:

• Lending money to members
• Providing guarantees for personal borrowings
• Selling assets below market value
• Forgiving debts owed to the SMSF
• Allowing members to use SMSF assets personally
• Paying excessive amounts for services provided by related parties

Importantly, the prohibition may also apply indirectly through third-party arrangements. Even where the assistance is not provided directly by the SMSF, the arrangement may still breach the rules if SMSF resources are effectively being used to benefit members or relatives.

The ATO has issued guidance confirming that indirect arrangements can still contravene section 65 where there is a sufficient connection between the SMSF resources and the benefit provided.

Trustees must therefore carefully assess all transactions involving related parties to ensure they do not constitute prohibited financial assistance. 

Borrowing Restrictions

SMSFs are generally prohibited from borrowing money under section 67 of the SIS Act. The borrowing restrictions are intended to reduce risk within the superannuation system and prevent excessive leverage of retirement savings.

However, there are limited exceptions that allow borrowing in specific circumstances.

The most common exception is the Limited Recourse Borrowing Arrangement (LRBA) under section 67A of the SIS Act. An LRBA allows an SMSF to borrow money to acquire a single acquirable asset, provided strict conditions are met.

Under an LRBA:

• The borrowed funds must be used to acquire a single identifiable asset
• The asset must be held in a separate holding trust
• The lender’s rights are limited to the acquired asset in the event of default
• The SMSF must obtain beneficial ownership of the asset

While LRBAs can provide investment opportunities, they also introduce additional complexity and risk. Trustees must carefully consider:

• Liquidity requirements
• Loan repayments
• Interest rate risk
• Diversification concerns
• Market volatility

Improper borrowing arrangements may result in significant compliance breaches. Trustees should therefore obtain professional advice before entering into any borrowing arrangement.

Restrictions on Acquiring Asstes from Related Parties

Section 66 of the SIS Act prohibits SMSFs from acquiring assets from members or related parties except in limited circumstances.

This restriction is designed to prevent members from transferring personal assets into superannuation inappropriately or manipulating asset values.

There are several important exceptions to the rule, including:

• Listed securities acquired at market value
• Business real property acquired at market value
• In-house assets acquired within allowable limits
• Certain widely held unit trusts and managed funds

Business real property is one of the most commonly used exceptions. SMSFs may acquire commercial property from related parties provided the transaction occurs at market value and satisfies all legislative requirements.

For example, an SMSF may purchase a commercial property from a member and lease it back to the member’s business, provided the arrangement is commercial and properly documented.

Residential property, however, generally cannot be acquired from related parties.

Trustees should ensure all acquisitions from related parties are carefully reviewed for compliance before proceeding.

Restrictions on Charges Over Fund Assets

Under Regulation 13.14 of the SISR, SMSF assets generally cannot be used as security for borrowings or subjected to charges.

This restriction is intended to protect superannuation assets from being exposed to external claims or liabilities.

In practice, this means trustees cannot:

• Use SMSF assets as security for personal loans
• Provide guarantees over SMSF assets
• Allow creditors to place charges over fund property

Limited exceptions apply in relation to properly structured LRBAs, where the acquired asset itself may be subject to limited recourse security arrangements.

Trustees must ensure they do not inadvertently breach these rules through financing or related party arrangements.