What is the arm’s length rule?

All SMSF investments have to be made on a sound commercial basis – often referred to as being “arm’s length”.  Generally this is easy to do – for example, if your fund buys shares on the stock exchange, it is obviously buying them at the market price, you can’t control the dividends you receive and so the investment is arm’s length. 

The situation is potentially less clear when related parties are involved. When your fund buys assets from related parties or makes investments that might be linked to you or your family, you need to make sure that everything occurs on a normal commercial basis and that the fund is not disadvantaged by giving favourable terms to other parties.

Tax law also imposes much higher rates of tax where the bias is the other way around – i.e., where the super fund is receiving a highly favourable outcome that is not consistent with an arm’s length arrangement. (Income earned under these circumstances is referred to as ‘non arm’s length income’ and is taxed at the highest marginal tax rate.)