The SISA contains a number of investment restrictions with which the trustees are required to comply. In assessing whether these prohibitions have been complied with, the auditor examines the nature of each material investment, to ensure that the investment is permitted under the SISA.

Collectables and Personal Use Assets

Collectables and personal use assets under the SISA and SISR are permitted investments for SMSFs, provided the asset was not acquired to provide a personal benefit for the member or their related parties. Collectables or personal use assets^[160] that are acquired by the fund on or after 1 July 2011 are subject to restrictions^[161] contained in the regulation 13.18AA of the SISR including that:

• They must not be leased to any related party^[162] of the fund;
• They must not be stored or displayed in the private residence of any related party of the fund;
• They cannot be used by any related party of the fund;
• Trustees are required to make a written record of the reasons for the decisions on where to store the collectables and personal use assets and keep the record for at least 10 years;
• They must be insured in the name of the fund within seven days of acquisition;
• Transfers of ownership to related parties must be done at market value^[163] determined by a qualified independent valuer;^[164] and
• The auditor obtains sufficient appropriate audit evidence that trustees have complied with the restrictions on collectable and personal use assets of the fund.

Membership investments, such as ski lodge, country club or golf club memberships, providing a right to use a facility or service, will usually fail the sole purpose test if the trustees or members derive a current day benefit from the investment. Furthermore, the SISR prohibits these lifestyle assets from being used by the member or related party of the fund.^[165] The auditor may refer to the examples in ATO Ruling SMSFR 2008/02 to assist them in assessing whether or not an investment in a lifestyle asset is a breach of the SISA and SISR.

Investments in holiday houses or apartments need to be reviewed to ascertain if there has been use or enjoyment of the property by the trustees, members or a related party, as this is a strong indication that the sole purpose test has been breached and may also render the investment an IHA,^[166] in which case the IHA limits will apply. Furthermore, the SISR prohibits the use of such investments by members and related parties of the fund.^[167]

Generally, investments that provide an ancillary benefit as part of the investment need to be examined to determine whether the investment as a whole meets the sole purpose test. Ancillary benefits include, but are not limited to, such things as a discount on a product or service, priority access to a facility, upgrades or free products or services.

In-house Assets

An IHA of a SMSF is an asset that is a loan to a ‘related party’ (defined term), an investment in a related party, an investment in a related trust, or an asset of the SMSF subject to a lease between the trustees and a related party of the SMSF.^[168] A related trust is a trust that a member or employer-sponsor controls.^[169] There are a number of exceptions to the definition of IHA and transitional provisions included in Part 8 of the SISA.^[170] The auditor needs to be familiar with these exceptions when considering IHA requirements.

The SISA has strict limits on the level of IHA permitted to be held by the SMSF. The market value of the IHA must not exceed 5 per cent of the total market value of the SMSF’s assets at the time of acquisition^[171] and at year end.^[172] Also, the trustees are prohibited from acquiring an IHA that would cause the total of all IHA to exceed this 5 per cent ratio. The auditor examines the investments of the SMSF to identify potential IHA to ensure that the legislative limits are not exceeded, either when they were acquired or at year end.

The auditor remains alert to schemes intentionally entered into or carried out by the trustees which have the effect of artificially reducing the market value ratio of the SMSF’s IHA, or by concealing the related party connection. Such actions are prohibited under the SISA.^[173]

If the level of IHA exceeds 5 per cent, the trustee is required to develop a written plan to reduce the level below 5 per cent by the end of the following income year. Where a SMSF has IHA that are greater than the 5 per cent limit, the auditor may obtain a copy of the rectification plan and include details of their testing in the audit working papers.

Acquisition of Assets from Related Parties

Trustees and investment managers are prohibited, under the SISA,^[174] from acquiring assets from a related party unless the assets are acquired at market value and are either:

1. listed securities;
2. business real property;
3. IHA within the 5 per cent limit; 
4. life insurance policies that are not acquired from a member or relative; or
5. assets which are ordinarily IHA but are exempted by the operation of subsection 71(1) of the SISA; and
   1. the asset is acquired at market value; and
   2. the acquisition would not result in a breach of the 5 per cent limit.

Business real property^[175] is land and buildings used wholly and exclusively for business purposes.^[176] It does not extend to:

1. vacant land, unless used in primary production;
2. land used for property development or shares held in an unlisted property owning company; or
3. residential properties except where the residence provides accommodation that is in the nature of a business (for example, for a motel); or the residence is on less than two hectares of a larger parcel of land which is predominately used in a primary production business.

Assets which would ordinarily be defined as IHA but which are exempt under the provisions of subsection 71(1) of the SISA, include deposits with an approved deposit institution, an investment in a pooled superannuation trust where the trustee has acted on an arm’s length basis, an asset which the regulator has determined is not an IHA, an investment in a widely held unit trust, and non-geared unit trusts which meet the other requirements of the SISR.^[177]

Ordinarily, the auditor examines the documentation surrounding the purchase of material investments, to ascertain whether the vendor was a related party. This may involve checking the contract or sale document to confirm who the parties to the transaction were and, to the extent possible, their relationship with the trustees and members. The auditor makes enquiries in the planning phase of the audit in order to identify parties, whether individuals or entities related to the trustees or members.

Arm’s Length Investments

The SISA^[178] requires the trustees and investment managers to invest and maintain the SMSF's assets at arm’s length. Indicators of non-arm’s length investments may include:

• Investments in a related party;
• Investments being managed by a related party;
• Details of parties to a contract indicate related parties;
• Uncommercial or disadvantageous terms of a lease or loan;
• Acquisition or disposals of SMSF assets that do not appear to be at commercial rates;
• No formal contracts established for loan, lease or other arrangement;
• Assets, such as rental properties, deriving little or no income, or income well below commercial rates; and
• Investments which are inconsistent with the investment strategy or entered into without a sound rationale.

The auditor assesses all aspects of the transaction, including that the settlement terms, interest rates, rents, lease refurbishment term, warranties, security and repayment terms are commercial in nature in accordance with section 109 of the SISA. The SISA^[179] requires that the terms and conditions of a transaction must not be more favourable to the other party than would be reasonably expected if the parties were at arms-length. ATO ID 2010/162 clarifies that there is no contravention of section 109 of the SISA if the terms are more favourable to the SMSF. However, if the terms are more favourable to the SMSF, the asset and associated income will be treated as non-arm’s length, resulting in the income (less associated expenses) being taxed as non-arm’s length income, and the asset disposal being treated as a non-arm’s length disposal.

Assets Held Separately

The trustees are required^[180] to keep the money and the assets of the SMSF separate from their personal or business assets of the trustees and from the assets of standard employer-sponsors. The auditor examines the affairs of the SMSF to identify possible situations where the assets of the SMSF may have become intermingled with assets of the trustees or standard employer-sponsors. The auditor checks that the assets of the SMSF are registered in the SMSF’s name or, where assets cannot be held directly by the SMSF (for example in some jurisdictions, a property title may not be able to be held in the name of the fund), there is other clear evidence that those assets are held beneficially on behalf of the SMSF, such as a declaration of trust or an acknowledgement of trust.

Where there has been a change in trustees, the auditor generally checks that the ownership documents for fund assets have been updated.

The auditor confirms that the SMSF maintains a separate bank account for all fund monies and examines payments and receipts to ascertain that dividends, interest and other income of the SMSF are not banked into personal or business accounts, particularly where a corporate trustee operates a number of bank accounts as well as conducting the affairs of the SMSF. The auditor may test that dividends declared for listed securities held are received and banked by the SMSF.

Loans and Financial Assistance to Members or their Relatives

SMSFs are not permitted to lend money or provide financial assistance to members or their relatives^[181] and the approved form auditor’s report states that the auditors procedures included “a review of investments to ensure the fund is not providing financial assistance to members, unless allowed under the legislation”. The auditor examines the bank account and obtains explanations for material withdrawals and deposits in order to ascertain whether any loan or financial assistance benefit has been provided to a trustee, member, or relative of a member or trustee. In certain circumstances, access by members or their relatives to SMSF funds may be considered to be an early access to benefits without meeting a condition of release.^[182]

In cases where funds are accessed in error by the trustees for non-SMSF use, the breach may affect the audit opinion, unless the amount is immaterial, the event is infrequent and repayment is made in full. Interest at commercial rates may also be appropriate.

The auditor reviews the ownership of the SMSF’s assets to ensure that a charge or other form of security has not been taken over any of the SMSF’s assets to secure a member’s or relative’s borrowings, which would be a form of financial assistance. This may require performing a title search for the SMSF’s real property to identify any encumbrances.

Borrowings

SMSFs are not permitted to borrow money,^[183] with the exceptions^[184] of borrowings:

1. to pay a benefit, pension or superannuation contribution surcharge liability (no longer levied), for a maximum of 90 days for up to 10 per cent of the value of the SMSF’s assets;
2. to cover settlement on a security transaction for a maximum period of seven days, for up to 10 per cent of the value of the SMSF’s assets provided that, at the time the relevant investment decision was made, it was likely that the borrowing would not be needed; or
3. that are part of a complying limited recourse borrowing arrangement.^[185]

Ordinarily, the auditor reviews the bank statements to ascertain whether any non-compliant borrowings were made during the period, whether by way of an overdraft or a loan account.

Margin lending, in general, involves a borrowing arrangement where a loan is taken out using the listed securities purchased as security for that loan. Margin loan facilities breach the SISA and SISR by virtue of the fact that the borrowing is not an approved exception to the borrowing prohibition and SMSFs are not permitted to give a charge over some or all of the fund assets as required by a margin lending arrangement. If the SMSF is involved in trading of securities or derivatives, the auditor examines related documentation for indications of the existence of margin lending arrangements, such as interest payments on broker’s statements, margin call payments or significant listed securities purchases without corresponding payments.

The auditor reviews any investments in derivatives, including options, futures, or swaps, to ascertain that the investments are in accordance with the investment strategy, any current legislative requirement and that the investment is not putting the assets of the SMSF at risk. Derivatives, due to their inherent nature, may be high risk and involve borrowings that may have recourse to the SMSF. Where the auditor is unsure of the legality of the investment, the auditor may need to seek legal advice as to whether the investment meets the investment restrictions. Active trading of derivatives may be construed as running a business and, consequently, may be a breach of the sole purpose test.

Where the SMSF has derivative instruments with a charge over assets that is required to be given for compliance with listing rules (covered calls), the auditor obtains the derivative risk statement prepared by the trustees and considers whether it complies with regulation 13.15A of the SISR.

Investments in limited recourse borrowing arrangements are an exception to the prohibition on borrowings. Limited recourse borrowing arrangements are complex financial arrangements whereby the SMSF buys an asset via a limited recourse agreement where there is some debt funding or borrowing to purchase the asset. The transaction is characterised by an asset held in trust for the SMSF, where the SMSF holds an interest in the income and the rights to acquire the asset. The SMSF may be required to make regular instalments or repayments. Recourse by the lender, against the fund trustee, in the case of failure to settle the loan, is required to be solely over, and limited to, the asset held in the trust arrangement. After commencing the borrowing, the SMSF is required to make at least one payment before purchasing the asset. Whilst there is no formal requirement for regular repayments or instalments, the lack of repayments may bring into question the commercial rationale of the underlying investment and whether the sole purpose test is being breached.

From 24 September 2007, superannuation funds were allowed to invest in certain limited recourse borrowing arrangements involving borrowing money to acquire a permitted asset. Those arrangements need to meet the conditions stipulated by the law in the former subsection 67(4A) of the SISA. Those rules continue to apply to limited recourse borrowing arrangements that were entered into before 7 July 2010.

For limited recourse borrowing arrangements^[186] entered into by superannuation funds on or after 7 July 2010, or previous subsection 67(A) of the SISA debt arrangements that have been refinanced after 7 July 2010:

1. the asset within the arrangement can only be replaced by a different asset^[187] in very limited circumstances specified in the law;
2. superannuation fund trustees cannot borrow to improve an asset^[188] (for example, real property);
3. the borrowing is permitted only over a single acquirable asset or a collection of identical assets that have the same market value;
4. the asset within the arrangement is not subject to a charge other than to the lender in respect of the borrowing by the superannuation fund trustee.^[189]

Procedures which the auditor may conduct in auditing compliance of limited recourse borrowing arrangements with the SISA and SISR may include:

Examination of the fund’s governing rules to determine if the SMSF is permitted to borrow.

• Examination of the investment strategy, or discussions with the trustees if there is no written investment strategy, to determine if limited recourse borrowing arrangements and the percentage of funds devoted to them are allowed within that strategy.
• Identification of the nature of the asset purchased and whether the vendor is a related party, so as to ensure that the transaction is permitted under the SISA, SISR and the fund’s governing rules.
• Determination of whether the debt arrangement or loan agreement is a limited-recourse agreement as required by the SISA,^[190] whereby the other assets of the SMSF are not used as security for the loan.
• Determination of whether the finance is provided by a related party, such as a family trust, in order to identify any potential non arm’s length dealings.
• Determination of whether the funds borrowed were used to purchase an asset held in the limited recourse borrowing arrangement.
• Determination of whether the funds borrowed have been used to improve an asset.
• Identification of whether the terms of the loan are commercial. Less than commercial interest rates may be a means of making additional contributions to the SMSF, whereas an excessively high interest rate may fail the sole purpose test, or potentially be a scheme to access benefits.
• Identification of any arrangements outside the SMSF, such as a personal guarantee, which may have recourse to the assets of the SMSF, other than the asset acquired (or any replacement), as this may be a breach of the borrowing restriction exception granted to limited recourse borrowing arrangements.
• Determination of whether the original asset has been added to in any way, either by additional shares or further purchases, since if the limited recourse borrowing asset has increased, this would indicate a further borrowing and therefore a potential breach of the prohibition on borrowing.
• For limited recourse borrowing arrangements entered into from 1 July 2010, determination of whether:
  • a replacement to the asset has been made contrary to the law;
  • the fund has not borrowed to improve an asset in the arrangement;
  • the trust asset is a single asset or identical assets that have the same value, for example ordinary shares; and
  • there is no charge over the asset except per the limited recourse arrangement.^[191]

Charges Over Assets

SMSFs are not permitted to use the assets of the SMSF to secure a debt facility^[192] and, hence, charges and liens over assets are not permitted. Also, charges and liens over any member benefits are prohibited. Additional audit procedures include review of any bank confirmations for charges, title searches on properties of the SMSF to identify any charges or liens, the Personal Properties Securities Register for parties registering interests against other SMSF assets and examination of the accounting records or bank statements to identify any interest payments made by the SMSF, which may indicate a loan facility.

Similarly, the auditor ordinarily reviews the ownership of the SMSF’s assets to ensure that a charge, or other form of security, has not been taken over any of the SMSF’s assets. This may extend to reviewing any product disclosure statement relating to assets acquired to determine whether the product has any recourse to the SMSF. Even if the marketing or summary material claims there is no recourse to the SMSF, the auditor still checks the actual provisions of the arrangement.

Where the SMSF has investments in related or unlisted unit trusts, the auditor is alert to any borrowings the unit trust may have and whether there is any recourse to the SMSF. Where a related unit trust has allowed a charge over its assets or has a borrowing, the investment in the unit trust becomes and remains an in-house asset of the fund.

Ordinarily, the auditor requests the most recent financial report and tax return along with distribution statements for investments in unit trusts, to identify net asset value, any debts owing by the unit trust and income received and paid by the trust. In certain cases, the unit trust deed may be required to assist the auditor in assessing the investment against SISA investment rules.

Asset Valuation

The trustees are required to value fund assets at market value.^[193] See paragraphs 191 to 202 for requirements and explanatory guidance on asset valuations.