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I have received a newly setup SMSF for audit for 2022 financial year. initially, two members rolled over $350,000 from their industry super funds.
The SMSF lent $300,000 on 3rd of June 2022 to a non related trust for the development of the properties for 6 months loan period with an option to extend the period of loan for another 6 months should the borrow elect to do so. initially, there is no Caveat lodged by the SMSF (Lender) on the properties being developed but the lender has the right to lodge a Caveat in the event of default. Since the loan is not secured initially and its 85% of the fund total assets I am hesitant to issue an unqualified report and I am also going to raise this issue in the managemnt letter.
Just wondering am I thinking along the right lines, is this also breach of any section of the SIS Act, do I need to lodge a contravention report?
Hi Dawood
A similar issue has been raised previously. I agree with your concerns. Given the loan was for 6 months from 3 June 2022 (with a 6 month rollover option) I would review if the loan has been repaid as a starting point.
In terms of the compliance audit, I would consider the following sections / regulations of SIS (& this will determine if any SIS breaches or need to lodge an audit contravention report (ACR)):
1) Section 62 - sole purpose test. Does the loan meet the sole purpose requirements?
Given that there is no security in place this would be of concern to me. I would want an explanation as to why there is no security in place and how the trustees have satisfied the sole purpose test.
2) Section 82 - 85 - in-house asset (IHA) rules. Is the loan to a related party?
If the loan is to an unrelated party the IHA rules will not be breached. You would need to obtain paperwork to support that the borrower is not a related party.
3) Section 109 - arm's length rules. Investments must be made on an arm's length / commercial basis.
Given that there is no security in place this would be of concern to me.
In relation to the above compliance concerns I would be requesting an explanation from the trustee as to:
i) why is there no security in place?
ii) how was the interest rate determined?
iii) what due diligence was done in relation to the borrowers ability to repay the loan?
iv) does the Fund's investment strategy allow for such an investment to be made?
Once you have obtained an explanation to the above queries that may assist in whether you need to qualify the compliance audit (and lodge an audit contravention report).
In relation to diversification (as $300,000 out of $350,000 invested in the loan) you can qualify on this if the trustees have not considered diversification as part of their investment strategy.
The audit report states in relation to regulation 4.09 re the investment strategy that "the fund trustee has an investment strategy, that the trustee has given consideration to risk, return, liquidity, diversification, the insurance needs of fund members, and that the fund's investments are made in line with that investment strategy. No opinion is made on the investment strategy or its appropriateness to the fund members."
Thanks
SMSF AAA
Thanks a lot for your quick reply.