QUARTER I 2022 | ISSUE 037 | THE PREMIER SELF-MANAGED SUPER MAGAZINE
are THE NEW DIRECTOR ID REGIME
FEATURE
STRATEGY
ANALYSIS
COMPLIANCE
Director ID numbers What it means for trustees
Death benefits Minimising tax payable
Sector statistics Methodology insight
Employee share schemes NALI implications
SMSF PROFESSIONALS DAY 2022 SYDNEY HYBRID EVENT | 31 MAY
Give yourself the opportunity to consider new strategies and glean a better understanding of the latest technical information. Our presenters, recognised as the best in the industry, will take delegates through the most important issues in the sector and the resulting implications and strategic opportunities for clients. FEATURED SPEAKERS
Graeme Colley
Executive Manager, SMSF Technical and Private Wealth SuperConcepts
Philip La Greca
Executive Manager, SMSF Technical and Strategic Solutions SuperConcepts
EVENT SPONSOR
EDUCATION PARTNERS
Paul Delahunty
Mark Ellem
Director, Self-managed Super Funds, Approved Auditors Portfolio Superannuation Australian Taxation Office
Head of Education Accurium
Tim Miller
Darin Tyson-Chan
Education Manager SuperGuardian
Publisher, Editor Selfmanagedsuper
COLUMNS Investing | 20 The case for breaking with convention.
Investing | 24 Asian markets as an income source.
Strategy | 28 Minimising tax on death benefits.
Compliance | 31 Property purchase procedures.
are
Strategy | 34 What’s involved in an SMSF wind-up.
Analysis | 38 Examining the methodology of SMSF statistics.
Strategy | 44 The many ways of withdrawing and recontributing.
Compliance | 48 The NALI conundrum with employee share schemes.
Strategy | 50 Estate planning advice complexities.
Compliance | 54 Funding property purchases.
Analysis | 57 The Quality of Advice Review.
Strategy | 60 Disposing of an SMSF property.
WHO ARE YOU?
THE NEW DIRECTOR ID REGIME
Cover story | 12
REGULARS What’s on | 3 News | 4 News in brief | 5 SMSFA | 7 CPA | 8 SISFA | 9
FEATURE Investing for the planet’s future | 16 SMSF interest and considerations.
IPA | 10 Regulation round-up | 11 Last word | 64
QUARTER I 2022 1
FROM THE EDITOR DARIN TYSON-CHAN INAUGURAL SMSF ASSOCIATION TRADE MEDIA JOURNALIST OF THE YEAR
Can’t have your cake and eat it too As we all know, there is a federal election looming this year that will probably take place in May. And if you believe the polls, we are on track for a change of government in 2022. So it’s particularly important to pay attention to the narrative Shadow Assistant Treasurer and Shadow Minister for Financial Services Stephen Jones is now building. And in an opportune and timely manner the member for Whitlam was the guest speaker at one of the first industry events for the year. I was particularly interested in getting a sense of what his and the Labor Party’s likely attitude is toward the sector in which we all play a part. Unfortunately, the only thing I walked away with after his speech was a sense of confusion as a result of the mixed messages Jones had just delivered. One point he was at pains to make was the fact he didn’t think it was the government’s job to dictate how superannuation savings are to be spent. In the same breath though he was highly critical of how the early access to superannuation COVID-19 relief measure had been executed because it had allowed people to spend up to $20,000 of their retirement savings on items that were not of a critical financial survival nature. However, immediately after this criticism he lavished praise on the results of the initiative, citing it had provided a much welcome boost to the retail sector of the economy. Is it just me
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or this a confused way of thinking? To my mind it seems contradictory to accuse someone who accessed their super early and bought a big screen TV as not using the money properly, but at the same time praising that same individual for sustaining the economic health of the retail sector when it was being smashed by the coronavirus. He also praised individuals he discovered had used their super to pay staff salaries during the most economically crippling part of the pandemic lockdown to date. Is this an acceptable use of these funds or is that definition reserved for more basic spending patterns, such as buying food for one’s family or paying off one’s mortgage? I’m pretty sure the loudest critics of the measure, such as the industry funds, which were against it in any way, shape or form, probably wouldn’t think so. So I walked away not exactly sure of what his attitude toward the sector and the portfolio is. To me it seems Jones basically wants to have his cake and eat it too and I don’t think this is possible. And it appeared to indicate our elected officials don’t seem to understand the most fundamental tenet of the superannuation system in this country – super is the individual’s money and they can spend it any way they see fit regardless of what ‘conventional thinking’ would otherwise dictate. I know I’ve said it before, but until the politicians get this point, sensible policy initiatives for the sector could be very difficult to come by.
Editor Darin Tyson-Chan darin.tyson-chan@bmarkmedia.com.au Senior journalist Jason Spits Journalist Tia Thomas Sub-editor Taras Misko Head of sales and marketing David Robertson sales@bmarkmedia.com.au Publisher Benchmark Media info@bmarkmedia.com.au Design and production RedCloud Digital
WHAT’S ON
Institute of Public Accountants Inquiries: Liz Vella (07) 3034 0903 or email qlddivn@publicaccountants.org.au
SMSF live audit NSW 21 February 2022 Institute of Public Accountants Level 12, 6 O’Connell Street, Sydney
UK pension transfers 31 March 2022 Recorded session
SMSFs and NALI – what does it mean? 31 March 2022 Recorded session
SMSF audit update 31 March 2022 Recorded session
On-demand bundle SMSF fundamentals 31 March 2022 Recorded session
Accurium Inquiries: 1800 203 123 or email enquiries@accurium.com.au
To have an upcoming event featured on the What’s On page, please contact darin.tyson-chan@bmarkmedia.com.au.
Webinar Accountant-focused session 11.00am-12.30pm AEDT Adviser-focused session 1.30pm3.00pm AEDT
Contributions masterclass 2022 QLD 23 March 2022 Christie Spaces Brisbane 240 Queen Street, Brisbane 24 March 2022 Webinar 12.00pm-3.30pm AEST
Free post-budget 2022 webinar 30 March 2022 Webinar 3.00pm-4.30pm AEDT
Legacy pensions masterclass 2022 27 April 2022 Webinar 12.00pm-3.30pm AEST
Death benefits masterclass 2022 28 April 2022 Webinar 12.00pm-4.30pm AEST
Smarter SMSF
Live Q&A
Inquiries: www.smartersmsf.com/event/
24 February 2022 Webinar 2.00pm-3.00pm AEDT
SMSF deductions under the microscope
Paying a pension from an SMSF 15 March 2022 Webclass 12.30pm-2.00pm AEDT
24 February 2022 Webinar 12.00pm-1.00pm AEDT
Changing face of SMSF
Heffron
23 March 2022 Webinar 11.00am-4.00pm AEDT
Inquiries: 1300 Heffron
Federal budget impact on SMSFs
Quarterly technical webinar
31 March 2022 Webinar 2.00pm-3.00pm AEDT
24 February 2022
Super unpacked
SuperConcepts
29 April 2022 Webinar 11.00am-12.00pm AEST
Inquiries: 1300 023 170
SuperGuardian
Virtual SMSF Specialist Course
Inquiries: education@superguardian.com.au or visit www.superguardian.com.au
SMSFs acquiring assets from a related party 2 March 2022 Webinar 12.30pm-1.30pm AEDT
DBA Lawyers Inquiries: dba@dbanetwork.com.au
SMSF Online Updates 4 March 2022 12.00pm-1.30pm AEDT 8 April 2022 12.00pm-1.30pm AEST 6 May 2022 12.00pm-1.30pm AEST
SISFA Inquiries: jane@sisfa.com.au
SISFA SMSF 13th Annual Forum – hybrid event VIC 22 March 2022 Westpac Offices 150 Collins Street, Melbourne 9.00am-5.00pm AEDT
Cooper Grace Ward Inquiries: (07) 3231 2400 or email events@cgw.com.au
2022 Annual adviser conference – hybrid event QLD 24-25 March 2022 Sofitel Brisbane Central 249 Turbot Street, Brisbane
29-31 March 2022 10.00am-2.00pm AEDT 5-7 April 2022 10.00am-2.00pm AEST
SMSF Auditors Association of Australia Inquiries: jane@sisfa.com.au
2022 Conference VIC 1 April 2022 Pullman Melbourne Albert Park 65 Queens Street, Albert Park 8.45am-6.00pm AEDT
SMSF Association Inquiries: events@smsfassociation.com
National Conference 2022 SA 20-22 April 2022 Adelaide Convention Centre North Terrace, Adelaide
SMSF Professionals Day 2022 – hybrid event Inquiries: Jenny Azores-David (02) 8973 3315 or email events@ bmarkmedia.com.au
NSW 31 May 2022 SMC Conference & Function Centre 66 Goulburn Street, Sydney 8.30am-4.30pm AEST
QUARTER I 2022 3
NEWS
Labor to champion bigger role for super By Darin Tyson-Chan
The Shadow Assistant Treasurer and Shadow Minister for Financial Services Stephen Jones has revealed Labor’s intention to have superannuation play a larger role in Australian society should it win the federal election this year. Speaking at a recent industry function, Jones told attendees: “We think we can be deploying superannuation funds in the interest of the members who own the funds, but also in the national interest. “We think government has a role to play, there is plenty
of capital around, but the government doesn’t have to be putting its own [money] up and shouldn’t. “But we do have an important role to play in ensuring that, particularly in the infrastructure sector, there is still flow ensuring that we have the capacity in certain strategic markets. We’d be one of the only countries in the world that wasn’t doing it if we let this opportunity go by. “So we think there is an important role in government working with industry to create investment opportunities, not with taxpayers’ money, in ensuring the national interest and the interests of the owners
of those superannuation funds.” However, he pointed out Labor was not in favour of imposing any dictate on exactly how people’s retirement savings should be spent. To this end, he criticised the Your Future, Your Super legislation for containing an element of this exact nature. “The directions power that was included in the Your Future, Your Super legislation, can you imagine if Labor did that? Included within a bill the power to direct a bank and insurance company and a superannuation fund how it could or couldn’t invest its funds. Forced divestment,” he said. “This is just capricious. It’s
Stephen Jones ideological, it’s ill-conceived and it’s got to stop.” To this end, he called for greater transparency in the formulation of legislation, which should include greater engagement with the financial services and superannuation industry.
Director ID request a one-off By Darin Tyson-Chan
Directors of a corporate SMSF trustee will only be required to apply for their mandatory director identification number once, regardless of when this company protocol is actually used. Under amendments made to the Corporations Act, company directors, including individuals holding office in an SMSF corporate trustee, must acquire a director ID number. The rules came into play on 1 November 2021 and stipulate existing company directors must apply for an ID number before 1 December 2022, individuals appointed to a directorship between 1 November 2021 and 4 April 2022 need to apply for an ID number within 28 days of their appointment, with people intending to be directors having to apply for an ID number before being appointed from 5 April 2022. The legislation covers enduring powers
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ATO confirms ID process. of attorney, and applications for director IDs can be made prospectively. However, under the act the ID can be cancelled if not used or made active within 12 months
of receipt, which has led to concern as to whether multiple applications will be needed in some cases. In a recent discussion with the SMSF Association, the ATO confirmed individuals will not need to request a director ID number more than once. When asked by SMSF Association technical manager Mary Simmons whether eligible individuals will be able to simply reinstate their cancelled director IDs, ATO SMSF industrial liaison, policy and governance senior director Martin Frauenfelder answered in the affirmative. “[It will be] relatively easy. To reactivate a director ID the person just needs to follow the same process as when they applied for the first time,” Frauenfelder noted. Simmons acknowledged how valuable this detail of the legislation is for SMSFs. “For the SMSF sector it’s particularly important when you’ve got alternate or successor trustees in place to deal with the death or incapacity of a trustee,” she noted.
NEWS IN BRIEF
SMSFA calls for limit simplification The current confusion surrounding transfer balance caps (TBC) can be solved by aligning those of superannuation fund members with the general TBC, according to the SMSF Association (SMSFA), which has also called on the government to reduce the number of total super balance (TSB) thresholds. The SMSFA made the calls as part of its 2022/23 budget submission to Treasury, stating the simplification of TBCs was its primary recommendation to government after the introduction of indexation on 1 July 2021 added greater complexity to the superannuation system. The submission stated that aligning superannuants’ TBC with the general TBC would provide certainty while reducing costs for funds and members and simplifying the administration required by the ATO, financial advisers, SMSF administrators and fund members. In calling for the simplification of TSB limits, the SMSFA submission recommended the removal of the $1 million TSB threshold for transfer balance account reporting, the removal of the $1.48 million and $1.59 million TSB bring-forward non-concessional contribution thresholds and aligning the disregarded small fund assets threshold to the general TBC.
SMSF members most satisfied SMSF have been ranked the highest for member satisfaction compared to all other types of funds in 2021, according to statistics released by Roy Morgan. The market research company’s latest “Superannuation Satisfaction Report” revealed SMSF customer satisfaction
significantly increased in the 12 months to December 2021. “Despite [satisfaction levels rising for all fund categories] it is self-managed super funds which still lead the way with a customer satisfaction rating of 80.1 per cent, up 8.5 percentage points on a year ago, ahead of public sector funds just behind in second place on 77.7 per cent, up 3.9 percentage points,” Roy Morgan chief executive Michele Levine said. The report, which was based on responses from 20,900 Australians with superannuation, noted the stock market’s strong performance over the past 18 months had supported the growth of customer satisfaction regarding industry funds, which reached a new high in 2021. The period covered by the report was the six months from July 2021 to December 2021, which had been impacted by extended lockdowns across the nation and significant financial support schemes being implemented.
New insolvency laws affect sector Following the federal government’s decision to change the insolvency legislation framework, the ATO has warned SMSFs with a corporate trustee may be disqualified where they have been involved in an insolvency event. In a website update, the regulator noted the government’s changes included a new debt restructuring process and a simplified liquidation process for eligible incorporated small businesses through the appointment of a restructuring practitioner. These changes also led to amendments to the Superannuation Industry (Supervision) Act, which commenced from 8 December 2021, and the creation of a new category of disqualified persons, which could impact SMSFs with a corporate trustee. “This new category applies when a restructuring practitioner is appointed in
an insolvency event. This will trigger the disqualification of a corporate trustee of a superannuation entity, including an SMSF, from managing a superannuation entity,” the ATO stated. “If your SMSF has a corporate trustee, and a restructuring practitioner is appointed, the company will no longer be able to act as the corporate trustee as it is disqualified. You need to notify us of the disqualification as soon as practicable.”
Class CEO departs Class has announced chief executive Andrew Russell has decided to depart his position on 16 February, the same date the scheme of arrangement for Hub24’s acquisition of the SMSF administration provider will be implemented. According to Class, Russell and the boards of the two companies agreed that with Class becoming a part of Hub24 following its acquisition, the time was right for him to step down. Russell has been in the role since May 2019 and will act as an adviser to Hub24 until 31 March, while Hub24 director of strategic development Jason Entwistle has been appointed interim chief executive and managing director of Class, reporting to Hub24 chief executive Andrew Alcock. Class chairman Matthew Quinn thanked Russell for his work at Class, noting he was a “talented chief executive and a transformational leader”. Russell said it had been a privilege to work for a driven organisation, which is expected to grow following Hub24’s acquisition. Hub24’s plans to purchase Class, first announced under a scheme of arrangement in October 2021, received approval in the Supreme Court of New South Wales on 4 February 2021, allowing the group to acquire all Class shares.
QUARTER I 2022 5
NEWS IN BRIEF
NALE review push Eleven industry bodies have called on the federal government to commit to a review of the non-arm’slength expenditure (NALE) rules and addressing the potential for general expenses to taint all of a superannuation fund’s income. The recommendation was made as part of a submission to Superannuation, Financial Services and the Digital Economy Minister Jane Hume in September 2021, recently released by Chartered Accountants Australia and New Zealand (CAANZ) The joint bodies, including the SMSF Association, Self-managed Independent Superannuation Funds Association and Association of Superannuation Funds of Australia, stated the NALE rules and the ATO’s interpretation of them would have harmful consequences that were not intended and should not be left unaddressed. “While the joint bodies have a number of issues with the reach of these provisions, our overarching concern is that the ATO’s interpretation of the law means that rather than merely addressing the mischief at which the government policy was directed, the rules could result in unwarranted significant and long-term detriment to fund members and could operate in conflict with a range of trustee obligations such as the best financial interests duty rule in the Superannuation Industry (Supervision) Act,” the submission from the 11 industry bodies said. “Given the significant impact these rules may have on retirement savings, the joint bodies ask that the government make an announcement that they will review the NALI rules in section 295550 of the Income Tax Assessment Act 1997 and encourage the ATO to provide further administrative relief until this review and relevant amendments to the legislation are enacted.”
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Crypto scams target SMSFs Scammers are continuing to target SMSFs, with the Australian Securities and Investments Commission (ASIC) warning of an escalation in marketing about crypto-assets recommending the creation an SMSF to invest in ‘high-return’ portfolios. The corporate watchdog noted an increase in the number of advertisements suggesting Australians switch from their retail and industry superannuation funds to an SMSF to invest in crypto-assets or cryptocurrencies. ASIC has advised trustees to be cautious regarding social media advertisements, online contacts promoting an investment opportunity, cold calls, text messages or emails recommending a super fund be transferred to an SMSF or investing in cryptoassets via an SMSF. It noted superannuation was an “attractive target” for scammers and crypto-assets were a high-risk and speculative investment, and advised “it is best practice to seek advice from a licensed financial adviser before agreeing to transfer superannuation out of a regulated fund into an SMSF”. The regulator added anyone who was an SMSF trustee would be responsible for any investment decisions and should seek advice and be aware of their obligations when investing.
Dixon in voluntary administration Dixon Advisory and Superannuation Services (DASS) has entered voluntary administration, appointing PwC partners Stephen Longley and Craig Crosbie to conduct the process. DASS, a wholly owned subsidiary of E&P Financial Group (EP1), cited the possibility of becoming insolvent in the future as the reasoning behind the decision. The move was made amid fears of actual
and potential liabilities the entity is facing stemming from a client class action being led by Piper and Alderman and Shine Lawyers, claims against DASS being determined by the Australian Financial Complaints Authority and an agreement made with the Australian Securities and Investments Commission to pay a $7.2 million penalty and $1 million in legal fees. The appointment of voluntary administrators was made with a view to facilitate the prompt transfer of DASS clients to a replacement service provider of the client’s choice as seamlessly as possible, and the preparation of a deed of company agreement that will provide for the comprehensive settlement of all DASS and related claims in an equitable manner for all clients and creditors.
SMSFA conference postponed The SMSF Association (SMSFA) has confirmed its national conference for 2022 has been pushed back to late April due to the current rise in COVID-19 cases across Australia resulting from the Omicron variant of the virus. SMSFA chief executive John Maroney said the industry body had been monitoring coronavirus-related developments as they relate to the safe operation of the conference but also the safe travel of all attendees to and from Adelaide, where the conference will be held. “With most states and territories including South Australia currently in the midst of escalating COVID-19 cases, we have decided to postpone our 2022 National Conference until April, [from] Wednesday 20 April to Friday 22 April 2022, immediately after the Easter break,” Maroney said. “We know most of our conference delegates are eager to return to face-to-face events and we are committed to presenting a national conference of the highest calibre. “Once the current wave of Omicron infections has passed, we expect that by April we will be able to gather together, in a controlled and safe manner, to enjoy this premium SMSF sector conference.”
CPA SMSFA
Exciting program to mark face-to-face return
JOHN MARONEY is chief executive of the SMSF Association.
The decision to postpone the SMSF Association National Conference at the Adelaide Convention Centre for obvious COVID reasons until 20 April has delivered some unexpected benefits. Firstly, the federal budget will have been handed down three weeks earlier, so delegates can expect association policy and education director Peter Burgess to analyse all its implications for the SMSF sector in his Legs & Regs update on the opening morning. Secondly, it means BT Financial Group head of financial literacy and advocacy and SMSF Association board member Bryan Ashenden will be able to deliver a policy update in the second plenary session at the end of the first day, but more about that later. Thirdly, the ATO’s Paul Delahunty, recently appointed director of SMSF auditors, will participate in the audit discussion group Q&A session on the second day. It will be a great opportunity for SMSF auditors to meet and hear from the regulator’s new director in this critical position for our superannuation sector. Ashenden’s session, appropriately titled “It’s (or is it) the end of the world as we know it?”, will be a must attend for delegates as he discusses the changes 2022 will usher in. As he will explain, this year marks the start of significant reforms in the regulatory landscape for those providing financial advice and related services. Consider the following: • the Australian Law Reform Commission is exploring the simplification of financial services laws, • Treasury is conducting its Quality of Advice Review following the royal commission, • the Financial Adviser Standards and Ethics Authority has been disbanded, with Treasury now setting the standards and responsible for the code of ethics, and • the Australian Securities and Investments Commission will have greater oversight of compliance. The list does not stop there. With adviser registration with the Tax Practitioners Board no longer required, will exemptions for accountants providing non-investment-related advice to SMSFs become part of the advisory landscape again? Will there be additional education requirements or will the existing requirements change? It all seems very daunting – at the very least, there will be much to ponder. The Thought Leadership Breakfast has become
part of the conference’s staple diet, providing the opportunity to crystal ball gaze a future industry trend. This year the two-hour session on the opening day will dissect how technology is having an impact on the sector today, where it is heading and what this will mean for practice owners, practitioners and at-scale SMSF service providers. Once again, an expert panel has been assembled, this year comprising David Smith, founding director of Smithink, which assists professional service firms with their strategy, business management, governance, mergers and acquisitions and succession, association chief executive John Maroney, BGL managing director Ron Lesh and OpenInvest cofounder and chief executive Andrew Varlamos. In what will be a conference first, a symposium will be held on day one. Titled “Resetting retirement income advice – Building a retirement advice-centred community and best practice system”, it boasts four high-calibre speakers: Allianz Retire+ investment specialist Tim Dowling, SMSF Association board member and former Retirement Income Review panellist Dr Deborah Ralston, Hub24 senior business strategy manager Greg Hansen and Encore Advisory Group executive chairman Tom Reddacliff. Two other plenary sessions certain to garner interest will be delivered by Cooper Grace Ward partner and association board member Scott Hay-Bartlem, who will address the topic of “The SMSF estate planning narrative – Joining the dots and bringing it all together with common conference themes and other current SMSF estate planning issues”, and Heffron managing director Meg Heffron, who will dissect the contribution strategy landscape in 2022. The popular workshops, which have become such a feature of these events, will not only provide delegates with a deep dive into current technical topics, but also offer an excellent opportunity for them to be discussed and debated in an open forum. The national conference has always been the ideal event for industry trends and changes to be analysed. But it’s not just an educational experience. Over the years it has allowed delegates to network at the many social functions that help make it the pre-eminent event on the SMSF calendar. This year, after more than two years since the last face-to-face event, this opportunity to engage with their peers at all levels will be savoured all the more. See you in Adelaide in April.
QUARTER I 2022 7
CPA
NALI rules put opportunities out of reach
RICHARD WEBB is financial planning and superannuation policy adviser at CPA Australia.
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Recent changes to the rules on non-arm’slength transaction requirements may impose a heavy tax burden on super funds that acquire assets at a discount. They may also render employee share schemes inaccessible to SMSFs. Here’s what you need to know. In 2017, changes designed to bring non-arm’slength expenditure, where these expenses did not necessarily give rise to non-arm’s-length income (NALI), into the non-arm’s-length transaction tax regime introduced considerable uncertainty. The NALI regime is designed to provide disincentives to trustees against arbitraging between tax rates. Essentially, they penalise ‘mate’s rates’ by imposing a 45 per cent tax rate on income or capital gains related to transactions that are undertaken with a related party at anything other than a commercial or market rate. Ostensibly aimed at limited recourse borrowing arrangements, the changes have since been the subject of Law Companion Ruling (LCR) 2021/2. This ruling considered services provided to a fund by the trustee or their associates. A consultation is also presently underway on consequential amendments to Tax Ruling (TR) 2010/1-DC. LCR 2021/1 has received a great deal of coverage for several reasons. One of the key sources of dissatisfaction has been the treatment of assets once they have been the subject of a non-arm’s-length arrangement. In certain cases, this may only affect income generated by the asset. However, where the acquisition of the assets themselves was undertaken on a non-arm’s-length basis, it has been held that the assets themselves will be taxed at the non-arm’s-length rate of 45 per cent on both income and on capital gains. This occurs regardless of whether the assets are in the accumulation or pension phase and continues to apply to income received from the asset regardless of how long the asset is held. This makes the circumstances by which a fund acquires assets very important as this could determine how any proceeds from the asset are taxed. Any kind of discount could trigger a NALI event and ‘tarnish’ the assets for the entire period they are held by a fund. One such event where a discount could be provided is where shares are acquired by an SMSF through an
employee share plan. The ATO’s consultation on TR 2010/1-DC considered the dual question of the acquisition of assets by an SMSF, together with in-specie transfers. Up until the ATO issued LCR 2021/2, the regulator’s view of assets acquired by a fund at a discount to market value was that the transaction was a combination of an acquisition and a contribution. In cases such as this, the discounted amount became a contribution as a balancing item. Consequently, the assets were deemed to be acquired at their market value. Any discounts on acquisition were treated as assessable income by the employee. However, the proposed TR 2010/1-DC states it is no longer the case that such a discount will be assessed as a contribution, with the assets concerned now to be subject to NALI. To this end, LCR 2021/2 states the income generated by the shares into the future, and any capital gains from disposal of the assets, would now be NALI and taxed accordingly. Further, the NALI rate applies to the assets in full and not a smaller rate to reflect the discount applied to the shares. Employee share schemes are often not widely available to employees. Commonly, they may only be available to senior executives or other personnel with special remuneration arrangements. The potential exception offered by LCR 2021/2 could allow an affected employee to claim such a discount is in accordance with normal commercial practice. Yet, they would have to convince the ATO that, in the instance that only a small number of employees are eligible for the discount, this is ‘normal commercial practice’, which may be somewhat difficult. Even though LCR 2021/2 offers this possibility, it’s not a scenario contemplated by the proposed TR 2010/1-DC, which appears to outlaw any arrangement where the fund acquires assets at a discount. Unfortunately, this means trustees are now going to need to be even more careful of how their fund acquires assets. It may also mean employee share schemes are inaccessible to SMSFs in the immediate future, unless shares are acquired at market value.
SISFA
Time for balanced SMSF reporting regime
MIKE GOODALL is a board member of the Self-managed Independent Superannuation Funds Association.
If you have an SMSF, you’ll no doubt be well aware of the reporting regime you need to comply with. Aside from the usual annual report, in 2018 a new series of reports based on particular events around the transfer of any money out of the fund into income streams was introduced. Known as event-based reporting, this framework allows the ATO to manage your transfer balance cap (TBC). Your TBC is an account with a lifetime limit on the total amount of superannuation that can be transferred into retirement-phase income streams, including most pensions and annuities. If you started your SMSF before 1 July 2021, your TBC was $1.6 million. From 1 July 2021, for new funds established from that date, the limit was increased to $1.7 million. If you started your fund prior to 1 July 2021, your limit will be gradually increased up to the current $1.7 million over time. You can check what your actual limit is via the ATO’s online portal. Back to event-based reporting: when the first member of an SMSF commences an income stream from the fund, this is an event that is reported to the ATO using a transfer balance account report (TBAR). The TBAR enables the ATO to record and track an individual’s balance for both their TBC (for income streams) and their total superannuation balance. There are a number of events that trigger the need to lodge a TBAR besides the moving of funds into the TBC and these include a death benefit income stream paid to a reversionary beneficiary, if you establish a limited recourse borrowing arrangement, any personal injury payments and any commutation directive by the ATO. The regulator recently asked the industry for comments on a proposal to streamline the eventbased reporting regime by introducing compulsory quarterly reports for SMSFs. The Self-managed Independent Superannuation Funds Association and Tax & Super Australia have jointly responded to the ATO’s proposal as we believe this is an unnecessary increase in reporting, adding to the
compliance burden of funds to the tax office with no material benefit. Rather, we suggest there should be a single set of annual reporting deadlines for all SMSFs, which will also assist with streamlining the reporting arrangements. This would reduce red tape and allow SMSFs to complete all their reporting requirements at once, such as the tax return, financial statements and TBAR. Considering around 93 per cent of SMSFs only have one or two members, moving to a more frequent reporting regime will increase administrative obligations, remove flexibility and add more red tape for the majority of the one to two-member funds. To keep on top of their TBAR obligations, large SMSFs have access to specialist software enabling lodgement with the ATO. Smaller SMSFs that may not have ready access to this software would find it extremely difficult to keep on top of their TBAR compliance and run the risk of additional penalties for late lodgement of the report. This may require SMSF trustees to seek advice from their accountant/tax agent on a more regular basis, which in turn will increase the cost of running an SMSF in the long run. The ATO’s paper for comment notes that having an annual reporting regime could result in excess transfer balance tax assessments being delayed for some members. We believe this could be alleviated by SMSFs voluntarily lodging TBARs early. In our view, the adverse outcome to a small cohort of members does not outweigh the additional administrative burden to many SMSFs. A final point worth making with TBAR is the need for a method to deal with the requirement to value a pension accurately at the time of commencement when this value may not be known at the time a TBAR is due. In this situation an SMSF may use a reasonable estimate, but any material change in the value of the pension makes accurate reporting challenging. The ATO needs to assist SMSF trustees with greater guidance in this area of reporting.
QUARTER I 2022 9
IPA
Time limited for better NALE outcome
TONY GRECO is technical policy general manager at the Institute of Public Accountants.
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Tax and superannuation professional bodies were hopeful following months of joint body advocacy efforts, countless articles on the potential scope of the rules and their adverse implications that the federal government would make some form of announcement before the end of 2021 to address the widespread concerns about the non-arm’slength income (NALI) and non-arm’s-length expenditure (NALE) rules. The Mid-Year Economic and Fiscal Outlook would have been an ideal time for the government to make this announcement to limit the scope to accord with the original policy intent, but unfortunately this was not the case. If the current rules remain intact, immaterial breaches could trigger a punitive tax rate on all future income of a super fund, which is an absurd situation, impacting on the superannuation balances of members. The impacts are broad, affecting all superannuation funds, and not just SMSFs. An example of a commonly conducted activity that is within the scope of the inequitable and punitive impacts of the rules is where trustees choose lower-cost options, such as in-house bookkeeping or auditing services at below market rates. A $100 discount on a general expense can taint all the income of the fund. A similar example is a plumber by trade who completes bathroom restoration work on a residential investment property held in his super fund to improve its rental earning capacity, and only seeks reimbursement for the cost of the materials. In these instances, based on the ATO’s interpretation of the current rules, not only is all rent forever subject to NALI and the top marginal tax rate, but the whole of the capital gain on disposal of the property in the future will receive similar punitive treatment. The recently released ATO guidance, namely Law Companion Ruling 2012/2 and Practical Compliance Guideline (PCG) 2020/5, make it clear the scope of the impacts is much wider than the original policy intent, which was to extend the existing NALI rules to capture NALE. The mischief in the firing line was a super fund borrowing money from a member at a reduced interest rate to circumvent the contribution caps by using NALE to inflate the fund’s income. No one contemplated the far-reaching and harmful consequences on members for benign commonplace scenarios would also be caught. The scope of the law only
became clear following the release of the abovementioned ATO guidance, containing examples that made it evident the administration of the rules is broader than what anyone would have anticipated based on the original policy intent back in 2018. There is also the administrative burden of having to show certain transactions were conducted at arm’s length, introducing quasi transfer pricing methodology into the realms of SMSFs whenever trustees try to choose lower-cost options, such as staff discounts for using some of the resources of their employer. There are no qualms among the industry bodies about supporting the original policy intent. The ATO’s recent interpretative guidance highlights the broad application of these rules, arguably beyond the original policy intent, which is at the heart of our concerns. Given the ATO’s administrative stance on its interpretation of the rules, a law change is required to alter the scope and impacts, while still preserving the original policy intent. There still needs to be a disincentive and a consequence for targeted mischief, rather than potentially affecting all income of the fund. The fact the rules operate automatically also goes against existing anti-avoidance provisions in our tax legislation as it requires the commissioner to make a determination for the anti-avoidance to apply. Another sore point among the industry bodies. The automatic application will also cause SMSF auditors grief when they go about their normal audit processes. There should also be provision for rectification of any breaches and a penalty regime that aligns with the tax consequences of not conducting the transaction at market value or on an arm’s-length basis. While we have had a temporary hiatus, all is about to change if there is no amendment to the law. The ATO last year announced an extension to the transitional compliance approach in PCG 2020/5 for another 12 months, which means it will not allocate compliance resources in the 2022 financial year to determine whether the NALI provisions apply to all the income of the fund where it incurs NALE of a general nature. SMSF professionals need to think carefully about what services they provide to their fund from 1 July 2022 and, more importantly, educate trustees about the impacts of the rules given the significant financial consequences that could arise from minor benign actions.
REGULATION ROUND-UP
Insolvency amendments and corporate trustees Treasury Laws Amendment (2021 Measures No 5) Bill 2021 Louise Biti Director, Aged Care Steps Aged Care Steps (AFSL 486723) specialises in the development of advice strategies to support financial planners, accountants and other service providers in relation to aged care and estate planning. For further information refer to www.agedcaresteps.com.au
New insolvency rules introduced in 2021 required amendments to section 120(2) of the Superannuation Industry (Supervision) (SIS) Act, to include a new category of disqualified persons. This may have an impact for SMSFs with a corporate trustee. From 8 December 2021, if a restructuring practitioner is appointed in an insolvency event, the corporate trustee will be disqualified from acting as trustee. The ATO needs to be notified as soon as practicable and the SMSF will have six months to restructure the fund to meet SIS rules, be wound up or become a small Australian Prudential Regulation Authority-regulated fund.
2021 budget superannuation proposals Treasury Laws Amendment (Enhancing Superannuation Outcomes for Australians and Helping Australian Businesses Invest) Bill 2021
Legislation was introduced into parliament in October 2021 to implement a range of superannuation changes that were initially announced in the 2021 federal budget. These include: • removing the $450 per month threshold for superannuation guarantee eligibility, • reducing the eligibility age to access downsizer contributions to 60, • continuing to apply the work test for people aged 67 to 75 if claiming a deduction for personal contributions, • increasing the cut-off age to use the bringforward rule for non-concessional contributions from under age 67 to under age 75, and • enabling trustees to choose the exempt current pension income calculation method when member interests are in both accumulation and retirement phases for part of the year. The proposals will allow trustees to either use the actuarial method for the whole year or use the segregated method for periods during which the fund is fully in retirement pension phase and the proportionate method for the rest of the year.
Definition of contributions Taxation Ruling 2010/1 Income Tax: Superannuation Contributions (Draft)
Taxation Ruling 2010/1 defines the ATO’s view of
the term ‘contributions’ and this ruling has been under review since the 2017 changes. Draft proposed changes have now been released by the ATO. In particular, the draft changes deal with the interaction between non-arm’s-length income (NALI) and contribution rules. It is clear from the proposals that trustees must acquire assets, whether under a sale contract or as an in-specie transfer, at market value to ensure NALI does not arise. The changes are expected to be completed in mid-2022.
SuperStream Rollovers Guide v3 ATO.gov.au QC67540
SMSFs are now required to use SuperStream to process rollovers, except for those made using an in-specie transfer. The ATO has updated the SMSF rollover guide on its website to take into account the new rules and processes.
Guide for setting up an SMSF NAT 75397
The ATO released a new guide in November 2021 on setting up an SMSF. This is aimed at providing consumers with information to decide whether an SMSF is appropriate and how to set up a fund. It also encourages consumers to seek professional advice.
Moving to Online Services for Business The ATO is changing how it interacts with auditors by moving more functions onto the Online Services for Business (OSB) tool. From 1 March, the electronic superannuation audit tool (eSAT) will be decommissioned and replaced by using the OSB. Updates have been made to the online services tool to provide the ability to prepopulate auditor details into audit convention reports and audit complete advices. In late December 2021, the professional-toprofessional mailbox was closed. Auditors will now use the OSB tool to request non-binding guidance.
Death notification service A new government initiative, the Australian Death Notification Service, can be used to notify a range of participating organisations that a person has died, with a single lodgement. This aims to simplify estate administration, especially as more organisations continue to join the service.
QUARTER I 2022 11
FEATURE
are THE NEW DIRECTOR ID REGIME
Directors of an SMSF corporate trustee will now need to obtain a director identification number in order to continue to play that role. Tia Thomas examines how the system works and some of the associated challenges.
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FEATURE DIRECTOR ID REGIME
The requirement introduced last year to obtain a director identification number for trustees of an SMSF with a corporate trustee structure has been largely accepted by the sector, but the machinations of the regime have proved challenging. After its implementation on 1 November 2021, more than 250,000 directors have applied for a director ID and these numbers are expected to surge as future deadlines approach. While the additional procedures and document collection can be seen as an inconvenience for those affected, the security protocols have been designed to improve the integrity of all company directorships by preventing incidents of fraud and identity theft, which are increasing in number. To this end, SMSF Association policy manager Tracey Scotchbrook believes the regime will allow the Australian Securities and Investments Commission (ASIC) to better protect trustees’ private information due to the track and trace nature of the framework. “Prior to the director ID, there was no process around identity and identifying someone who was a director of a company. There was no gatekeeping if someone was using someone else’s details illegally,” Scotchbrook says. As all directors need to comply with the new regime, she urges directors of an SMSF with a corporate trustee to apply earlier than necessary, via the myGovID app, mail or telephone, in order to avoid any legal consequences that can arise under the Corporations Act 2001. When applying for the ID, she says individuals need to pay particular attention to the finer details of the online process. “People need to set up a myGovID account and that is quite different to a myGov account. It will require someone to have a smartphone or smart device to be able to access the myGovID,” she says. “It will prompt you and take you through a process of scanning in your ID and putting in details, and this will be an essential first step because that provides the security check.”
“Prior to the director ID, there was no process around identity and identifying someone who was a director of a company. There was no gatekeeping if someone was using someone else’s details illegally.” Tracey Scotchbrook, SMSF Association
Verante director and SMSF specialist adviser Liam Shorte suggests directors pre-organise documents, including driver’s licence, passport and birth certificate, if applying online to prepare for potential complications. “If you are an immigrant, make sure you have completed your Medicare card
as well, because the problems for a lot of people is that documents do not match correctly,” Shorte explains. “You need to have your tax file number (TFN) as those documents will prove your identity. It can be very quick for some people, but for those that come from overseas there can be slight differences in their names and it can take up to half a day to get it sorted and some have had to resort to the paper applications.” In particular, this method will assist SMSFs manage the deadlines with the process where existing directors have until November 2022 to obtain a director ID, while new directors appointed from 1 November 2021 to 4 April 2022 only have 28 days to do so. Further, after 5 April 2022 newly appointed directors will need to have their ID in place beforehand. The implications of these deadlines also extend beyond current company directors. Chartered Accountants Australia and New Zealand superannuation leader Tony Negline warns replacement directors and existing powers of attorney will need to comply with the requirement and the stipulated deadlines and should allow for additional time for the process to be completed. “Let’s say we are talking about a fund where the trustees are overseas for an extended period of time and do not want the fund to become a non-resident fund, or where the trustees are potentially suffering from some type of mental incapacity,” Negline says. “The enduring power of attorney is appointed in their seat, but that individual has to resign as a trustee and then someone else has to be appointed in their place. That new director would also need to have an ID.” On a positive note, an individual director only requires one ID. Even if an individual’s ID has been made invalid because it hasn’t been used for 12 months, it can be reactivated upon request as long as the person can legally Continued on next page
QUARTER I 2022
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FEATURE DIRECTOR ID REGIME
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still hold a directorship. Financial advisers have played a vital role in spreading awareness, but it is important to note their scope of assistance is limited as practitioners cannot complete the application on behalf of a client due to privacy restrictions. However, financial advisers have quickly adapted to the regime requirements. “Accountants and advisers do have an important role to play, particularly around the education aspect, and helping and guiding their clients to make sure they are aware of the requirements and that they are complying,” Scotchbrook says. “Certainly for any new directors being added, the accountant and adviser is going to have to be aware of how these rules operate, particularly the timing of when someone needs to be registered.” She warns those that do not comply will receive a penalty depending on the severity of the breach, including misrepresenting a director ID or applying for multiple numbers. “It is a fine of up to $13,200 under the criminal provisions and up to $1.1 million under the civil provisions,” she says. Contraventions of the Superannuation Industry (Supervisory) (SIS) Act can additionally lead to directors being disqualified. Such actions include if a person is declared bankrupt, if the director has been an officer of two or more
companies that have entered liquidation in the past seven years, or if the individual has engaged in dishonest conduct. However, the penalties should not cause SMSF trustees too much angst in the short term due to the ATO’s initial compliance approach to the new requirement. ATO assistant commissioner Martin Jacobs confirms the regulator is taking an educational approach to provide directors who have attempted to adhere to the new rules with the opportunity to resolve non-compliance events. “It is always hard [during] transition periods, but we have tried to make it as clear as we can on the website about who needs to apply and when,” Jacobs notes. “When we look at why this measure has been introduced, which is to support addressing the challenge of illegal phoenixing, there will be circumstances in which we will take a different approach to non-compliance.” He says directors who are willing to work with the ATO to resolve noncompliance activity will be better suited to the process, as the regulator will send two separate letters reminding directors to obtain an ID and if no response is received other contact methods will be explored prior to legal action. “After we have made contact with them and advise them of the consequences, it brings their attention to the fact that they need to get a
director ID. Then we will help support them, whether it’s a digital application or whether it’s because they had challenges, in terms of completing the documentation,” he reveals. The educational approach is also deemed to work in the favour of directors living overseas as there can be a number of obstacles, including a lack of awareness, limited time and documents. “Individuals can go to the Australian embassy and consulates to get documents verified, and in certain countries we have arrangements so people are authorised to certify documents. But we do recognise there is a more onerous obligation on people to have to go and get a document certified, which is why we’re going to be accepting and understand if people need additional time,” Jacobs says. Scotchbrook further notes directors living overseas may need to consider paper applications, which reinforces the need for early organisation as sending documents via mail can be unpredictable regarding timelines. In addition, the ATO will be offering to support numerous SMSF trustees who are pre-retirees or retirees who may not be as proficient with online procedures. This is despite 93 per cent of the applications received since the regime’s implementation having been made via myGovID. Nevertheless, Shorte indicates he is
“As auditors, unless there is a real-time alert system, we will only find out when we do the audit, which is normally anywhere from six months to two years after the event.” Ron Phipps-Ellis, Evolv
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FEATURE
“It’s certainly very critical for us to have in terms of helping prevent the use of false and fraudulent director identities.” Martin Jacobs, AT O
already experiencing the challenges for clients in the older demographic. “What I am finding is that we have a lot of trustees in their 70s and 80s now, so we are having to walk them through the process. We are going to start the process when they come in for their interview and we’ll probably spend 15 minutes walking them through the process,” he notes. “Even though we have 10 months,
remember that the sooner we get it started the better. Any client that has had to make any change or change a trustee or set up a new LRBA (limited recourse borrowing arrangement), we are taking that opportunity to get their ID in place.” Despite the director ID reducing the risk of fraud, Evolv chief executive Ron Phipps-Ellis has already identified a flaw in the system and says the benefits for auditors are limited as the regime fails to recognise their role in notifying regulators of trustees who have been disqualified, which is not an automated process. “Auditors are required to check if a trustee, director or an individual is a disqualified person, which is defined in the SIS Act. We normally check this annually by logging into the ASIC website. This is a manual process that takes a bit of time,” Phipps-Ellis notes. “As auditors, unless there is a realtime alert system, we will only find out when we do the audit, which is normally anywhere from six months to two years after the event.” He suggests an automated alert system be installed that would inform accountants, auditors and other financial services participants of a director’s status, despite the responsibility of informing the industry being placed on the trustee. Negline suggests scepticism could present another headwind for the framework. He says a lot of directors have the mindset of: “I am retired and so why should I have to go through all this hassle just because of the actions of a small minority of people who want to do the wrong thing?” “It’s hard not to have sympathy for that view. But you will tell the government information about yourself once and it will be populated across licences or accreditation and so hopefully it will lead to efficiency,” he says. The high volume of digital applications calls for quality security protocols in order to protect privacy of
information, and the systems involved utilise built-in cryptographic technology on smartphones to identify an individual’s fingerprint or facial recognition. Negline suggests the privacy protocols of the IDs will need to be the same or similar to those that apply to a TFN. “I think it would probably be a good idea for financial advisers and also accountants to actually handle director IDs in the exact same way. We might not necessarily need to do that at this point in time, but I think that for safety purposes we should treat things like tax file numbers,” he says. “That’s probably where the system will go in the long term, so then we will be ahead of the curve rather than having to play catch-up.” Jacobs says the ATO has discussed the ideology and while the personal information detailed in a director ID will not be disclosed, it will not quite meet the same secrecy standards of a TFN. “Currently, there is no change to the ASIC online transaction forms, which stipulated you cannot currently provide a director ID number to ASIC. There is no ability to capture it, nor have we included it at the moment in ATO lodgements,” he says. “In 2023, when we do the new companies release, I guess we are expecting the director identification number to be something that would be requested. So when you go to appoint a director or you try to change director, that’s the likely stage we’re going to ask for the person’s director identification number.” Even though the system is in its infancy, Jacobs is very optimistic about the outcomes it will eventually produce. “It’s certainly very critical for us to have in terms of helping prevent the use of false and fraudulent director identities and it’s going to make it easier for government regulators to trace director relationships over time,” he concludes.
QUARTER I 2022 15
FEATURE
Once the province of small boutique managers, ESG investing has moved into the mainstream, attracting investors across the spectrum. Yet, as Jason Spits writes, it’s far too soon to state it has settled and advisers have a key role to play in unpacking this new frontier.
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FEATURE ETHICAL INVESTMENT
In an industry full of acronyms, financial advisers and their clients are coming to terms with another – ESG, short for environmental, social and governance – which is being used to define a specific type of investing that has moved from the fringes to the centre of attention. Operating under a number of wider terms, such as ethical investing or sustainable investing, ESG has in one form or another been part of investing and financial advice for more than 20 years, but it has only been in the past few that it has moved from a niche category to a holistic approach to investing and portfolio construction.
E is for… Much of this has been due to a greater interest in the E component of ESG, which has attracted attention as more people become concerned about climate change, according to Evergreen Consultants director Angela Ashton. “What people are focusing on is the E side of ESG because it has so much media attention, particularly after the recent Australian bushfires. It was a growing trend prior to that, but we had a series of natural disasters in Australia which are being considered as signs of climate change and people are going to focus on that when considering ESG,” Ashton says. “It has helped grow interest in ESG investing, more so than social and governance issues as the latter can be more esoteric for many people.” Schroders sustainability investment director Ella Reilly says while environmental factors are usually the first thing that come to mind, events of recent years have turned investors minds to consider more social factors as well. “In our annual ESG study among 23,000 retail investors across the globe, we saw the COVID-19 pandemic has brought a raft of environmental and social issues to the fore,” Reilly reveals. “Nearly half of those respondents – 47 per cent – said environmental issues were a key thing, but more people – 52 per cent – were aware of social issues and said those things were more important to them.” BetaShares chief executive Alex Vynokur
also believes that while the environment has been a first consideration, investors have been given prompts to consider other issues with the passing of modern slavery legislation in many countries and the Hayne royal commission putting a spotlight on governance issues, while the Me Too and Black Lives Matter movements have elevated social issues. As a result of this, Vynokur says the inflow of money into investment products that are broadly ESG focused, as well as those addressing specific issues, is starting to climb at significant rates. For example, inflows into ethical exchange-traded funds (ETF) increased by 145 per cent in 2021, and of the 400,000 SMSFs that hold an ETF, 30 per cent have some form of ESG investment, according to BetaShares data. “If we just focus on the environment and addressing climate change, that will require the mobilisation of billions of dollars in capital and a lot of technological innovation, which creates significant demand for various investment opportunities,” Vynokur says. This interest is being reflected in the concerns of investors as well, according to Ethical Investment Services chief executive Michelle Brisbane, who says environmental concerns are the main issue for clients, with an expectation the other issues will also be considered. “We see the E component as the leading theme for clients coming to see us and the social factor is a concern for some clients, while the governance factor is something we monitor as part of our research. Clients do not usually have issues with the governance, but expect our research addresses this for all our approved investment recommendations,” Brisbane explains. There is also an alternative social driver for some clients, HLB Mann Judd Wollongong partner and superannuation specialist Mitchell Markwick says, which is bringing people to ESG investments. “There is a social factor, a social pressure, when people are looking to invest in environmentally appropriate-style investments. It is at the forefront of a lot of people’s minds and they are looking at the ESG parts of an investment because
there is a bit of social pressure to do so,” Markwick suggests. “This means there can be a lot of talk about it, because the social factor makes it the right thing to do, but at present I don’t think ESG investing is as widespread as it could be and we have probably around 5 per cent of clients that have a portfolio built around ESG investing.”
Loose definitions These new opportunities for investing have led to the rise of ‘greenwashing’ where companies seeking ESG investment inflows present a more ethical and socially conscious way of doing business than is actually true. Testing those claims may be possible, but it can be a time-consuming task for financial advisers and SMSF trustees who have to understand the terminology in use when discussing ESG and how companies are applying it. The problem is there is no standard set of definitions being used in Australia, Zenith Investment Partners head of responsible investments Dugald Higgins points out, which in turn impacts the ability of funds management firms to offer products to investors. “ESG definitions are a hotly debated topic and everywhere around the world there are calls for it to happen but nobody knows how to do it,” Higgins observes. “What we have seen in Europe is they have had a crack at this and tried to create a system that classifies companies as ‘green’ or ‘brown’, which has become known as the European taxonomy, but it is not perfect. “Once there is a framework which everybody agrees to, we can take the next step with a fund that is investing sustainably and look at that fund and monitor its holdings against the taxonomy to see what it is doing and how well it matches the framework.” Ashton says because ESG investing is still in its infancy and there is a lack of set definitions for it, in many cases what constitutes ESG is determined by the views of investment managers, advisers Continued on next page
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FEATURE ETHICAL INVESTMENT
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and their clients. “Do you invest into a company that fares poorly on ESG now, but is really committed to improving? Some people will not invest in iron ore producer Fortescue even though it has stated it wants to produce ‘green’ iron by 2025. So, do you invest now because it has committed to greening their industry?” she asks. “There is a lot of that kind of thing going on where something is green in the eyes of the beholder because there are no ‘accepted’ frameworks. “There are frameworks, such as the United Nations Principles for Responsible Investment (UNPRI), and those produced by the Responsible Investment Association Australasia (RIAA), but people don’t really use them.” Reilly suggests advisers faced with this wealth of information but without defined parameters should consider questions of transparency and ask for evidence of ESG processes. “How a fund manager creates a sustainable approach to handle ESG is not always going to be in the fund name and there are companies and fund managers who simply hide behind being a signatory to the UNPRI,” she says. “We highlight the importance for advisers to ask for evidence of how is a fund manager, or a company, taking into account ESG risks and opportunities in their business model and in their investment process. “They also need to report on what they have done during this time of debate about what a robust investment process looks like. If the evidence is there that a manager does not walk the walk, there’s a high risk of losing business and we have seen managers with these ineffective policies and processes being left behind as capital moves out towards those who can do it.”
Not an asset class Marshalling all this information into a useful resource and set of knowledge to assist clients is vital, according to Higgins, who feels it is important advisers understand ESG investing is more than a broad-brush approach covering everything when
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“We highlight the importance for advisers to ask for evidence of how is a fund manager, or a company, taking into account ESG risks and opportunities in their business model and in their investment process.” Ella Reilly, Schroders
assisting clients to create a portfolio. “ESG investing is about managing assets while incorporating environmental, social and governance factors into investment decisions and being able to identify and evaluate ESG risks and opportunities,” he says. “While all these approaches can take into account non-financial considerations, they are subtly different. I would argue that all investment strategies can have ESG elements applied to a greater or lesser extent as it complements traditional financial analysis and portfolio construction techniques. “The same cannot be said for pure
ethical and sustainability-focused investing, which tends to meaningfully change the objective and shape of a portfolio’s holdings.” For SMSF practitioners used to covering more complex and technical issues for clients, providing advice around ESG investing will also require an individual approach aligned to the specific values each client brings to the table, according to Brisbane. “Part of an SMSF’s stated investment strategy will include ‘the fund wishes to apply ethical or ESG screens to the investment choices’ and this can be accomplished by considering a client’s values and how they can be best aligned with their investments,” she says. “Companies that focus on and manage their ESG factors are better managing the resource efficiency of their businesses, and therefore it can be argued there is a greater opportunity for longer-term outperformance compared to those not managing ESG factors. “Not paying attention to ESG also increases the risk of a business and it is more prone to share price shocks if found to have deficiencies in its ESG approach. For example, garment manufacturers not addressing modern slavery and found out to have this as an issue in their supply chains.” In their interactions with advisers, Ashton and Higgins are seeing two broad patterns emerging in how advisers are approaching ESG investments and, unsurprisingly, in some cases it is not too different from any other niche investment approach. “Some people are using it as a satellite approach where they are using very green funds with a strong impact investing approach around a core of Australian equities. There is not a lot of those type of funds around and they tend to be expensive, but there are people ready to use those sorts of investments,” Ashton says. “The other approach is people who are more worried about the planet overall, for example, and thinking about the legacy they leave.” Higgins adds for this group, while there is no universal standard for assigning ESG factors, there are strategies available for advisers to pull together.
FEATURE
“What people are focusing on is the E side of ESG because it has so much media attention, particularly after the recent Australian bushfires.” Angela Ashton, Evergreen Consultants
“For some advisers, that may be working with a direct equities portfolio and simply applying a negative screen on the traditional ‘sin sectors’,” he says. “For others, they may wish to create a portfolio of managed funds with strong, complementary aspects regarding sustainability to create a portfolio that seeks to minimise harm and maximise a progressive transition on key issues. However, given the variation of client requirements, mass customisation of approaches is difficult.”
Values versus performance And what is the cost to the investor for delving into ESG? Aside from the advice and investment management fees, does ESG leave performance on the table while saving the planet? Brisbane and Vynokur believe this is not the case. “Clients want good returns from investments that meet their ethical criteria and RIAA research over the long term indicates that returns are either as good as or better than mainstream counterparts,” Brisbane notes. “As such, the common requests we receive from clients are to review existing portfolios to realign them with their values and divest other investments.” Vynokur recognises the issue of performance may have been an issue in the past, but indicates this is no longer the case as evidenced by several different industry trends. “When we started BetaShares in 2010 the conventional wisdom at the time was you have to sacrifice performance for values, but over the past decade investors have understood that is not the case and
this has brought more investors to adopt sustainable investing as the core,” he says. “If you look at just the sheer weight of dollars coming into ESG products, from an industry perspective, there is a significant rise in the rate of adoption. But we are also seeing a trend by regulators actually informing superannuation trustees they are not doing their job if they fail to consider ESG risks in portfolios.” But does the same apply for SMSFs and are there problems if a fund goes all in on ESG investing in the same way some have significant exposures to property? “There should not be any regulatory problems with ESG or ethical investing as it just is an overlay for an investment portfolio,” Brisbane says. “The ESG aspects are addressed across the entire portfolio and each asset class and ESG is not an asset class. Rather, we see ESG becoming a first-pass filter for investors to look at before they begin to formally evaluate an investment as they do today in the areas of performance, financials and strategy management. “As mentioned, research by the RIAA indicates no loss of financial performance by applying an ESG filter and academic research supports a better return per unit of risk – Sharpe ratio – for ethical investment portfolios. So, we see aligning members’ ethical values with the investment portfolio as in keeping with the sole purpose test.” Markwick concurs with Brisbane but adds, as in the case of investing in property, ESG investing needs to be reflected in the investment strategy. “I doubt we will ever see the ATO state that since an SMSF invested in some form of ESG product and it did not produce a
return similar to a normal investment that it will be penalised,” he predicts. “I don’t see that happening, but from my perspective I would like a reference to an allocation in the investment strategy to an ESG-style investment where the trustees acknowledge they are allocating a particular amount of the fund to that sort of style investment.”
More work to do Given the current trajectory of societal interest and availability of ESG investments, it would appear this market will continue to grow, creating new homework for advisers. “Appetite for ESG consideration is growing across all demographics. Investors are starting to realise, and returns are proving, ESG investing can provide a safer portfolio, with solid returns, as well as the knowledge that your money is working towards better world outcomes. There is an increased interest in impact investments and SMSFs are ideal vehicles to hold these assets in a super environment,” Brisbane says. And Ashton suggests this is where the homework begins, but with varying approaches. “Some advisers are on the front foot when it comes to ESG, while others are being led by their clients, but in many cases they still remain unsure how a conversation on this topic will go. They don’t know the topic well enough and therefore don’t know what say to a client when it comes to ESG,” she says. “While there are still a number of curly questions to be answered, advisers who get in on it early will lead in this area and they are already definitely starting to write more business and see more funds flow.”
QUARTER I 2022 19
INVESTING
Consider stepping outside the box
Investors are likely to face greater challenges in generating strong returns in 2022 and beyond. Anthony Murphy puts forward the case for including alternative asset classes in portfolios as a solution to the headwinds on the horizon.
ANTHONY MURPHY is chief executive of Lucerne Investment Partners.
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Global markets have started 2022 on shaky ground and investors, who have enjoyed strong market conditions for nearly two years, are taking stock and wondering where they go from here. The ASX 200 Accumulation Index fell 6.13 per cent in January and was down 2.52 per cent for the 2022 financial year as at 31 January. This correction should not come as a surprise and is well overdue, particularly when considering the steep rise in
global asset prices combined with the hubristic behaviour of many investors and markets in recent times. For context, 40 per cent of all US dollars in the system were printed in the past 20 months so markets have certainly had some assistance. However, the market is now rationalising and investors need to follow suit. One must think forward when considering their portfolios, but too often we look in the rear-view mirror to repeat what
has previously worked. This is completely normal behaviour and works in many facets of life. But the investment world is a different beast and it’s time to look through the windshield at that road ahead, which we believe is a windy one for years to come. In 2021, central banks around the world continued to label inflation as transitory, but this has now changed. Inflation is here to stay and central banks will turn to their traditional playbook and commence raising interest rates. We are already witnessing this from our commercial banks in Australia, increasing interest rates before the Reserve Bank of Australia (RBA) has officially raised the cash rate. It seems they’re already looking through that windshield. We believe the cash rate will increase by 3 per cent to 5 per cent before the end of 2023. At Lucerne Investment Partners, we have positioned investor portfolios to hold 15 per cent to 20 per cent exposure in listed long-only equities, with an even split between domestic and international markets. The balance of portfolios consists of a mix of alternatives, property, infrastructure and select credit, which is primarily private debt. We are less reliant on market conditions than ever and believe flexibility and control in investment mandates is critical for the years ahead. Our flagship fund, the Lucerne Alternatives Investment Fund (LAIF) delivered 23.77 per cent for 2021 following 21.13 per cent for 2020 and is expected to deliver a positive return for January 2022. We are pleased with these results and the core focus of our investment committee, more than ever, is to preserve this performance while still being able to deliver attractive riskadjusted returns across all market cycles. LAIF has primarily delivered these returns by avoiding large drawdowns, particularly in bear markets. LAIF contracted 6 per cent during February and March 2020, a period that saw the ASX 200 Index decline by 27 per cent. To combat inflation, we believe the RBA could increase the cash rate by as
much as 5 per cent by the end of 2023. As interest rates rise, global asset prices should contract, and therefore prioritising investment strategies that can still deliver positive returns across all market conditions becomes an important consideration. Alternatives as an asset class have always played a role in institutional and many family office portfolios. Yet, everyday investors have often under-allocated to this asset class, a trend that is now appearing to reverse. Established financial services firms are now dedicating greater resources to offering clients access to alternatives, which include private equity, long/short equity strategies, convertible notes, precious metals, resources, quantitative funds and digital assets. Previously, such strategies were primarily available to qualified wholesale investors only, but through vehicles such as LAIF and listed investment companies, retail investors can now also access these investments. Allocating a portion of your portfolio to a diverse pool of alternative strategies can complement traditional asset class holdings. When considering a selection of alternatives, it’s important to ensure the different investments in the basket hold low levels of correlation with one another. For context, LAIF currently holds 14 different alternative strategies, which carry differing performance characteristics. To this end, it currently has no portfolio holdings in long-only listed equity funds. Over a threeto-five-year period we expect all strategies to generate positive performance, but this performance is captured from each strategy during different periods. A good example of this is our allocation to the hard-closed Perennial Private to Public Fund II, which represents a 6 per cent weighting in LAIF. This fund targets revenue-generating unlisted companies in the private space that are seeking growth acceleration capital and are aiming to list or trade sale within two to three years. Given most of the fund’s investments are held privately until listing or sold, the fund carries very little correlation with the ASX 200 and has a great level of control over
One must think forward when considering their portfolios, but too often we look in the rear-view mirror to repeat what has previously worked.
these investments and their liquidity timing. As these unlisted companies continue to grow, further capital raisings are completed often at higher valuations than Perennial’s entry point/initial cost. Perennial then revalues these companies to reflect the new valuation. The fund returned in excess of 10 per cent for January 2022 (following a significant uplift and revaluation in a key underlying holding), which is an exceptional result given the performance of equity markets and we expect further strong upside in 2022 and beyond as additional revaluing events occur across the maturing portfolio. Outside of alternative fund strategies, we encourage investors to consider emerging trends in the market and how to best own these trends directly. In 2021, we researched corporate and consumer trends in the travel and accommodation industry and the growing bias toward private, apartment-style accommodation instead of hotels because of COVID – the world is changing. We acquired a convertible Continued on next page
QUARTER I 2022 21
INVESTING
Continued from previous page
note investment in a company called Urban Rest Apartments, which provides high-quality and flexible terms on serviced accommodation. We secured an attractive double-digit interest rate and the ability to convert to equity in the business at an attractive valuation. Such an opportunity would not have existed in ordinary equity markets and many listed companies already had future earnings post COVID priced in. Investors should also consider the private debt market and the quality riskadjusted returns that can be accessed in this space. For some time we have partnered capital with private debt managers that can secure equity-like returns with security over fixed assets such as property. Strategies in this space can deliver high single-digit and low doubledigit returns with very little volatility. Quality managers are selective in the types of transactions they support in this space. As interest rates rise, the returns in private debt can increase. When considering the long-term annualised return of the ASX 200 is 8 per cent, a similar or greater return can be achieved in private debt investments for much less risk. The passive ‘buy and hold’ model has worked well over the past decade. Post the global financial crisis, passive investing has performed well and continued to do so following the market crash in early 2020 thanks to the enormous stimulus packages released by governments and central banks worldwide. This environment has seen record amounts of inflows into superannuation funds and exchangetraded funds, a rising tide that has floated all boats. The same period has witnessed record low returns in defensive asset classes, such as cash and bonds, resulting in many portfolios taking overweight positions to equities, increasing risk profiles across the board. Declining interest rates to effectively zero has further fuelled price appreciation across equities and property and additional stimulus in the past two years has increased
22 selfmanagedsuper
When considering a selection of alternatives, it’s important to ensure the different investments in the basket hold low levels of correlation with one another.
valuations further still. Interestingly, the Future Fund is now also warning investors about the windy road ahead and is taking a bias toward active management. This approach is also supported by the fact more active managers are now outperforming passive and we expect this trend to continue for the 2022 income year and the years ahead. Also, some of the great investment names, such as Buffett and Dalio, have underperformed the market recently as they reduce equity exposure and build a war chest for when asset prices become attractive. This will happen. So, how does one best prepare themselves to transfer from a passive to more active mandate to stay ahead of the broader market? Spending the time and effort to research and partner capital with independent tier-one investment managers is worthwhile and your portfolio will thank you for it. There is a genuine skill set in selecting a good manager and knowing when to best hold that manager or, indeed, exit. As different themes emerge in the market,
investors need to consider how to best own that theme and when considering which managers are deserving of their capital, which is a privilege, some key areas of focus for us include: • Size does matter – is the manager committed to staying small and nimble relative to the size of their asset class? We like managers of private equity strategies who cap funds under management at $200 million. • Alignment – how much is the manager (and their family) personally invested in their own strategy? • Remuneration – is the manager better incentivised via performance as opposed to high management fees? This also assists with staying small and nimble. • Performance attribution – how does the manager derive their performance and indeed outperformance against the relative benchmark? Can this be achieved consistently over time across different market cycles? • Poor investments – how does the manager address poor investment outcomes and what have they learned to ensure this is minimised on a goforward basis? In summary, we encourage investors to take stock and review portfolios and consider how they are positioned for markets ahead. The attractive economic and stimulus conditions we have enjoyed since 2010 are behind us and that road is going to become windy. Going forward, investing and generating meaningful portfolio returns is going to become a lot harder. Investors should consider the addition of investments that can deliver sound absolute returns, which can include a mix of alternatives and private debt. We encourage investors to take a deeper understanding into their underlying investments, gain a greater level of control and ensure their portfolios are truly generating quality risk-adjusted returns. This approach will bode you well and we wish you every success for 2022 and the years ahead.
SAFAA 2022
Caroline Bowler CEO, BTC Markets
Tim Buckley Director of Energy, Institute of Energy
Justice Sarah Derrington, President, Australian Law Reform Commission
Rachael Falk CEO, Cyber Security Research Centre
Senator the Hon Jane Hume Minister for Superannuation, Financial Services & the Digital Economy
Andrew Inwood Founder/Principal, Core Data
Joseph Longo Chair, ASIC
Chris Perkins President, CoinFund
Sterling Shea Managing Director, Morgan Stanley
INVESTING
The Asia region income story
Caution is often recommended when looking to invest in Asian markets due to volatility, corporate governance and government interference. Geoff Bazzan warns focusing on these factors too much could see investors miss out on strong income opportunities emanating from the sector in the coming years.
GEOFF BAZZAN is head of Asia-Pacific equities at Maple-Brown Abbott.
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In assessing equity returns, dividends matter. Hitched to the powerful effects of compounding, which is often referred to as the eighth wonder of the world, reinvested dividends can account for more than half the total return generated from equities. This immutable force is as relevant in Asia as it is in any other investment destination on the globe. What
is unique to Asia are the favorable foundations in place to support a growing and sustainable base for dividends going forward. As earnings recover across Asia, we are encouraged by the proactive steps many management teams are taking to reward shareholders via increased dividends and other capital management initiatives. Supported by strong
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The extremely strong financial health of many listed corporates across Asia is a virtue of the region that is often overlooked.
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balance sheets and an improving free cash-flow profile, the building blocks for improved total returns from Asia are being firmly established. As highlighted in Figures 1a and 1b, dividends are expected to grow strongly over the next two years, well beyond their pre-pandemic levels.
provided as a general guide only and should not be relied upon as an indication of the future performance. The Asia region is home to more companies with a net cash balance sheet than anywhere else in the world and there are many companies across the region with the potential to significantly increase their returns to shareholders. As well as having some of the world’s strongest balance sheets, Asian corporates have typically adopted a more conservative approach to capital management, with an average payout ratio of 34 per cent over the past decade, significantly below the global average of 45 per cent (according to figures from MSCI monthly data). The scope for catch up is very much in place.
It is important to note forecasts or estimates are not a recommendation to buy, sell or hold. They are point-in-time views and may be based on certain assumptions and qualifications not set out in part or in full in this article. Forward-looking statements including projections and estimates are
Since May 2001, the MSCI Asia ex-Japan Index has delivered a total return of 547 per cent or 9.4 per cent a year. Over that time, accumulated dividends have accounted for some 49 per cent of the total return or 6.5 per cent a year. While in any given Continued on next page
QUARTER I 2022
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INVESTING
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many stocks and markets in the region, the prospects for such companies to deliver an attractive total rate of return look promising. With a lower payout ratio and a more robust financial footing, we see strong grounds for an increase in returns to shareholders over the years to come (see Figure 3). Japan
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an increased regard for improved capital management 60 policies supported by a trend of rising free cash flow. With the payout ratio 55 in Asia at a modest 32 per cent at year end 2021, we expect dividends per share 50 can comfortably grow in line with, or in excess of, earnings. Coupled with favorable starting valuations across
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Alongside balance sheet strength, a critical determinant of a company’s ability to grow and sustain its dividends is its payout ratio or the amount of earnings it can comfortably return to shareholders each year as a dividend. On average, the payout ratio across Asia has typically been much lower than we see in Australia or indeed the rest of the world. Historically, there are several reasons for this, including differing tax structures and an historic preference from many growth-hungry companies to divert cash flows to capital expenditure. As earnings continue to recover to their pre-pandemic levels, we are encouraged by the number of companies showing
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Strong balance sheets The extremely strong financial health of many listed corporates across Asia is a virtue of the region that is often overlooked. Indeed, Asian companies have some of the strongest balance sheets, in terms of gearing, liquidity and cash to market cap, in the world. So it is surprising so much attention is instead given to volatility within Asian markets and the need for caution with respect to varying levels of governance, regulation and government intervention. Having learned the harsh lessons of the 1997 Asian Financial Crisis, many management teams have adopted a conservative position regarding their capital structure and this places the Asia region in an enviable situation compared to the rest of the world. As well as providing a valuable buffer to the potential impacts of rising interest rates, the health of Asian balance sheets offers a solid foundation to fund and sustain growing dividends across the region.
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year the contribution from dividends can seem modest, due to the power of compounding the contribution from reinvested income is a powerful driver of long-term equity returns that shouldn’t be ignored (See Figure 2).
Figure 2: MSCI AC Asia ex-Japan – Cumulative total return since 2001
Companies increasing divedends
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After several years of cyclical contraction, Asia offers one of the most prospective earnings recovery stories across the global equity universe.
Asia remains a strong, long-term structural growth story The opportunity for nominal growth and for companies, particularly among those that are well-governed and sustainable, to grow cash flow and return it to shareholders is very attractive in Asia despite the nearterm headwinds we might see in China or cyclical weakness. The structural story remains undiminished. Better capital discipline and an improved earnings outlook are conspiring to increase the free cash-flow yield evident across the Asia ex-Japan region. Historically, the corporate mantra was focused on growth and a desire to expand capital expenditure at the expense of dividends and other capital management initiatives. As earnings recover, the scope for management teams to reward shareholders appears far greater now. Underpinning the improving cash-flow performance is a corresponding uplift in the bottom-up earnings outlook for the region. After several years of cyclical contraction, Asia offers one of the most prospective earnings recovery stories across the global equity universe.
Dividend income can’t be ignored In Asia, as is the case elsewhere in the world, the long-term return from equities is approximately evenly shared between income and capital growth. High-yield strategies on their own are not necessarily a successful strategy, with the highest-yielding sectors in Asia ex-Japan typically underperforming the broader market of that region over the long term, with scant statistical evidence to support its relevance as a single-factor strategy. The Asia ex-Japan region is uniquely placed to offer investors exposure to upside in dividend growth by virtue of its recovering earnings trajectory and an apparent willingness to accept an increasing payout profile. With interest rates across much of the region likely to increase in response to rising inflation, in our own Asian growth dividend strategy we have been focusing only on those companies with the financial strength and business models that can sustain and grow earnings while supporting dividend growth over time.
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STRATEGY
Optimising tax outcomes in death
A legislative amendment made in 2013 has allowed for more effective tax outcomes for death benefit beneficiaries, but there is one critical contingent factor, Nicholas Ali writes.
NICHOLAS ALI is SMSF technical support executive manager at SuperConcepts
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While we often (rightly) focus on control of an SMSF when a member dies, it is often not relevant as many funds have relatively straightforward requirements from an estate planning perspective. Perhaps more important real-world issues revolve around strategies to maximise the super benefits paid to beneficiaries. One area in which trustees (and some practitioners) lack knowledge is superannuation interests. Many people think a member has one superannuation interest, which is the case if the member balance is in accumulation mode. What is not fully understood is each pension is considered a separate superannuation interest. As such, each pension can have its own proportion of tax-free and taxable components even within the one SMSF. This can provide some strategic planning opportunities regarding death benefits. But first, let’s wind the clock back a little to see how we have got to this point.
The ATO first raised the issue on 20 August 2004 with the release of Interpretative Decision (ID) 2004/688, which stated “once a fund no longer has any current pensions in payment and there is no provision for a contingent pension to commence, the fund no longer requires current pension assets”. In other words, where there was no reversion in place for a superannuation income stream, any monies used to fund the income stream, then paid out of the fund as a lump sum or cashed within the fund would come under accumulation mode and be taxed accordingly and therefore potentially be subject to capital gains tax (CGT). Any non-reversionary income stream would automatically become an accumulation benefit of the deceased even if it subsequently became a death benefit pension for a spouse. The introduction of Simpler Super on 1 July 2007 created further issues, with earnings on an accumulation account being considered a taxable component. Moreover, it also meant the separate superannuation interest calculated and crystallised at the commencement of the pension ceased and the pension components were then amalgamated with any other accumulation benefits of
the deceased in the fund. Taxation Ruling 2013/5 reconfirmed this long-held view and stated: “The commissioner considers that a superannuation income stream ceases when there is no longer a member who is entitled, or a dependant beneficiary of a member who is automatically entitled, to be paid a superannuation income stream benefit from a superannuation interest that supports a superannuation income stream.” Below is an example of how CGT on death used to be treated under ATO ID 2004/688.
Example – CGT on death Barry is a widower and sole member of his SMSF. He has an account-based pension with a capital value of $1.85 million. This income stream has been running for several years. The assets of the fund include a property valued at $750,000 with a cost base of $500,000. Barry has one child, Dwayne, who is an independent adult. Barry passes away on 1 July and leaves his superannuation entitlement to his son. Dwayne sells the property on 1 September for $750,000 to fund the lump sum death benefit paid on 1 December. Sale price $750,000 Less: cost base ($500,000) Net capital gain $250,000 Less: CGT discount ($82,500) Assessable capital gain $167,500 CGT payable by SMSF ($25,125) Net amount $724,875 Even though the property was used to fund a pension just prior to Barry’s death, because there was no member who is entitled, or a dependant beneficiary of a member who is automatically entitled to be paid a superannuation income stream benefit, the income stream ceased on Barry’s death and his benefit reverted back to accumulation mode.
Changes made in Mid-Year Economic Fiscal Outlook In response to criticisms the commissioner’s preliminary view in the Draft Ruling was
inequitable, the government announced in the Mid-Year Economic Fiscal Outlook released on 22 October 2012 there would be amendments to the legislation to allow the tax exemption for earnings on assets supporting superannuation pensions to continue following the death of a fund member in the pension phase until the deceased member’s benefits have been paid out of the fund. The amendments introduced in the Income Tax Assessment Amendment (Superannuation Measures No 1) Regulation 2013 clarified how the exempt current pension income (ECPI) and tax-free and taxable components are calculated regarding a death benefit arising from a non-reversionary pension: • ECPI continues after death, if the benefit is dealt with ‘as soon as practicable’, and • the benefit can be paid as a lump sum, new superannuation income stream or a combination of the two. Therefore, in the previous example, if Dwayne pays Barry’s benefit as a lump sum ‘as soon as practicable’, the ECPI status of Barry’s pension assets continues and the SMSF will not incur the $25,125 CGT. This increases the lump sum benefit payable to Dwayne. Earnings from the date of the primary pensioner passing to the time the benefit is dealt with will also be considered amounts used to fund a super income stream and therefore will be exempt from tax. Bear in mind the regulatory amendments do not remove an obligation to pay lump sum tax where the benefit is received by non-tax dependants. The regulation also creates an alternative method for calculating the tax-free and taxable components of certain superannuation benefits paid after the death of a person who was receiving a super income stream immediately before their death: • tax-free and taxable components retain their proportions, • this includes earnings on the assets supporting the pension but does not include additions arising from insurance
proceeds or allocations to the deceased’s account via an anti-detriment payment.
Example – earnings on superannuation interest Betty was in receipt of a non-reversionary pension at the time of her death on 1 July 2021. Betty’s spouse, Simon, wants to take Betty’s benefit as a death benefit pension. Betty’s benefit in the fund was $650,000 at the time of her death, consisting of 50 per cent tax-free and 50 per cent taxable components. By the time Simon received grant of probate on 1 November 2021, Betty’s benefit in the fund was $700,000 (that is, it had earned $50,000). Simon commenced a new death benefit pension on 1 November 2021, which was the earliest Betty’s benefit could be dealt with. The $50,000 earnings will be considered earnings on assets relating to an income stream superannuation interest, not on an accumulation super interest. Therefore, the earnings will be in the ratio of tax-free/taxable as follows: Tax-free $350,000 (50%) Taxable $350,000 (50%) Total $700,000 (100%) But this will only occur if the death benefit lump sum and pension are paid ‘as soon as practicable’. Otherwise all the earnings will be a taxable component: Tax-free $325,000 (46%) Taxable $375,000 (54%) Total $700,000 (100%)
Example – Separate superannuation interest Bill, 61, was in receipt of two nonreversionary pensions – one consisting entirely of a tax-free component and one consisting entirely of a taxable component as follows: Tax-free pension $500,000 (50%) Taxable pension $500,000 (50%) The fund assets are worth $1 million, with a cost base of $500,000. Bill passed away on 1 July 2021 without Continued on next page
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STRATEGY
Continued from previous page
any death benefit nomination in place. Bill’s wife, Wendy, his executor, decides to pay the 100 per cent tax-free pension as a cash lump sum to their adult child, Mark, on 1 September 2021. Wendy decides to take Bill’s 100 per cent taxable pension as a death benefit pension on 1 September 2021. Assets are sold within the fund to allow for the cash lump sum to Mark. The fund earns 10 per cent from the date of death until the benefits are paid (1 September 2021), so at that date it was worth $1.1 million. As per the 2013 regulation amendments, the superannuation interests remain separate super interests after Bill’s death and can be dealt with separately, but only if done so as soon as practicable. The assets sold to facilitate the tax-free cash lump sum to Mark will be included as ECPI and not subject to tax on earnings or CGT. Selling $550,000 of assets to pay a cash lump sum to Mark would incur nil CGT. If not paid as soon as practicable, however, CGT would be payable on the sale of assets as follows: CGT on sale of assets: Sale price $550,000 Less: cost base ($250,000) Net capital gain $300,000 Less: CGT discount ($100,000)* Assessable capital gain $200,000 CGT payable by SMSF ($30,000) Net amount $520,000 * Inside super the CGT discount rate is onethird if the asset is held for greater than 12 months. Given the assets were sold to pay the cash lump sum to Mark, the fund being subject to CGT to pay the lump sum cash benefit dramatically reduces the amount he receives. The 2013 bill also makes it clear earnings on the assets will be in the same proportions as the superannuation interests, that is, either tax-free or taxable. The $100,000 capital growth will therefore have an equal 50 per cent tax-free component and 50 per cent taxable component:
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It is of great significance for trustees and their advisers/accountants to understand the importance of maintaining separate superannuation interests.
payable (including Medicare levy) This outcome impacts the death benefit in three ways: 1. ECPI will not continue and the fund will be subject to CGT (based on the original cost base of the asset/s transferred in specie and/or sold). 2. Earnings from the date of death until the benefit is dealt with will be a taxable component. 3. The pensions will cease to be separate superannuation interests and will become one accumulation superannuation interest.
What does ‘as soon as practicable’ mean? Tax-free pension $550,000 (50%) Taxable pension $550,000 (50%) Again, if not paid as soon as practicable, the $100,000 earnings would be on an accumulation benefit and therefore a taxable component: Tax-free component $500,000 (45.45%) Taxable component $600,000 (54.55%) However, perhaps of more significance is if the benefits are not used to commence a death benefit pension or pay out the death benefit lump sum in a timely manner, the two super interests would cease and revert to one accumulation interest within the fund. This means the lump sum benefit paid to Mark will not consist solely of a tax-free component as the one accumulation interest will mean both pension interests are mixed. The lump sum death benefit to Mark would then consist of the following components: Tax-free component $243,158 (45.45%) Taxable component $291,842 (54.55%) Total $535,000 (100%)* * Mark’s benefit is only $535,000 because $15,000 CGT is deducted first (the CGT is levied equally between Wendy and Mark, so any benefit paid to Wendy will also be reduced by $15,000 CGT). Now that part of Mark’s cash lump sum consists of a taxable component, lump sum tax would be payable as follows: $291,842 x 17% = $49,613 lump sum tax
Unfortunately, there is no hard and fast rule, but the ATO’s general rule of thumb is the death benefit must be paid within six months from the date of death (often called the death benefits period). However, death benefits can take longer in some circumstances, in which case the ATO may accept a longer death benefits period. The ATO considers the following events acceptable reasons for paying death benefits outside of the accepted six-month period: • taking time to seek specialist advice, • delays in determining the validity of a binding death benefit nomination, and • trying to locate beneficiaries. Conversely, the regulator will not accept the following as reasons explaining why the death benefits took longer than six months to pay: • waiting for the ‘right time’ to sell an asset, • the fund having insufficient cash to pay the benefit, and • the trustees having personal issues and not being able to administer the fund. It is of great significance for trustees and their advisers/accountants to understand the importance of maintaining separate superannuation interests. Unreasonable delays to the payment of death benefits can undermine sound estate planning strategies and cause undue stress at a time it is least needed.
COMPLIANCE
Proper procedure in property purchases Acquiring a property in an SMSF is not necessarily as easy as it seems. Mark Ellem details some of the actions and procedures needing navigation before these assets can be included in a fund’s portfolio.
MARK ELLEM is head of education at Accurium
Australians have a love affair with property and this is no more apparent than with SMSFs. The ATO’s June 2021 quarterly statistical report shows around 15 per cent of SMSF assets are invested in property. However, these statistics include as categories the structures of listed and unlisted trusts, as well as limited recourse borrowing arrangements (LRBA), but not their underlying assets. Based on real property being a predominant asset of these structures, the exposure of SMSFs to the real property asset category could be as high as 20 per cent or even slightly more. This popular asset class gives rise to a number of compliance considerations, including the structure to use to hold real property.
Initial reviews to conduct Prior to an SMSF making an investment in property and any other type of asset for that matter, the following steps should be taken: 1. Review the SMSF’s trust deed – the deed provides the trustee’s power as to what they can do, what they are required to do and what they cannot do. Once you establish what the trust deed says, you can then apply the law to ascertain whether the proposed action by the trustee will comply. 2. Review the SMSF’s investment strategy – it would be prudent for the fund’s investment strategy to be reviewed either prior to or at the time of consideration of the proposed property acquisition. Revision of the strategy and amendment, if required, to the asset allocation ranges would need to be done prior to the fund’s acquisition of the asset. Further, for an investment in property, the strategy should specifically consider the factors in Superannuation Industry (Supervision) (SIS) regulation 4.09 to ensure it has addressed the risks associated with the SMSF having a
substantial portion of its investments in an illiquid asset. 3. Super law prohibition, restrictions or requirements – review the superannuation law to determine whether the proposed asset acquisition is permitted under the law and if there may be any specific requirements to comply with, for example, acquiring business real property from a related party must be done at market value.
Don’t forget the sole purpose test An overriding requirement for any asset acquired or held by a superannuation fund is the sole purpose test, as outlined in section 62 of the SIS Act. This is particularly important where the property is being acquired from a related party under the business real Continued on next page
QUARTER I 2022 31
COMPLIANCE
Continued from previous page
property (BRP) exception. Simply ensuring the acquisition complies with section 66(2)(b) BRP exception and section 71(1)(g) in-house asset exception may not be sufficient. The SMSF should also have evidence to show the acquisition also meets the sole purpose test. On this point reference can be made to the ATO’s decision impact statement from the Aussiegolfa case and particularly the following from that statement: “We do not consider that the case is authority for the proposition that a superannuation fund trustee can never contravene the sole purpose test when leasing an asset to a related party simply because market-value rent is received. “It is the purpose of making and maintaining a fund’s investments that is central to identifying if there is a contravention of the sole purpose test. We note the observations of the court that a collateral purpose, and a contravention of section 62 of the SIS Act, could well be present if, for example, the circumstances indicated that leasing to a related party had influenced the fund’s investment policy. “For example, in the commissioner’s view a superannuation fund trustee will contravene the sole purpose test if the fund acquires residential premises for the collateral purpose of leasing the premises to an associate of the fund, even where the associate pays rent at market value.” While this statement concerned the Aussiegolfa case, and particularly the leasing of residential property to a related party, consider the circumstances where an SMSF acquires, either from a related party or an unrelated party, a commercial premise that suits the needs of a related business to which the premises are leased. What evidence would the SMSF trustee(s) have obtained to show the leasing of the premises to the related party did not influence their decision to acquire that property? Without such evidence it could be argued the SMSF acquired the property for the purpose of meeting the needs of the related business, contrary to the sole purpose test.
32 selfmanagedsuper
It would be prudent for the fund’s investment strategy to be reviewed either prior to or at the time of consideration of the proposed property acquisition.
on the time passed from when the SMSF acquired the property with individual trustees to when the trusteeship changes to a company, there could be challenges in obtaining the relevant documentation to support the premise the property was held by the individuals in their capacity as trustees of the SMSF, as well as potentially legal costs. If there is a restriction on holding the property in the name of the SMSF, ownership of the property must still be clearly established. The ATO states this can be achieved by caveat, or creating an instrument or declaration of trust to enable the SMSF to assert its ownership.
Also, where an SMSF amends its investment strategy, by disposing of existing fund assets to generate the required cash to acquire the property, it would be prudent for the SMSF trustee(s) to be able to demonstrate how the acquisition of the property is a better investment than the current investment(s) held. Again, particularly if the property is to be leased to a related business.
Structures to hold property
Make sure the property title is correctly recorded
SMSF acquires property outright
This is crucial, not just to ensure compliance with SIS regulation 4.09A to keep fund assets separate from trustee personal assets, but also to protect the asset from any future claim in the event of the bankruptcy of a member of the fund, who is also a trustee or director of the corporate trustee or where they are pursued by creditors. Refer to the recently reported case of Frigger v Trenfield (No 10), which dealt with an SMSF with undischarged bankrupts and what assets were available to creditors and whether certain assets, which were claimed to be assets of their SMSF and so protected, were indeed assets of the SMSF. An incorrect asset title could also lead to future costs to correct. For example, an SMSF changes from individual trustees to a corporate trustee and when the title is changed for the property, the relevant revenue office states their records show the property was never held by the title holders in a trustee capacity, potentially resulting in no duty concessions applying. Depending
There are a number of structures that can be used to acquire a property involving an SMSF, members, and related and unrelated parties. There is also the LRBA, which requires a specific structure when acquiring property. While a full analysis of each option cannot be explored in this article, below is a brief outline of each option.
For an SMSF that has the cash and can acquire an asset outright, the SMSF trustee(s) should address the issues previously outlined. It would also be best practice to ensure all rental property income and expenses are transacted via the fund’s bank account. The SMSF trustee(s) should also ensure the fund’s property is not used as security for any loans. Where the SMSF has individual trustees and property title registration is only recorded in their names, without reference to the SMSF, the fund’s property could be swept up in a lender’s eagerness to place a charge on personal assets for a loan. SMSF holds an interest in a property together with a member
Section 71(1)(i) of the SIS Act excludes from the definition of an in-house asset “property owned by the superannuation fund and a related party as tenants in common, other than property subject to a lease or lease arrangement between a trustee of the fund and a related party”.
Consequently, an SMSF can have an interest in a residential property with a related party, provided it is not leased to a related party, and that it is owned as tenants in common. Note: where the property is business real property, it is excluded from being treated as an in-house asset. This arrangement, while allowing an SMSF to hold an interest in a property together with a member, does not permit the fund to increase its interest by acquiring all or part of the interest held by the member, unless the property is BRP. A solution to this issue is provided by the next structuring option. SMSF holds interest in property via ‘nongeared’ unit trust
A unit trust that complies with the requirements of SIS regulation 13.22C is excluded from being treated as an ‘in-house’ asset. Consequently, the SMSF, together with a member or other related parties, can hold units in the trust, which in turn acquires the property. This structure offers the advantage, over the tenants-in-common structure, of the SMSF being able to increase its indirect interest in the property, where the property held does not meet the definition of BRP, for example, a residential property. However, there are strict compliance requirements for a non-geared unit trust, as outlined in SIS regulation 13.22C. Further, if any of the events listed in SIS regulation 13.22D occur, the SMSF’s investment in the related unit trust is no longer excluded from the in-house asset rule. This can be costly to deal with as it cannot be rectified. Holding a property in a non-geared unit trust, even where the SMSF holds 100 per cent of the issued units, that is, the SMSF could have acquired it directly, can also provide reduced land tax costs, depending upon the relevant jurisdiction, and can also ring fence the property from other assets held directly by the SMSF and may provide some protection from any action against the property asset. SMSF holds interest in property via unrelated unit trust
The legislation prohibits a superannuation fund from holding more than 5 per cent of
the market value of assets in in-house assets. Included in the definition of an in-house asset is “an investment in a related trust of the fund”. Consequently, an SMSF can invest in a unit trust that does not meet the definition of a related trust and that investment is not treated as an in-house asset. Generally, this would require the involvement of unrelated parties, which in turn requires an understanding of when an SMSF controls a unit trust. It also requires planning for the situation where unitholders leave the structure, which could result in the unrelated unit trust now being a related unit trust and subject to the in-house asset rules. LRBA
Section 67A of the SIS Act enables an SMSF to borrow money under an arrangement, known as an LRBA, to purchase a single asset or a collection of identical assets. The asset is held on trust so that the SMSF trustee acquires a beneficial interest, with a right to acquire legal ownership of the asset, generally once the loan has been repaid. Any recourse the lender or any other party has under the LRBA against the SMSF trustee is limited to that single fund asset.
Other considerations The following is a list of other considerations for an SMSF trustee when considering buying property: Non-arm’s-length income (NALI) and expenditure rules – with SMSFs able to acquire BRP from and lease BRP to related parties, transactions need to be on an arm’s-length basis otherwise the NALI provisions in section 295-550 of the Income Tax Assessment Act (ITAA) 1997 may apply and tax such income at the top marginal tax rate, currently 45 per cent. Application of goods and services tax (GST) – there are special rules for the GST in relation to an SMSF. Focusing on property, GST will generally only be relevant where the fund is registered or required to be registered for GST and the property held by the SMSF is commercial property for
GST purposes,new residential property for GST purposes, or vacant land. Importantly, when an SMSF is acquiring property or selling property, consideration should be given to any potential GST consequences of the transaction. Annual compliance and audit requirements – Prior to acquiring an interest in property either directly or via an interposed entity, it would be prudent to inform SMSF trustees of the compliance and audit requirements for the property asset category so they are aware of the potential audit requests. This could require the same issue being addressed each income year, for example: • the market value of the property or units in the unit trust at each 30 June, • showing the unit trust continues to satisfy the requirements of a ‘nongeared’ unit trust and no events outlined in SIS regulation 13.22D have occurred, • where the property is not BRP, it has not been used by a related party, particularly if it is located in a popular holiday destination, and • no charge is held over the property, except as permitted for an LRBA. Dealing with the death of an SMSF member – SIS regulation 6.21 requires a deceased member’s benefit to be cashed as soon as practicable. An SMSF that has a significant portion of assets in property can present a challenge to meet this requirement. Prior to the introduction of the transfer balance cap (TBC), a death benefit income stream was a common approach, however, the TBC may restrict this strategy.
Conclusion There are many compliance, tax and practical issues associated with an SMSF investing in real estate. Understanding these and applying them to your SMSF clients will contribute to property being a successful part of the fund’s investment portfolio. These can be achieved through education, whether it be the adviser, accountant or administration undertaking such education or those same people providing it to their SMSF clients.
QUARTER I 2022 33
STRATEGY
Closing the SMSF chapter
The choice to wind up an SMSF is not one to be taken lightly because doing so is absolute. Tim Miller takes a look at what to consider during this decision-making process.
TIM MILLER is education manager at SuperGuardian.
34 selfmanagedsuper
Every year since 2018, almost as many SMSFs have been wound up as have been established. The decision to wind up a fund should not be taken lightly as once a fund is wound up there is no turning back. Winding up an SMSF is in many instances a far bigger decision than establishing one because the trustees are no longer dealing with a blank canvas and are now left with the likelihood of deconstructing many years’ worth of work.
One of the most important elements of winding up a fund, regardless of where the members sit in the superannuation life cycle, is time. Ultimately, trustees need to have options with regards to all the moving parts associated with being a superannuation member while they start and work through the process of closing down the SMSF and so they need to afford themselves sufficient time to get the job done. Time is not the only issue. Other important elements also exist and are identified
throughout this article. None of these issues are sufficient enough to change the decision-making process, but may change the timing of the decision.
Ask the important questions Over the years, the ATO has released a number of valuable resources around winding up an SMSF and has identified a number of key questions trustees should ask themselves when considering the action. Those questions are: • Do they have a good knowledge of their responsibilities and obligations? • Do they have the time to run the SMSF? • Are SMSF running costs more than they want to pay or would another super fund cost less? • Are they able to continue managing the fund’s investments effectively or would they get higher returns if their super was managed in another type of fund? • Do they still want the responsibility of running the fund, including paying fines if things go wrong? • Do all trustees still agree on how to manage the fund? Has there been a falling out or relationship breakdown?
Reasons for winding up Having contemplated those questions, the reasons for winding up an SMSF are likely to fall into one or more of the following categories: • all the members and trustees have left or want to leave the SMSF, • all the benefits have been paid out of the fund, for example, following the death of a member, • the SMSF no longer meets the needs of the members, • members/trustees don’t have the time, skill or knowledge to manage the fund, • the SMSF is not cost-effective, • the members decide to relocate overseas, • relationships between fund members break down as we all know spouses separate and siblings can often not see eye to eye, and
One of the most important elements of winding up a fund, regardless of where the members sit in the superannuation life cycle, is time.
• trustee disqualification, such as bankruptcy. All of the above reasons are valid when making the decision to wind up, but equally each has a counter argument to suggest there is value in continuing with the fund. As per the comment above, once a fund is wound up, there is no turning back, so it’s important to consider whether additional members, alternative service providers or alternative trustees may provide a solution to the fund’s issues. In limited circumstances, such as when the ATO directs the trustees to wind up the fund, there is of course no alternative, so the appropriate steps need to be taken.
Wind-up flags While time is critical in the wind-up process to ensure trustees allow themselves sufficient time to action all necessary items before falling into a new financial year, there are other flags that will often determine the timing of a wind-up. Two of the biggest issues are benefit payments and member contributions, but equally significant are fund investments and fund taxation. Fund taxation is a theme that will not only impact the final return, but also whether the timing
of the wind-up is appropriate.
Contributions and benefit payments What is critical in the decision to wind up a fund is what the members are doing with their superannuation benefits. If they are still accumulating super and are unable to access their benefits, then they need to contemplate to where their benefits are to be rolled over and where future contributions are going to be paid. If they receive employer contributions, do they want to continue to receive contributions in the SMSF right up until its final days or do they want to have their contributions directed to their new superannuation fund as early as possible? With contributions, the earlier they are redirected the greater the chance of minimising the risk of lastminute amounts resulting in recalculations of taxation liabilities for the fund and it also gives their employer time to adjust. The last thing a member needs is for their employer to make a contribution in July to a fund that has been wound up in June. At the other end of the life cycle if the members are receiving a pension, then they may want to continue to make pension payments from their SMSF for as long as possible to ensure the fund retains access to its exempt pension income deductions. This will be useful as the fund sells, down assets to liquidate the members’ balance as it will provide a taxation benefit that would not otherwise be afforded if the members elect to stop their pension early. Of course this issue, about when to stop the pension and when to sell the assets, is also relevant if, instead of paying out a lump sum, the members are rolling their pension into another fund. It’s also important the fund pays the minimum pension for the year, including a pro rata amount if the pension ceases on a date other than 30 June. Don’t get caught out thinking the new fund will pay the pension for the entire year as failure to pay the pro rata minimum will result in the fund losing its tax exemption for the Continued on next page
QUARTER I 2022 35
STRATEGY
Continued from previous page
entire year, which could be disastrous. To execute a rollover, the trustees must first commute the pension, roll it over and recommence it in the new fund. Some funds, namely retail platform-based funds, will allow the paying fund to transfer the assets from the SMSF to their product via an in-specie transfer. It’s less common to see this with industry funds, but if you don’t ask you won’t know. If all the assets are transferred in one hit, from an SMSF perspective, it may be determined that the pension has ceased immediately before those assets are transferred, resulting in a potential capital gains tax liability on the sale. It may be a better option to progressively sell assets while entitled to the pension exemption and then roll over cash. Everyone’s fund is going to be different so again it’s important to consider the taxation ramifications. The other key issue with pensions is the reporting for transfer balance account purposes. If the trustees transfer to a larger fund, the new fund will report any new pension immediately whereas the SMSF may lag in its reporting of the pension commutation. This could lead to an excess transfer balance cap assessment, which is preferably avoided. As such it is imperative the SMSF reports early.
member balance to be rolled over. Also, it must be determined if there any assets the trustees are wanting to retain. This may be for sentimental purposes, although the sole purpose test may suggest otherwise, or it may be a business asset that is being retained by the family. If the answer is yes, then trustees will have to determine how this is to be achieved. For example, will the family or another entity acquire the assets from the fund (at market value) or do the members have an entitlement to a benefit payment and so will make an in-specie transfer of the assets. Make sure the ownership reflects the actual owner and that the valuations reflect arm’slength transactions. Another issue that can create problems for winding up funds is frozen assets or listed shares that have a perceived nil value but are awaiting the capacity to be written off to be provided by the ATO. In these instances it will often require some level of practical common sense. Is there a capacity to complete a transfer form to transfer ownership (at nil value) to the members? Even if the registry can’t complete the transfer, will the beneficial ownership nature of the transaction allow for the fund to move forward? These are issues often needing to be addressed, but will have to be done on a fund-by-fund basis.
Taxation Fund investments As alluded to above, possibly the most significant reason why time is the most valued possession with regards to the wind-up process is the investments of the SMSF. If the trustees attempt to rush the wind-up process and have a significant pool of assets, chances are they will run into problems. Trying to wind up a fund in June that holds units in managed funds during the last quarter of the year may mean you’ve got to take into consideration the distributions that are likely to hit in July or perhaps August, as well as wait for the tax statements. If the trustees give themselves longer, then they can identify income patterns and more accurately reflect the
36 selfmanagedsuper
What is commonly overlooked when undertaking the process is losses, both tax and capital losses. Trustees must know what the fund is forgoing by winding up at a certain point. Are there unused losses that could be valuable for contributing members or are there sudden capital losses due to significant market events? In some instances those capital losses could be valuable if there are also capital gains in the wind-up year, but it’s an area that is probably not always front of mind.
Other issues For most funds, the wind-up process should be relatively simple albeit there are bridges to cross to close it down. In some
What is critical in the decision to wind up a fund is what the members are doing with their superannuation benefits.
instances there will be other roadblocks to the process. If the fund pays legacy pensions or is a Qualifying Recognised Overseas Pension Scheme fund holding benefits originating from the United Kingdom, then there will be some hurdles that need to be considered. Of course, these funds will be in the minority.
Concluding the process If, of course, the trustees are winding up their fund to pay a final benefit out to themselves and/or other members, then the timing is less of an issue, but they still want to get their calculations right and have satisfied the appropriate condition of release to be able to fully access their money. They also want to get the timing right so they can avoid unnecessary administration fees by crossing financial years. As a final point, make a list of all the administrative things that need to be done. Notify the ATO via the final return, wind up the corporate trustee if there is no further use for the trustee company, cancel any insurance and buy a nice box to store all the fund records in for the next five to 10 years as the trustee responsibilities don’t end on the day the fund is wound up.
Combining a salary sacrifice arrangement with a transition-toretirement (TTR) pension has long been a strategic staple of pre-retirement planning. The tax savings combined with the ability to augment potentially reduced income has obvious appeal. Over the past three-and-a-half years, however, there have been sige degree to which they will benefit is worthwhile. Relying on pre-2017 conceptions of the strategy risks members experiencing unfavourable outcomes.
ANALYSIS
The numbers game
The latest ATO statistics show the highest rate of quarterly SMSF growth in five years, but we still haven’t cracked the 600,000-fund milestone. Kevin Bungard digs into the stats to tell us why we’re not there yet and what’s missing from the industry’s quarterly reporting.
KEVIN BUNGARD is Australian general manager at MyWorkpapers.
38 selfmanagedsuper
The latest ATO “SMSF Quarterly Statistical Report”, covering up to September 2021, contained some positive news for the SMSF industry, with net new funds for the quarter at the highest level in five years. A total of 7459 net new funds were added in the September quarter, which is up 35 per cent on the 5530 reported in the same quarter the previous year. As per Figure 1, the ATO has reported a total of 24,567 net new funds added across the four quarters to September 2021. This strong in-quarter growth is indeed welcome news for the industry after the past couple of very disruptive years. Unfortunately, as we’ll examine
in a moment, the overall industry growth is being slowed by a hidden drag not really highlighted in the regulator’s report. The total number of SMSFs reported by the ATO in the September data was 598,452. So given the strong growth being reported, why haven’t we broken through that 600,000-fund threshold yet?
A four-year conversation It’s not COVID playing tricks with your sense of time, we really have been on the cusp of exceeding 600,000 funds since September 2017. Back then, the ATO reported the number of SMSFs as being within 2000 funds of the 600,000 milestone
register has been treading water in the 590,000 to 600,000 range for 17 quarters.
report does not include the first reported numbers shown in Figure 2.
But what about the reported inquarter growth?
The baseline keeps getting lowered
With the total numbers of SMSFs on the register not really changing over four years, how do we reconcile that with the in-quarter growth numbers shown in Figure 1? To get to the bottom of this, let’s start by pointing out the September 2021 ATO
5000
Figure 1: Net new SMSFs (as first reported), per quarter,4000 to Sep 2021 FY21
8000
Dec
Mar
Jun
Sep
What’s happening here?
7000 No. of SMSFs
Figure 3 shows the latest ATO quarterly data versus the ATO’s first reported value. The latest data contains heavily revised numbers, shown in orange, that are much lower than originally reported. To see the original numbers you need to go back and look at each of the old ATO reports or look at the press stories published when the figures were first announced. With each new quarterly report, the number of funds in earlier quarters keeps getting revised down and, as you can see, the current number of SMSFs in September 2017 is now 35,000 less than the number FY22 the ATO first reported.
6000 5000 4000 FY21 Dec
Mar
FY22 Jun
Sep
Even if the total number of SMSFs in September had remained unchanged, from the 597,900 reported in June, the latest report would have shown a growth of 6907 funds for the September quarter. That’s because the in-quarter growth is only being measured after historical adjustments have been made to the baseline number. Figure 4 shows what is happening. The ATO report uses the numbers outside of the
60
59 No. of SMSFs on ATO register (’000)
No. of SMSFs
(598,620 funds). The latest ATO report for September 2021 says there were 598,452 funds; 168 funds less than there were four 8000 years ago. Figure 2 illustrates the numbers of SMSFs, as first reported by the ATO, 7000 over the past four years. The count represents the numbers of SMSFs on the government’s Super Fund Lookup 6000 register at that time. As can be seen from the graph, the number of SMSFs on the
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600
600
595
595 590 585 FY18
600 595
FY19
Sep Dec Mar Jun Sep Dec Mar Jun
No. of SMSFs (’000)
No. of SMSFs (’000)
No. of SMSFs (’000)
Figure 2: Number of SMSFs at the end of each quarter Sep 2017 – Sep 2021 (as first reported)
590 585 580
575 FY22
FY20
FY21
Sep Dec Mar Jun
Sep Dec Mar Jun
570 Sep 565
590
Sep 2017 rev
560
585 FY18
FY19
Sep Dec Mar Jun Sep Dec Mar Jun
FY20
FY21
FY22
Sep Dec Mar Jun
Sep Dec Mar Jun
Sep
FY18 Sep
QUARTER I 2022 39
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Mar
N
592 +418
591
September 2021 total
Establishments in this qtr
Revised June 2021 total
Back-dated establishment
Original June 2021 total
Wind-ups in this qtr
-144
-7325
590
Back-dates wind-ups
ANALYSIS
590,993
Figure 3: Revised v original number of SMSFs at the end of each quarter Sep 2017 – Sep 2021
600
No. of SMSFs (’000)
595 590 585 580 575 570 Number of SMSFs as first reported
565
Number of SMSFs (latest revisions)
Sep 2017 revised down by -35,475
560
FY18 Sep
Dec
Mar
FY19 Jun
Continued from previous page
grey box and the numbers shown in the grey box are not mentioned; they ignore the total number of SMSFs previously reported for June, the backdated wind-ups or the backdated establishments. The worrying thing is that these corrections are very significant. As shown in Figure 4, the adjustments almost wipe out the entire in-quarter growth for the quarter.
This isn’t a one-off There is an argument to be made that if this was a one-off error, then reporting the growth ignoring the corrections would be an acceptable practice. Unfortunately, in this case, the cause of the errors in the earlier data is not a one-off, it is a persistent and recurring problem. As reflected in Figure 5, the average backdated change over the 16 quarters was a loss of 5158 funds per quarter and that
40 selfmanagedsuper
Sep
Dec
Mar Jun
FY20 Sep
Dec
Mar Jun
exceeds the average in-quarter growth of 5147 funds over that period. This hidden but constant drag of backdated wind-ups is why we have not passed 600,000 funds despite the addition of 82,352 new funds over the past four years.
In-quarter growth v overall growth Effectively, rather than additional growth, the new funds added over the past four years have replaced funds that have turned out to have been wound up, and that has seen the total number of funds on the register fall slightly from 598,620 in September 2017 to 598,452 in September 2021.
Can we make this more transparent? The ATO does provide all the data and if you’re prepared to go digging for it, you can, as we have done here, work out what the impact of the backdated wind-ups are. Unfortunately, given the adjustments are buried in the detailed numbers spread
FY21
FY22
Sep Dec Mar Jun
Sep
across separate reports, getting to the net impact is a lot of work. As suggested above, if the quarterly reports included a summary of the total of backdated adjustments, as per Figure 4, or even just as a table as shown in Figure 6, then it would be clearer to all in the industry as to what was going on.
How big are the delays in reporting? Backdated wind-ups are a significant factor affecting SMSF reporting, but just how late are these wind-ups being reported? The ATO usually finds out about a fund’s wind-up via the SMSF annual return. The backdating therefore indicates the funds being wound up are failing to lodge annual returns in a timely fashion. Seventy per cent of the SMSF wind-ups, in a financial year, typically occur in the last quarter, so let’s look back at the June 2017 quarter and see how long wind-ups take to get included in the revised stats.
No. of SMSFs (’000)
Known unknowns and their quarterly 585 reporting impact Of course, it is not just wound-up funds 580 missing from the quarterly reporting. The 575 ATO has on a couple of occasions advised there were 80,000 to 90,000 SMSFs or up to 15 per cent of funds that had failed to570
FY22
597 596 595 594 593 592 +418
591
590,993
Sep 2017 revised down by -35,475 FY19
Revised June 2021 total
Back-dated establishment
lodge returns on time. The ATO flags these funds as ‘details removed’ on the Super Fund Lookup register, but these funds have effectively dropped off the ATO’s radar. Without the annual lodgement data, the regulator does not have a great handle on the make-up of these funds, that is, they are known unknowns. The ATO does highlight the quarterly reports use projections based on the returns it has received, but the regulator does not currently quantify how many funds are missing in those reports.
Wind-ups in this qtr
-144
-7325
590
FY18
598,452
597,900
565 560
+7603
September 2021 total
598
Not mentioned in ATO report
Establishments in this qtr
599
Back-dates wind-ups
The Superannuation Industry (Supervision) (SIS) Act requires trustees to report a change of status of a fund within 28 days. That means once the decision to wind up a fund is actioned, the fund’s tax return should be lodged as soon as possible rather than waiting until the normal lodgement deadline. If we assume most wind-ups occur towards the end of the quarter, then it appears about 40 per cent of SMSFs are complying with this requirement. Unfortunately, it seems about 45 per cent of funds are instead waiting until the normal lodgement date in May and a further 15 per cent of SMSFs wait another year. It’s unclear why so many funds are lodging late as there does not seem to600 be any advantage in doing so and perhaps more communication is needed about595 the requirement to lodge wind-ups as quickly as possible. 590
600
Original June 2021 total
Wind-up lodgement requirements
Figure 4: Reconciliation of ATO quarterly reported number of SMSFs Jun 2021 to Sep 2021
No. of SMSFs on ATO register (’000)
The latest report tells us we now know there were 11,179 SMSFs wind-ups in the June 2017 quarter, but when that number was first released back in late 2017, the ATO reported it was 181 funds. Figure 7 shows the history of that June 2017 number as reported over the past four years. If you look at the data for other periods, you get a similar chart. If we look at the percentage of wind-ups that are recorded over time, we find on average: • less than 2 per cent of funds are lodged in the quarter they are wound up, • 40 per cent are lodged a quarter later, • 85 per cent of wind-ups are recorded within the first year, and • it takes another year to get that number to 95 per cent.
Looking at ATO tax return data The number of lodgements received is, however, included in the ATO’s annual taxation statistics data. That data set is based on returns received by the end of October each year. Figure 8 shows a comparison of the number of funds on the SMSF register in June 2017 (blue line) versus the number of SMSF tax returns lodged (green line), and how those numbers have been revised over the
Continued on next page Number of SMSFs as first reported
Number of SMSFs (latest revisions QUARTER I 2022 41
FY20
FY21
ANALYSIS STRATEGY
Figure 5: Net backdated reduction in number of SMSFs per quarter Sep 2017 – Sep 2021 0
No. of SMSFs
-2000 -4000 -6000 -8000 -10,000
Average quarterly revision = -5158 funds
-12,000 FY18 Sep
Dec
Mar
FY19 Jun
Sep
Dec
Mar Jun
FY20 Sep
Dec
Mar Jun
Figure 6: Reconciliation table of Jun 2021 and Sep 2021 quarterly reported number of SMSFs Original June 2021 total Back-dated wind-ups
597,900
12,000
No. of June 217 SMSFs wind-ups
Back-dated establishments 10,000 Revised June 2021 total Wind-ups in this quarter
8000
Establishments in this quarter September 2021 total
6000
-7325 +418 590,993 -144 +7603 598,452
That gap of 90,000 for the 2017 financial year has been narrowed each time the reporting is updated, but the most recent past four years. data we have from October 2020 still shows Given most lodgements are not due until a gap in excess of 25,000 lodgements 11 months after the end of the financial year, 2000 when compared with the latest revised the first lodgement data we have for the number of 565,035 SMSFs on the register 2017 financial year is ‘as at’ October 2018. in June 2017. At that time fewer than 500,000 SMSFs 0 had lodged their returns, that is, 90,000 If we project out another couple of years Seplines 2017 2017 Mareven 2018 funds less than the number of funds on the Jun 2017 (see dotted in theDec chart), it seems, (first report) (+1 qtr) (+2have qtrs)a gap of (+3 qtrs) ATO register at 30 Jun 2017. after six years, we will still Continued from previous page
42 selfmanagedsuper
4000
FY21
FY22
Sep Dec Mar Jun
Sep
around 10,000 funds that will not be properly accounted for and, of course, by the time we catch up with all those funds that were on the register in 2017, we will have had another six years of other funds falling behind. The ATO has not yet published the 2020 financial year lodgement data, but the data for the 2019 financial year lodgements is available and that still showed a gap of 90,000 funds.
Can we make this more transparent? As noted earlier, the ATO has occasionally provided further details on the scale and make-up of this missing lodgement data. At the SMSF Association conference in February 2019, ATO superannuation assistant commissioner Dana Fleming noted for the 2017 financial year there was a 14 per cent non-lodgement rate and that these funds held an estimated $28 billion in assets. Fleming also included details about the number of funds that have never lodged or have lapsed after previously lodging. Given missing funds continue to make up 15 per cent of all funds, it would be helpful if the ATO were to include that sort Jun 2018 Jun 2019 Sepreports 2021 as a of information in the quarterly (+1 year)practice, (+2 years) (latest) standard for example, something
0
600
No. of SMSFs
-2000
590
-4000
580
-6000 -8000
570
-10,000
Average quarterly revision = -5158 funds
-12,000 FY18 Sep
Dec
FY19
Mar
Jun
Sep
Dec
Mar Jun
Sep
Dec
Mar Jun
560
FY21
FY22
Sep Dec Mar Jun
Sep
FY20
Figure 7: Delays in reporting SMSF wind-ups that occurred in Jun 2017
550 540
Figure 8: Convergence of registry and lodgement data for Jun 2017
530 520
12,000
510 600
500
FY18
ec
Mar
No. of June 217 SMSFs wind-ups
10,000 590
490 580
8000
570
6000Average quarterly revision = -5158 funds
FY19 Jun
Sep
Dec
F
Mar Jun
Sep
Dec
4000
Mar Jun
560
FY21
FY22
Sep Dec Mar Jun
Sep
FY20
Appromiately 90,000 of SMSFs are ‘Known Unknowns’
550 540
2000
530 520
0
On register (Sept)
12,000
Jun 2017
Sep 2017
Dec 2017
Mar 2018
Jun 2018
Jun 2019
Sep 2021
(first report)
(+1 qtr)
(+2 qtrs)
(+3 qtrs)
(+1 year)
(+2 years)
(latest)
510 Return lodged (Oct)
500
10,000
490 FY17
8000
FY18
FY19
FY20
FY21
FY22
FY23
Figure 9: Mock-up of how quarterly reports might show the impact of missing lodgements
6000
4000
Up-to-date SMSFs
2000
First year SMSFs
0
503,452 5000 NeverJunlodgers ‘Lapsed’ lodgers 2019 Sep 2021
Jun 2017
Sep 2017
Dec 2017
Mar 2018
Jun 2018
(first report)
(+1 qtr)
(+2 qtrs)
(+3 qtrs)
(+1 year)
1 year late
(+2 years)
(latest)
5000
10,000
2 years late
10,000
20,000
3 years+ late
15,000
30,000
Total
30,000
60,000
Total SMSFs missing lodgements Total SMSFs like the table shown in Figure 9. Providing this missing lodgement information, along with the backdated data mentioned previously, would allow the industry to have a clearer understanding of the scale of these data challenges and of
90,000 598,452
the level of estimation being made in the quarterly reporting.
Why we should care about this missing data At any point in time there are 90,000
SMSFs that are being estimated in the quarterly reporting and perhaps a third of those funds are likely to have already been wound up. If we are not careful, the backdated impact of the wind-up funds could lead to misstating the overall growth rate of the SMSF industry. Unfortunately, it’s not just the growth statistics that may be misstated; the total number of SMSFs is also used to calculate the estimated total balance of the SMSF industry and that in turn is used to estimate the size of the SMSF segment and of Australia’s overall retirement savings. If the ATO provided a little more data on the effect of backdated changes and of the status of fund lodgements, then the industry would be able to make more informed decisions and better plans. At the very least, the industry, regulators and politicians would have a clearer view of what is really happening in this crucial part of the superannuation industry.
QUARTER I 2022 43
STRATEGY
The rewards of recontributions Withdrawal and recontribution strategies can result in achieving better tax outcomes for SMSF members and their death beneficiaries. Craig Day illustrates how this can be achieved in more than one way. The recontribution strategy is a common strategy used by financial advisers for many years to reduce the tax on lump sum death benefits paid to non-tax dependants. However, there are a range of SMSF specific issues that need to be thought through before implementing any recontribution strategy, including whether it even makes sense to do so.
What is the recontribution strategy? CRAIG DAY is head of technical services at Colonial First State.
The recontribution strategy in its most basic form involves a member withdrawing a tax-free lump sum from superannuation and then recontributing back into super. The traditional aim of this strategy is to convert a taxable component into a tax-free component by cashing out lump sums that consist either partly or fully of a taxable component and then recontributing that amount as a non-concessional contribution (NCC), which then counts towards the tax-free component. For example, a member over the age of 60 with a benefit made up entirely of taxable component could potentially save up to $17,000 in death benefit tax per $100,000 of lump sum death benefit paid to a non-tax dependant by implementing the strategy.
Recontribution quirks for SMSFs While a simple one-off recontribution works fine in an SMSF, things can get a little more complicated where the amount the client wishes to cash out and recontribute exceeds their NCC cap under the bring-forward rule, as this may require the client to recontribute several times over a number of years. In this case, without a proper understanding of the rules and a little bit of strategy, an SMSF client may not get the outcome they were totally expecting. For example, while most people implement the recontribution strategy after 60 to ensure the lump sum will be tax-free, it’s important to remember the proportioning rules still apply to require the
44 selfmanagedsuper
lump sum to be broken up into its constituent tax components. As stipulated in section 307-125 of the Income Tax Assessment Act 1997 (ITAA), this is done by applying the same tax component proportions to the lump sum as the super interest they are drawn from. For example, a $10,000 lump sum withdrawn from an interest made up of a 30 per cent tax-free and 70 per cent taxable component would consist of $3000 tax-free and $7000 taxable components. This means with each subsequent recontribution, the following withdrawal will be made up of increasing amounts of tax-free component, thus increasing the number of transactions and time it would take to fully convert a taxable component to a tax-free component via this strategy.
Case study Andrew, a retired divorcee, turns 65 on 8 August 2022 and has $550,000 in an SMSF that is 100 per cent taxable. He has nominated his non-financially dependent adult daughter, Sabrina, to receive his death benefit via a binding death benefit nomination. If Andrew were to pass away, his death benefit would be subject to tax of up to $93,500 (that is, $550,000 x 17%). If Andrew implemented a recontribution strategy under the current rules, he could make three withdrawals across a period of three financial years, recontributing the funds back into superannuation each time as NCCs. This would be comprised of a $110,000 contribution in 2022/23 and 2023/24, and then a $330,000 contribution triggering the bring-forward provision in 2024/25 when he reaches age 67. However, if Andrew recontributed back into his SMSF, a significant portion of his superannuation balance would remain as a taxable component when he turned 67 due to each withdrawal being made up of increasing amounts of tax-free component due to
Table 1 Total balance ($)
Tax-free ($)
Taxable ($)
Taxable (%)
Pre-1st recontribution
550,000
0
550,000
100
Post-1st recontribution
550,000
110,000
440,000
80
Post-2nd recontribution
550,000
198,000
352,000
64
Post-3rd recontribution
550,000
409,200
140,800
26
the proportioning rules. For example, after implementing this strategy, he would still be left with a $140,800 taxable component after three years as reflected in the table 1. In this case, it should be noted Andrew would still get the same outcome even if his NCCs were contributed or credited to a separate accumulation account, that is, the lump sums were drawn from his original account, account A, and the NCCs credited to a separate account, account B. This is because under regulation 307200-02(a) of the Income Tax Assessment Regulations (ITAR) (1997 Act) 2021 the proportioning rules treat all of a member’s different accumulation interests in an SMSF as one superannuation interest. Therefore, Andrew’s two separate accumulation accounts would need to be combined into one to determine the tax components of any subsequent benefit payments. However, to try and recontribute his full balance before the work test would apply at age 67 (applicable at the time of writing), Andrew could consider recontributing the withdrawn amounts to a different fund, which would ensure all the withdrawals from his SMSF would remain 100 per cent taxable component. Table 2 shows the outcome where his benefits in Fund A are recontributed as NCCs to a second fund, Fund B. However, this would require Andrew to have two separate funds, which would potentially increase cost and complexity. Please note both case study scenarios assume no indexation of contributions caps
and that no earnings have accrued and no further concessional contributions have been made over the three-year period. Also, any increase in taxable component due to concessional contributions and/or accrued earnings within accumulation phase would result in Option 1 being even less effective when compared to Option 2. However, another option could be for Andrew to commence an account-based pension (ABP) within his SMSF prior to commencing a recontribution strategy. Under regulations 307-200-02(b) and 307-200-05 of the ITAR (1997 Act) 2021, this provides a different outcome as the proportioning rules treat an interest that supports a superannuation income stream as a separate super interest. Therefore, if Andrew commenced his ABP with a 100 per cent taxable component, any future lump sum commutations would consist of a 100 per cent taxable component, regardless of whether he had since recontributed NCCs back into an accumulation account in his SMSF. An added benefit of the above strategy is it could allow a member to segregate taxable and tax-free components into two separate pensions, which could then allow a member to direct death benefits be paid in the most tax-efficient way. For example, if Andrew wanted Sabrina to receive 20 per cent of his death benefit with the balance being paid to a second spouse, he could achieve this outcome by commencing an ABP worth $550,000
(100 per cent taxable component) and then withdrawing and recontributing $110,000, which he could then use to commence a second ABP for $110,000 (100 per cent taxfree component). This could then be paid to Sabrina tax-free on his death.
Other SMSF recontribution issues Where an SMSF has insufficient cash to implement a recontribution strategy, the trustees would either need to dispose of assets to provide the required liquidity or the fund could process the recontribution via an in-specie benefit payment and contribution. However, any strategy involving inspecie transfers would need to be handled carefully as it would require the ownership of the asset to be transferred at the market rate twice in quick succession and the asset would need to be of a class that is able to be acquired from a related party. In addition, the sale or transfer of any capital gains tax (CGT) assets would trigger transaction costs and a potential CGT liability, which would need to be factored into any cost-benefit analysis of the strategy. Alternatively, where a member had previously commenced a retirementphase income stream, any capital gains would either be fully or partially exempt, depending on the fund’s circumstances. Trustees should also be very wary of methods that may be promoted as a way of avoiding the potential CGT implications Continued on next page
QUARTER I 2022 45
STRATEGY
Table 2 Total balance ($)
Tax-free ($) (Fund B)
Taxable ($) (Fund A)
Taxable (%) (Combined)
Pre-1st recontribution
550,000
0
550,000
100
Post-1st recontribution
550,000
110,000
440,000
80
Post-2nd recontribution
550,000
220,000
330,000
60
Post-3rd recontribution
550,000
550,000
Nil
Nil
Continued from previous page
associated with recontribution strategies and SMSFs. These have included: • recording the cash out and recontribution via journal entry only with no amounts ever leaving or being recontributed back to the fund, and • a promissory note being passed back and forth between the trustee and member with a benefit payment and contribution being recorded, despite the promissory note never being presented or honoured. Neither of these strategies have withstood scrutiny, with the ATO issuing both Interpretative Decision 2015/23 confirming benefit payments cannot be paid via journal entry and Taxpayer Alert 2009/10 warning trustees about the potential tax avoidance issues associated with the non-commercial use of promissory notes and cheques.
Is it actually worthwhile doing? While the recontribution strategy is relatively common, a valid question is whether it’s actually worthwhile doing – especially considering members aged 60 or over can withdraw their benefits tax-free prior to death. In this case, it’s also relevant to note a recontribution strategy: • only financially benefits the member’s non-tax dependant beneficiaries and could actually disadvantage a client where the fund will incur taxes, such as CGT, and other transaction and
46 selfmanagedsuper
administration costs, to implement the strategy, and • relies on a member’s death benefit actually being paid to a non-tax dependant, such as an adult child, instead of their spouse. However, withdrawing super prior to death obviously requires a person to know when they are likely to die, which will not be the case in the event of sudden death due to accident or illness. Also, an elderly or terminally ill person would need to have the capacity to withdraw their benefits while still alive. In this case, a person’s enduring power of attorney may also be reluctant to withdraw their benefits prior to death to avoid death benefits tax as they are generally required to act in the best interests of the person and not their beneficiaries.
Other reasons to implement recontribution strategies A recontribution strategy can also provide a number of other advantages, especially where it involves a spouse. For example, it could allow a couple to equalise their superannuation balances, which could provide a number of benefits. These include: • maximising the total amount of benefits a couple could transfer to the tax-free retirement phase where one member of the couple has accumulated more than the transfer balance cap (TBC). For example, this could allow a member who had accumulated $200,000 more than the TBC to withdraw the excess amount
and recontribute to the super account of their spouse, who could then use it to commence their own ABP (assuming they had sufficient cap space), and • allowing a client to qualify for any concessions based on their total superannuation balance (TSB), such as the catch-up concessional contribution rules or work test exemption rules, which have TSB eligibility thresholds of $500,000 and $300,000 respectively. Using a recontribution strategy to increase the super balance of a younger spouse may also allow an older spouse to gain access to a higher rate of age pension, as super in accumulation phase is exempt from the assets and income tests until a person qualifies for the age pension. An individual currently needs to be 66.5 years old to be eligible for the age pension and this threshold is increasing to 67 for those born on or after 1 January 1957.
Anti-avoidance As the recontribution strategy may result in less tax being paid by a non-tax dependant beneficiary, the application of Part IVA anti-avoidance rules of the ITAA 1936 has always been a possibility. However, it is important to remember that the application of Part IVA to any recontribution arrangement will always be assessed on a case-by-case basis. So while a plain vanilla recontribution may be fine, if you push the boundaries there are no guarantees.
COMPLIANCE
Employee share scheme NALI doubts The introduction of the non-arm’s-length expenditure rules has now brought uncertainty over employee share schemes involving SMSFs. Dan Butler and Shaun Backhaus give their insights into the current status of the situation.
DANIEL BUTLER (pictured) is a director and SHAUN BACKHAUS a senior associate at DBA Lawyers.
48 selfmanagedsuper
Acquiring shares under an employee share scheme (ESS) via an SMSF may appear attractive, but substantial uncertainty has arisen following the ATO’s recent Law Companion Ruling (LCR) 2021/2 on the application of the non-arm’s-length income (NALI) rules to such a transaction. This ruling focuses on NALI arising from the non-arm’s-length expenditure (NALE) changes to section 295-550 of the Income Tax Assessment Act (ITAA) 1997 that came into effect from 1 July 2018.
Typical ESS Many employers, including small, medium and large employers, seek to encourage their employees to work in the best interests of the company by offering an ESS to align their employees’ interests with the business. Research suggests companies having an ESS generally perform better than companies that do not offer such plans. Under an ESS, companies typically offer employees the opportunity to acquire shares in the organisation at a discounted price. There are also a range of tax rules that cover the taxation of ESS interests and certain employees may qualify for some tax relief, such as the ability to defer the taxing point or obtaining a more favourable tax treatment compared to ordinary income under section 83A-115 of the ITAA. Many ESS allow employees to nominate a related entity, such as a family member, a family company, a family trust or an SMSF, to acquire the shares on offer. Naturally, section 66 of the Superannuation Industry (Supervision) (SIS) Act 1993 needs to be considered if an SMSF acquires an asset from a member or related party. However, we will focus solely on the potential application of NALI in this article.
Note the tax rules generally assess the employee on any discount granted via an ESS even if the employee nominates another family member or related entity, such as an SMSF, that ends up acquiring the shares.
ESS discount treatment prior to LCR 2021/2 The ATO generally treats discounts on shares as assessable income to the employee. Where the shares are nominated to an SMSF, the ATO has also treated any discount as a contribution. This is confirmed on the ATO webpage QC 26221 where the regulator states: “A super contribution is anything of value that increases the capital of a super fund and is provided with the purpose of benefiting one or more particular members of the fund, or all of the members in general. “For example, when shares acquired under an ESS are transferred to an SMSF at less than market value, the acquisition results in a super contribution because the capital of the fund increases and the purpose of the acquisition is to benefit a member, or members, of the fund.”
The impact of LCR 2021/2 on ESS shares acquired by SMSFs The ATO states in LCR 2021/2 that: “[18] [NALE] incurred to acquire an asset (including associated financing costs) will have a sufficient nexus to all ordinary or statutory income derived by the complying superannuation fund in respect of that asset. This includes any capital gain derived on the disposal of the asset…” It therefore appears the purchase by an SMSF of an asset like a share at a discount will result in all future dividends and net capital gain on disposal of that asset being treated as NALI and
broadly taxed at 45 per cent. Moreover, the amendments introducing the NALE changes to section 295-550(1)(b) and (c) of the ITAA apply retroactively, regardless of when the ‘scheme’ was entered into. Thus, it appears SMSFs may be exposed to NALI on dividends and net capital gains for shares acquired at a discount under ESSs, despite those shares being acquired prior to 1 July 2018. This analysis would appear to provide a big adverse impact on SMSFs acquiring ESS shares at less than market value. As such, advisers now need to alert clients to this risk or face potential professional negligence claims.
Does TR 2010/1-DC have any relevance? The ATO also recently issued a revised draft for consultation ruling on what is considered a contribution in the form of Tax Ruling (TR) 2010/1-DC. This revised ruling seeks to clarify the divide between what is a contribution versus what is NALI. In particular, the ATO’s broad view is that an asset purchased for less than its market value gives rise to NALI. In particular, paragraph 25C states: “25C. In circumstances where an … [SMSF] … purchases an asset under a contract at less than market value, the superannuation provider has incurred [NALE] under a non-arm’s-length dealing for the purposes of applying the [NALI] provisions in section 295-550. We do not consider that the difference between the consideration paid (if any) and the market value represents an in-specie contribution being made as the asset has been acquired under the terms of the contractual agreement and not through an in-specie contribution.” An SMSF typically purchases ESS shares by paying the company directly. The company provides the discount to the SMSF as part of the ESS provisions. These provisions form part of the contractual terms and conditions relating to the SMSF acquiring the ESS shares as
This analysis would appear to provide a big adverse impact on SMSFs acquiring ESS shares at less than market value. As such, advisers now need to alert clients to this risk or face potential professional negligence claims.
the nominated purchaser. Thus, it appears the ATO’s latest view is that discounts offered to SMSFs on ESS shares are no longer contributions. This is a major change to the long-established practice based on TR 2010/1, which has been a binding public ruling that has been relied on for the past 11 years or more. The ATO’s latest draft view also differs from its current view reflected on its website at QC 26221. TR 2010/1-DC remains in draft as a range of professional bodies have made submissions to the ATO to clarify the uncertainty with LCR 2021/2 before they can consider what submission can be made in relation to TR 2010/1-DC.
Is there a concession for certain discounts in LCR 2021/2? LCR 2021/2 at [51] states:
“51. A complying superannuation fund might enter into arrangements that result in it receiving discounted prices. Such arrangements will still be on arm’slength terms where they are consistent with normal commercial practices, such as an individual acting in their capacity as trustee (or a director of a corporate trustee) being entitled to a discount under a discount policy where the same discounts are provided to all employees, partners, shareholders or office holders.” However, many ESSs are only offered to a particular class of employee, for example, senior managers and executives, rather than to all employees and, in certain cases, shares may be offered to greater than say 75 per cent of permanent employees who have completed at least three years of service, for example, as required by section 83A-105 of the ITAA. Importantly, an offer to 75 per cent or similar cohort does not satisfy the ATO’s discount policy in LCR 2021/2 at [51]. The above analysis highlights the substantial uncertainty arising on this subject as a result of the ATO’s position reflected in LCR 2021/2 and 2010/1-DC.
Conclusion SMSFs that acquire shares at a discount via ESSs risk NALI being applied to future dividends (including any franking credits) and any net capital gain on future disposal of the shares. We recommend that given the uncertainty that currently exists as outlined above, before an SMSF acquires any further ESS shares, expert advice from a tax expert with superannuation experience in dealing with the latest NALI developments be obtained. Indeed, advice should be sought before any dealing with shares previously acquired under an ESS as the tax impact is now subject to substantial uncertainty. Companies and advisers providing ESS interests should be updating their disclosures to point out the uncertainty and risks noted above.
QUARTER I 2022 49
STRATEGY
The finer details of death benefits Formulating an estate plan for an SMSF member is a complicated process. Grant Abbott lays out the critical items advisers need to determine when providing death benefit-related advice.
GRANT ABBOTT is the founder of Lightyear Docs.
It is projected that more than $300 billion in SMSF monies will be transferred from current SMSF members by way of death benefit transfers over the next 20 years. The sad part is much of it will be litigated and this brings costs, family squabbles and no access to much-needed income for the grieving family. Moreover, it is now in our face as a large percentage of SMSF members reach their twilight years. The continuous dire warnings from legal experts that binding death benefit nominations (BDBN) are easily attacked, plus the less than optimal advice of estate planning lawyers directing a deceased member’s superannuation to their estate, only to be potentially attacked by a family provisions challenge, means there is no certainty when it comes to SMSF estate planning. However, a solution might be at hand.
The new skill: SMSF specialist estate planners You may already have the skills to advise in the field of superannuation estate planning. The key issue is whether you are technically competent to provide advice on superannuation estate planning. In that regard I had a big hand in drafting the SMSF industry competency standards for the Financial Services Training Package in the early 2000s and they are still relevant today. These standards are objective and all practitioners must adhere and show their competency in dealing with SMSF members and trustees. They are over 50 pages long and identify the following competency requirements when it comes to advising on death benefits and SMSF estate planning. These are mandatory requirements: • the client is informed of the treatment of death benefits, • the client is aware of the impact of the trust deed on death benefit payments (lump sum and pension), • the adviser shows an ability to identify relevant
50 selfmanagedsuper
Superannuation Industry (Supervision) (SIS) Act and Income Tax Assessment Act (ITAA) legislation and regulations relevant to each client, • the adviser shows an ability to use a range of interpersonal and communication skills to relate to a range of clients, and • the adviser is able to identify and show knowledge of the tax treatment of death benefits (lump sum and pension issues). Some 15 years on, in my opinion, a good SMSF specialist adviser and certainly one with estate planning knowledge must be able to answer the following death benefit issues: i. Should a BDBN be used? And what type and what cases show their deficiencies? ii. What is an SMSF will and how is it different to a BDBN? iii. Will current BDBN cases impact current SMSF estate planning? iv. How is the trustee or board of directors of a corporate trustee of an SMSF convened in the event of the death of a member? v. Does the member’s entitlements cease on death or carry on post death in the name of the legal personal representative? vi. Is it possible for an SMSF trustee to create a testamentary trust on the death of a member – one that flows from the SMSF and sits outside the estate? vii. Who can be paid directly from a superannuation fund? viii. What is tax dependency? ix. Can a reversionary pension go beyond two people to multi-generations such as grandchildren? x. What tax rates are applicable to life insurance death benefit pensions? xi. How do the family provisions laws in each state impact direct death benefit payments versus super passed to a deceased member’s estate? xii. How can you protect super from a family provisions claim if a member wants to pay all of their super to an adult child from the first marriage and not children from their second?
Table 1: The payment of death benefits to a member’s SMSF estate Beneficiary
Allowable superannuation benefit
Spouse
Lump sum, income stream and/or both
Dependant child under the age of 18
Lump sum, income stream and/or both, however, any income stream must be commuted by age 25
Financially dependant child between the ages of 18 and 25
Lump sum, income stream and/or both, however, any income stream must be commuted by age 25
Disabled child
Lump sum, income stream and/or both
Dependant grandchild
Lump sum, income stream and/or both
Non-dependant grandchild
Lump sum via the legal estate
Dependant brothers, sisters and parents
Lump sum, income stream and/or both
Non-dependant brothers, sisters and parents
Lump sum via the legal estate
Dependant child over the age of 25
Lump sum
Non-dependant (not a child of the member)
Lump sum via the legal estate
Legal estate
Lump sum
These are just some of the questions a competent SMSF specialist adviser and lawyer are required to know and, more importantly, communicate with a client on top of advising the trustee on administering a deceased member’s superannuation estate.
Building an effective SMSF estate plan Creating an effective SMSF estate plan can be a long and demanding task, requiring great skill from a specialist adviser in order to achieve coverage of all contingencies. Advanced skill, care and time are required in developing and documenting an SMSF estate plan. My experience shows the key elements of an estate plan are to: a. determine what is important to the SMSF member in relation to looking after their family and dependants in the event of their death, b. determine who is going to control the
c.
d.
e.
f. g.
distribution of the deceased member’s superannuation interests as super benefits upon the person’s death, create a blueprint to deliver the desired SMSF estate planning goals using the right combination of vehicles and life insurance if need be, make sure the plan is simple, certain and easy for all parties to understand before the person dies, ensure the person or people left in charge of implementing the plan on behalf of the deceased know what they are doing or use experienced advisers to deliver the plan. For an SMSF this is the trustee of the fund, ensure the SMSF estate plan is taxeffective, and ensure it complies with the laws and any chance of legal disputation is minimised.
can be carried out via the direct transfer of a deceased member’s super interests from their family SMSF to a dependant under section 62 of the SIS Act. This may be by way of a lump sum or pension, although there are legal limitations for the trustee of a fund paying an income stream or pension pursuant to SIS regulation 6.21. The strategic possibilities for a member of a fund in terms of their SMSF estate planning are shown in Table 1.
Who is a dependant? As noted above, the sole purpose test in section 62 of the SIS Act provides that the trustee of an SMSF can pay death benefits to a dependant upon the death of a member. There are different definitions of dependant in the SIS Act and the ITAA. Table 1 looks at the SIS Act, which includes a child as a dependant, even though they may not be
The SIS Act and death benefits For the most part, SMSF estate planning
Continued on next page
QUARTER I 2022 51
STRATEGY
Continued from previous page
financially dependent. For tax purposes a dependant receives favourable taxation treatment – no death benefits tax on the payment of taxable components – which leads us to the next point. Section 302-195 of the ITAA: meaning of death benefits dependant 1. A death benefits dependant, of a person who has died, is: a. the deceased person’s spouse or former spouse, or b. the deceased person’s child, aged less than 18, or c. any other person with whom the deceased person had an interdependency relationship under section 302-200 just before he or she died, or d. any other person who was a dependant of the deceased. It also includes someone receiving a superannuation lump sum if the deceased died in the line of duty as a member of: a. the defence force, b. the Australian Federal Police, c. the police force of a state or territory, d. a protective service officer, or e. the deceased member’s former spouse or de facto spouse. The meaning of ‘interdependent relationship’ has been described by the courts and taxation commissioner as “one of continuing mutual commitment to financial and emotional support between two people who reside together. The definition will also include a person with a disability who may live in an institution but is nevertheless interdependent with the deceased. For example, two elderly sisters who reside together and are interdependent will be able to receive each other’s superannuation benefits tax-free. Similarly, an adult child who resides with and cares for an elderly parent will be eligible for tax-free superannuation benefits upon the death of the parent.”
Who is a financial dependant? A financial dependant at law falls within
52 selfmanagedsuper
section 302-195(1)(d) of the ITAA. In that regard, the issue of who is a financial dependant has occupied the courts’ mind for more than a century in relation to workers’ compensation, taxation and superannuation matters. There is substantial High Court precedent on who is a financial dependant in Aafjes v Kearney (1976) 180 CLR 1999 and Kauri Timber Co (Tas) Pty Ltd v Reeman (1973) 128 CLR 177. Specific to superannuation, there have been two significant cases concerning the meaning of financial dependant for the purposes of super law: Malek v FC of T [1999] ATC 2294 and Faull v Superannuation Complaints Tribunal [1999] NSWSC 1137. In Malek’s case, Antoine Malek was aged 25 when he died. He was single, had no children and, prior to his death, he and his widowed mother lived together. Mrs Malek received a disability support pension of about $153 a week, but her accountant estimated Antoine contributed around $258 a week to Mrs Malek’s living expenses for food, mortgage payments, taxi fares, medical expenses and other bills. The issue at hand was whether Antoine’s mother was a financial dependant. The taxation commissioner argued she was not and to this end stated the person had to be wholly or substantially reliant on the ongoing support provided under the arrangement. The tribunal reviewed the cases on financial dependence and in its decision cited the following authoritative statement from Justice Gibbs of the High Court: Gibbs said in Aafjes v Kearney (1976) 180 CLR 1999 at page 207: “In Kauri Timber Co (Tas) Pty Ltd v Reeman (1973) 128 CLR 177 at pp 188–189, I accepted that one person is dependent on another for support if the former in fact depends on the latter for support even though he does not need to do so and could have provided some or all of his necessities from another source. I adhere to that view.” The decision of the Administrative Appeals Tribunal was that Mrs Malek was a financial dependant because the financial support she received from her son maintained her normal
standard of living. Moreover, she was reliant on the regular continuous contribution of the other person to maintain that standard. In Faull’s case, the court held the mother of 19-year-old Llewellyn Faull was a financial dependant of his at the time of his death and determined his death benefit in its entirety should be paid to her without any tax deduction. At the time of her son’s death, Mrs Faull had regular employment that earned her an annual income of $30,000. Her wages were supplemented by an amount of $30 a week paid by her son as board and lodging. Although the sum paid to Mrs Faull every week by her son was small, the court stated: “The payment of that amount augmented her other income and, to that extent, she was dependent upon the deceased for the receipt of some of her income. Accordingly, she was partially dependent upon the payments made by the deceased.” Both of these cases, which have been cited in numerous ATO private binding rulings, concluded that partial dependence and reliance is enough to establish financial dependence for the purposes of the SIS Act and the ITAA provided the payment is ongoing and recurring.
Regulator guideline The Australian Prudential Regulation Authority (APRA) has also considered the issue of financial dependence and in its payments standard guideline, APRA Guideline No.I.C.2, it stated the following: “There is no need for one person to be wholly dependent upon another for that person to be a ‘dependant’ for the purposes of the payment standards. Financial dependency can be established where a person relies wholly or in part on another for his or her means of subsistence. Nor must the recipient show a need for the money received from the deceased member in order to qualify as a dependant. Moreover, since partial financial dependency can generally be sufficient to establish a relationship of dependence, it is possible for two persons to be dependent on each other for the purposes of the payment standards.”
SMSF TRUSTEE EMPOWERMENT DAY 2022 SYDNEY HYBRID EVENT 15 SEPTEMBER 2022
Attending SMSF Trustee Empowerment Day 2022 will allow trustees, to be armed with the most critical information and strategies to ensure your fund is the best it can be from all perspectives. Don’t miss this opportunity to hear from key sector participants such as the ATO and other technical experts about the most current legislative, compliance and strategic issues affecting them.
FEATURED SPEAKERS
Julie Dolan
Head of SMSF & Estate Planning
Tim Miller
Education Manager
SAVE THE DATE
COMPLIANCE
Options for acquiring real estate
Funding a property purchase can be challenging due to the size of the capital outlay required. John Maroney outlines two methods that can make the process easier and the associated compliance issues requiring attention.
JOHN MARONEY is chief executive of the SMSF Association.
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Investing in property via an SMSF continues to grow with commercial and residential properties representing the third most popular asset class for SMSFs. Comprising about 15 per cent of all SMSF assets, behind Australian shares and cash and fixed deposits, it’s a percentage that has remained constant over the year even though the total value of assets owned by SMSFs has increased. No doubt most SMSFs have a knowledge of this asset, both residential and commercial. In this
instance familiarity does not breed contempt – quite the opposite. Adding to property’s allure is the ability for SMSFs to borrow to purchase new property as it offers trustees an opportunity to acquire real estate that might otherwise be beyond their financial reach. Borrowing can also allow an SMSF to achieve greater asset diversification as a smaller proportion of the fund’s assets are required to be invested in property as opposed to directing a large portion
of the fund’s assets into one lumpy asset. But, and this is an important point, using an SMSF to borrow can be complex and the risks associated with gearing may mean it is not a suitable strategy to achieve your retirement goals. This article will consider the pros and cons of gearing via a limited recourse borrowing arrangement (LRBA) inside an SMSF, as well as what’s entailed when an SMSF co-owns a property with a related party. The first step before borrowing is to check the trust deed and review the investment strategy. If you then decide buying a property using an LRBA is the right strategy, it’s important to ensure your SMSF’s trust deed allows your fund to borrow. If it doesn’t, the deed will have to be updated. Investing in property must be for the sole purpose of providing retirement benefits to members or their dependants upon the member’s death. It also needs to be consistent with your SMSF’s investment strategy. The investment strategy must consider the risks associated with borrowing, particularly the possibility the fund’s cash flow may be impacted by movements in interest rates or lengthy periods of rental vacancies. Where property is a major portion of your SMSF’s total assets, your investment strategy should also consider an exit strategy to ensure that, in the event of an unforeseen event, your SMSF is able to continue meeting its ongoing obligations and is not forced to sell. As a rule, an SMSF cannot borrow unless the LRBA meets very specific requirements and trustees will need professional legal advice to ensure they get it right. Some of the key requirements are: • the loan can only be used to acquire a new property on a single title. The only exception is where there is some kind of impediment to the property that prevents different titles from being sold separately, • the new property acquired must be legally held by a separate trust, with the SMSF trustee the beneficial owner. This
trust must not perform any other function or transactions or own any other assets other than the property. The trustee of this trust should not be the same trustee as your SMSF and the additional costs of establishing and maintaining the trust are generally not tax deductible to the fund, • the loan must be limited in recourse. This means if your SMSF is unable to meet its loan obligations, the only asset that the lender has recourse to is the property that was bought using the loan. This form of asset protection ensures that not all fund members’ retirement savings are at risk if an SMSF defaults on the loan, • there are no restrictions on who can provide the finance to an SMSF, meaning it could be a financial institution, a member or any related party to your fund. However, where the lender is a member or related party, the loan needs to be maintained at arm’s length to ensure the arrangement does not attract penalty tax, and • when an SMSF uses an LRBA to acquire property, there are significant restrictions on the type of modifications that can be made to the property. While the borrowing remains in place, no changes to the property can be made that change the fundamental character of the property. There are also restrictions on what the borrowed money can be used for; as a rule of thumb it is limited to purchasing costs and paying for repairs and maintenance of the property. Any improvements need to be funded by the fund’s available cash reserves. Once the borrowings are repaid, the legal ownership of the property can revert to an SMSF. Provided the LRBA has been set up correctly, there should be no capital gains tax consequences when the property is transferred. There may also be stamp duty concessions that apply on the transfer, so getting legal advice is important. Structuring the arrangement correctly and ensuring there is no breach of any of the other investment rules, particularly when dealing with a member or a related party, is essential if your SMSF is to enjoy
Investing in property must be for the sole purpose of providing retirement benefits to members or their dependants upon the member’s death.
concessional tax treatment on the income and any capital gains generated by the new property. It is also important to ensure all documentation is prepared and executed properly to avoid common errors, such as the property title being registered in the name of your SMSF, rather than in the name of the trustees of the separate trust, while the borrowing is still in place.
Tenants-in-common arrangements As an alternative funding option, SMSFs can consider investing in property with other parties, including fund members – what is called a tenants-in-common arrangement. Like LRBAs, co-investing is gaining more attention, a consequence of reduced contribution caps and members’ total superannuation balances limiting the ability for SMSFs to accumulate sizeable superannuation benefits in their fund. Where an SMSF acquires real property as a tenant-in-common, it will own a fixed proportion of the property. Each tenant’s interest is separate and distinct from the other owners, which allows each owner to dispose Continued on next page
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COMPLIANCE
of their share independently of the others. It also means the ownership between the different parties can be held in different proportions. For example, your SMSF could own one-third of the property and another party could own the other two-thirds. The ability to apportion the income and expenses associated with the property between investors, based on their fractional interest in the property, also makes the arrangement easy to administer. The SMSF would simply disclose its share of net income and expenses in its tax return each year. A tenants-in-common arrangement needs to be distinguished from a situation where your SMSF is purchasing the property with a related party as a joint tenant. In a joint tenant arrangement, each party has joint and equal ownership of the property instead of a clearly identified share in the real property. An SMSF owning property as a joint tenant is not considered appropriate, primarily due to the right of survivorship on the death of one party, which creates a complex set of issues on how to treat the fund’s increased share in the property. This includes consideration of the contribution rules and caps, as well as the restrictions that apply to the types of assets an SMSF can acquire from a member or any related party. An SMSF can buy a property as a tenantin-common with any other individual, another SMSF, a unit trust or a company. There are no restrictions with an SMSF being tenants-in-common with a member, relative or any other related party. However, where the parties are related, greater attention is required to always ensure the arrangement is established on proper commercial terms to avoid the risk of triggering the non-arm’slength income rules and the associated 45 per cent tax impost. The ATO views tenants-in-common deriving rental income as a partnership for tax law purposes. This makes them Part 8 Associates under the Superannuation Industry (Supervision) Act and so related parties of each other for superannuation purposes and the operation of the in-house asset rules.
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Co-owning real property with a member or related party is an option that allows an SMSF to gain exposure to property without incurring borrowing costs or using an interposed entity.
This means once a property is acquired as tenants-in-common, it can only be subject to a lease arrangement between the SMSF and a member or related party if it is a property used wholly and exclusively in a business. For example, if a commercial property is co-owned by a member and their SMSF, it can be leased to the member to conduct a business from it, provided the arrangement
is always on arm’s-length terms. If the property is a residential property, the SMSF could buy it from an unrelated entity with a member as tenants-in-common, but it would not be able to lease the property to the member for private use as it will be an in-house asset and unlikely to be below 5 per cent of the fund’s total assets. As the co-owners of the property are considered related parties, there are also restrictions with respect to what assets your SMSF can acquire from the other party to the tenants-in-common arrangement. This means if an SMSF wants to progressively increase its interest in the property by buying a portion or all the other party’s interest, it will only be able to do so if the property is a business premise. Your SMSF will be prohibited from acquiring any portion of the other party’s interest if it is a residential property. An SMSF can borrow to acquire the fund’s proportional interest in the property provided the loan is only secured against the fund’s fractional interest in the property. However, it is unlikely a bank would be satisfied with security over only a portion of the property, therefore this arrangement is most likely to require a related-party lender. This raises the practical issue that, as a trustee, it will be difficult to benchmark the loan to a commercial arrangement to ensure non-arm’s-length income does not arise. Likewise, any co-owner of the property may also be permitted to secure a borrowing against their fractional interest in the property. However, where the other party gives a charge over their proportionate interest in the property, there is a risk your SMSF’s position may be compromised should there be a default on any loan repayments. Co-owning real property with a member or related party is an option that allows an SMSF to gain exposure to property without incurring borrowing costs or using an interposed entity. But like LRBAs, the regulations are complex. Getting advice from an SMSF specialist adviser to assist in understanding the risks, rules and regulations that apply would seem prudent.
ANALYSIS
The Quality of Advice Review
The Quality of Advice Review currently being conducted by Treasury does not specifically have an SMSF focus, but there will still be implications for the sector resulting from the process, Bryan Ashenden explains.
BRYAN ASHENDEN is head of financial literacy and advocacy at BT Financial Group.
One of the most significant industry events this year is the Quality of Advice Review. It is being conducted by Treasury and comes in response to one of the recommendations from the banking and financial services royal commission. This review will explore a number of areas relevant to the provision of advice, not just the actual advice itself. What may not be readily apparent is the importance of this review to the SMSF sector, given none of the call-outs in the draft terms of reference
make any comments about it, and neither do they specifically say SMSFs or advice relating to them are exempt from the scope. So, how is the exercise relevant to SMSFs? Some of the answer to this lies in issues that are common across all areas of advice, SMSF-related or not, such as cost, disclosure and compliance. Further, how “clear, concise and effective” the advice Continued on next page
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ANALYSIS
Continued from previous page
is, which are fundamental requirements under the Corporations Act and apply to documentation such as financial services guides, product disclosure statements and statements of advice. There is no doubt advice in the area of SMSFs can be complex when you move into the realm of related parties, limited recourse borrowings and non-arm’s-length arrangements, to mention just a few. However, many of the common SMSF advice strategies are not more difficult than what would be employed via a retail or industry superannuation fund. Rather, difficulties often arise due to the question of who you are advising or what hat the client is wearing. Are they a member of a super fund that just happens to be an SMSF and you are providing some standard contributionrelated advice or advice on their underlying investments in the super fund? Or are they the trustee of the SMSF and you are giving advice around the investment strategy for the fund or insurance needs for the fund overall perhaps as a result of a limited recourse borrowing arrangement? And can we give this advice in one document or does it need to be in separate documents? Ideally, advisers should be able to provide complex advice without having to produce overly complex documentation that may impede the delivery of that advice. Clearly, the need for advisers to comply with the principles outlined in the Financial Planners and Advisers Code of Ethics is paramount, as is the obligation to comply with the best interests duty under the Corporations Act. This shouldn’t change as a result of the Quality of Advice Review and should be evidenced through the file notes or other records advisers hold to support the advice they provide. But how much of this or to what level of detail really needs to be contained in the documentation that is ultimately provided to the client? It is pleasing to see this is essentially one of the areas the Quality of Advice Review will
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Whether or not SMSFs can be treated or advised on a wholesale basis is a question the industry has grappled with for many years.
be focusing on. According to the draft terms of reference, one area of the review will be exploring “opportunities to streamline and simplify regulatory compliance obligations to reduce cost and remove duplication, recognising that the costs of compliance
by businesses are ultimately borne by consumers and serve as an impediment to consumers’ access to quality advice”. This is not a focus on how good the advice was or wasn’t, but on how that advice was produced and what was provided. Furthermore, the review will consider the terminology that exists in the advice sector. Consistent with a number of previous industry positions and submissions, the review will consider the legislative framework for providing advice, including “key concepts such as ‘financial product advice’, ‘general advice’, ‘personal advice’, as well how they are used, how they are interpreted by consumers, and whether they could be simplified or more clearly demarcated”. In this context, we need to go back and think about the last quality of advice review undertaken in the SMSF space. In June 2018, The Australian Securities and Investments Commission (ASIC) released “Report 575: SMSFs: Improving the quality
of advice and member experiences”. Given all that has occurred since then, it may come as a surprise this report was released only three-and-a-half years ago. It came during the midst of the royal commission, although it is important to remember the advice reviewed was provided to clients prior to that commission. While we don’t need to focus on the outcomes of that review itself, which were not overall positive, what it did identify was a lack of understanding by many SMSF members of exactly what was expected of them when running their own superannuation fund. This clearly demonstrates the need for good client education and is a fundamental principle Standard 5 of the Financial Adviser Standards and Ethics Authority Code of Ethics seeks to address. But providing this education can be challenging. Even though it did not address the quality of the advice provided, the ASIC report contained comments about the difficulties that can arise when demarcating between the concepts of personal advice, general advice and factual information. This, as noted in the report, is complicated by the perception, perhaps justifiable, that if clients are obtaining information from an expert in the area of SMSFs, those same clients have a belief they are receiving advice that is personal to their needs even if this was never the intention of the provider of that information. As such, SMSF advisers may be asking themselves the following questions. Has this led to more information being provided within a statement of advice because of the risk that it could be construed as personal advice? Has this added to the complexity of the statement of advice as a result? Has it detracted from the quality of that document as extraneous information has been added that has made it harder to decipher what the true recommendations for the client are? In looking to address these difficulties, client education is central to the solution. Appropriately qualified practitioners in the SMSF segment, whether it is the adviser,
accountant or auditor, can provide this information and should be heralded as the appropriate source of such education and information. The education should be provided in a manner that clearly indicates it is not personal advice to the client, rather it is part of an education process to help them understand what the actual advice they ultimately receive means and what they, as the trustee of an SMSF, need to do in line with their important role as the trustee. One final area that is proposed to be considered under the Quality of Advice Review is the “processes through which investors are designated as sophisticated investors and wholesale clients, and whether the consent arrangements are working effectively”. Whether or not SMSFs can be treated or advised on a wholesale basis is a question the industry has grappled with for many years. There was a long-held belief an SMSF could only qualify as a wholesale client if it met the professional investor test, holding at least $10 million of assets. While there were a number of legal opinions that offered alternative views, such as the ability to use the $2.5 million of net assets under the accountants certificate approach, this was not broadly followed. That changed somewhat in August 2014 when ASIC released a statement saying it would not take action where an SMSF was classified as wholesale under the accountants certificate approach. Notably, the regulator’s statement did not prevent clients taking action in the event of a mis-classification. Clarity around the ability for an SMSF to be classified as a wholesale client, and in what circumstances, would be welcomed. It would be helpful if the review considers the type of advice that can be provided on a wholesale basis. For example, does it make sense an SMSF could be classified as a wholesale investing vehicle and advice provided to the trustees on that basis, while at the same time requiring advice provided to one of that same fund’s trustees in their personal capacity as a member about a contribution to be done so on a retail basis? Is it this distinction,
The Quality of Advice Review should be welcomed by all professional advisers, whether operating in the SMSF sector or not.
or lack of distinction, that has added to or created some of the uncertainty and complexity? What about an SMSF that has $6 million in net assets, but all four members have a balance of $1.5 million each? Or an SMSF valued at $3 million, servicing one member with a balance of $2 million and $2.5 million of additional assets outside of super, and another member who has $1 million in fund assets disqualifying them from satisfying the wholesale classification personally? Can the SMSF be treated as a wholesale client in these circumstances? And should it be? And what if, in the second example above, the member with $2 million dies and their representative steps in to fulfil their responsibility until the benefits are paid out? Should the wholesale classification be retained or lost? Overall, the Quality of Advice Review should be welcomed by all professional advisers, whether operating in the SMSF sector or not. Advisers should take note of the draft terms of reference, which is on the Treasury website, as it influences what changes could and should be made to enable the delivery of clear, concise, effective and affordable advice. A review process that ultimately aims to achieve this should be applauded and supported by all.
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STRATEGY
SMSF property sale complexities
Disposing of property held in an SMSF involves additional legislative considerations, Jeff Song writes. Real estate investment continues to be a popular investment choice for SMSF trustees. Like with any investment, there will come a time when real estate needs to be sold. When considering whether to sell, trustees should be mindful of the relevant compliance requirements that need to be observed until the property has been completely transferred out of the fund. There are also a number of other important issues to consider in these circumstances. JEFF SONG is superannuation associate division leader at Townsends Business and Corporate Lawyers.
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Retirement objective The first question trustees need to ask themselves is: “How is the proposed sale in line with the purpose of providing retirement benefits to the members?” It may be a simple question to ask, but is not necessarily easy to answer as it requires a survey of all circumstances relating to the fund and the members.
Let’s consider the following example: • an SMSF has two members who are in accumulation phase, • Fund Pty Ltd as the trustee of the SMSF acquired an investment property for $500,000 that is now worth $1 million, • the property is leased to a related company, Family Pty Ltd, controlled by the members to run a family business, • the current market value of the family business is $1 million, • an unrelated investor approaches them and offers $2 million to purchase both the property and the business, • Family Pty Ltd plans to purchase another business for $1.5 million after selling its current business, and • the parties are negotiating the terms of two interdependent contracts, one for the sale of the property and the other for the sale of the business.
Primarily, all SMSFs must meet the sole purpose test, which requires the trustee to ensure the fund is maintained solely for the provision of benefits for members (or in the event of a member’s death, for the member’s dependants or legal personal representative) after the member’s retirement, attaining the age of 65, death or termination of employment by ill-health according to section 62 of the Superannuation Industry (Supervision) (SIS) Act. The fundamental trustee duties and the arm’s-length dealing provisions are additional compliance requirements to be observed in serving the sole purpose test and require the trustee to: a. act honestly, exercise care, skill and diligence as an ordinary prudent person and act in the best financial interests of the members as per section 52B of the SIS Act, and b. if related parties are involved, make investments on an arm’s-length basis on terms that are no more favourable to the related party than those that would reasonably have applied if the party was at arm’s length in line with section 109 of the SIS Act. The above requirements apply to all investment activities of the fund, including the sale of the property. In the example, Fund Pty Ltd as the property owner and Family Pty Ltd as the related-party business owner are considering entering into two interdependent contracts with the purchaser to simultaneously sell the business and the property. This interdependency of the contracts is not by itself a breach of the sole purpose test or the arm’s-length requirement as it is an inherent feature of a typical commercial arrangement of this kind and is not due to the related owners conducting themselves on a non-arm’s-length basis. As a matter of commercial reality, any investor looking to buy a business will only proceed if they can secure an enforceable right to use the business premises. This is usually achieved by securing a lease agreement or acquiring the business
From a CGT savings point of view, an optimum situation is where all interests in the fund are in pension phase for the entire financial year in which the property is sold.
premises. With the latter option, if the owner of the business is different from that of the property, the interested purchaser would need to approach and negotiate with both the owner of the property and the owner of the business. If as a result of the negotiation an agreement has been reached with all parties that the premises will be secured by the business purchaser also purchasing the premises, it is only commercially natural the relevant contracts are made interdependent to one another for simultaneous settlements. Also from the trustee’s perspective, a simultaneous sale could be a prudent thing to do. Selling a fully tenanted commercial property at its current best use can maximise its potential value, which would be in line with the best financial interests of the members. The sale could, however, be in contravention of the sole purpose test and potentially the other SIS Act compliance requirements listed above if any currentday benefits are obtained by the members or their related parties from the interdependent sale. The purchaser in the example is willing to pay a total of $2 million for both the property and the business. If the trustee and its related party negotiate with the purchaser to adjust the purchase price on
the two contracts, that is, by increasing the price of the business to $1.5 million and reducing the price of the property accordingly to $500,000 in order to finance the related party’s purchase of a subsequent business, the trustee would be in breach of the sole purpose test, the arm’s-length requirement and the fundamental trustee duties. In this case, the fund may lose its concessional tax treatment and the trustee and its directors could face civil and criminal penalties.
Practical tips Generally, this test is passed if the purpose is to realise the capital gains to either pay permitted benefits to members after their retirement, or to members’ dependants after their death, or to make subsequent investments so long as there are no other purposes, or the other purposes are remote and insignificant. So if the trustees are considering using the sale proceeds to help a struggling related party, discuss with them the sole purpose test and whether it is appropriate to sell. In a situation where a purchaser offers to pay a certain sum to simultaneously purchase the fund property and the related party’s business, no artificial adjustment in the price of each should be made. The trustee should exercise the care, skill and diligence as an ordinary prudent person to confirm and receive a fair market value for selling the property. Evidence supporting the price is a fair market price, such as an independent valuation, should be kept on the fund’s records if any related parties are involved. Timing and tax implications
In selling a property a complying SMSF will benefit from the concessional tax environment. With the one-third capital gains tax (CGT) discount, if the property has been owned for at least 12 months, and flat rate of 15 per cent generally applying to fund income, the effective CGT rate would be 10 per cent on any net capital gains. The CGT Continued on next page
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Continued from previous page
liability may potentially be lower or even reduced to nil depending on the timing of the sale and the extent to which the interest in the SMSF is supporting the payment of one or more retirement income streams. From a CGT savings point of view, an optimum situation is where all interests in the fund are in pension phase for the entire financial year in which the property is sold. In this case, any income, including any net capital gain from disposal of the property, would be exempt from tax. CGT implications of a sale could vary considerably for a fund with both pension and accumulation interests, depending on the segregation method used to calculate exempt current pension income. For example, any capital gains from selling a CGT asset that has been segregated to support payment of a pension can effectively be exempt from any CGT. When unsegregated methods are used, other considerations may affect the CGT implications. For example, if the members are to make sizeable contributions, such as downsizer contributions from the sale of their principal place of residence, the timing can make a significant difference to the potential CGT implications. Consider John and Mary, who have $1.6 million each in their SMSF as the only two members with their entire balance in pension phase. The fund owns a property worth $2 million with estimated net capital gain of $1 million if sold at current value. They also plan to sell their principal place of residence and contribute $600,000 of the proceeds to their fund as downsizer contributions. If the fund sells the SMSF property in June 2022, while the fund is in full pension mode, and receives a downsizer contribution in July 2022, the net capital gain of $1 million can be ignored for CGT purposes. If, however, the downsizer contributions are made before the sale or in the same financial year in which the property is sold, the fund will need an actuarial certificate to work out how much CGT will be payable in relation to the net capital gains.
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Careful planning and execution of the disposal is important for maintaining the complying status of the fund and protecting the financial interests of the members.
Other considerations
For goods and services tax and CGT purposes, a limited recourse borrowing arrangement (LRBA) bare trust is looked through as if it was the fund trustee that held and sold the property as determined by division 235 of the Income Tax Assessment Act 1997. For legal purposes though, an LRBA bare trustee generally lacks the required authority to sell the trust property and formal direction by the fund trustee to the bare trustee to sell the property is required. It would be prudent to have this direction in the form of a written resolution and a letter of direction. Also if the trustee plans to purchase another property under a new LRBA, consider whether the current financial circumstances of the fund could afford a new loan. While
the existing lender doesn’t assess the fund’s borrowing capacity for maintaining the LRBA loan, a new lender will assess the fund’s borrowing capacity at the time of the new loan application. While the interest rate for a new loan may be lower in the current low interest rate environment, stricter lending criteria and higher price tags on properties should be considered when reviewing whether the fund would have the required level of financial capacity to purchase another property. If a member has met a condition of release or if the existing loan to be fully repaid on sale is a related-party loan, consider if the repayment provides an opportunity for a member to make additional non-concessional contributions in the following year by having their total superannuation balance reduced. If the member’s total super balance for example is reduced from over $1.7 million to under $1.48 million from selling an LRBA property in the current financial year and a new LRBA is not entered into until 1 July 2022, the member would be able to contribute up to $330,000 as a non-concessional contribution in the 2023 financial year under the bring-forward rule. Trustees should also check if any death benefit nomination from a member provides a binding direction to allocate the property to a specified beneficiary. Depending on the trust deed, selling the property may render the nomination invalid to the extent it relates to the property. If the property is identified in any death benefit nomination, the relevant member should review it.
SUMMARY An SMSF investment in property will eventually have to be sold at some point. Careful planning and execution of the disposal is important for maintaining the complying status of the fund and protecting the financial interests of the members. Relevant considerations when selling will vary depending on the circumstances of the fund. Whether the sale is due to a member’s death, a stepping stone to the next investment or for other reasons, it is important the trustee seeks advice from appropriately qualified professionals in advance.
LAST WORD
JULIE DOLAN ILLUSTRATES THE TAX BENEFITS OF IMPLEMENTING A WITHDRAWAL AND RECONTRIBUTION STRATEGY
JULIE DOLAN is a partner and enterprise head of SMSFs and estate planning at KPMG.
64 selfmanagedsuper
One of the initiatives of the 2019/20 federal budget was to give Australians over 65 greater flexibility in making voluntary contributions. The initiative was to be implemented via three changes, being: • increasing the age at which the work test applied from 65 to 67, • the cut-off age for spouse contributions increasing from 70 to 75, and • aligning the bring-forward rule to the change in the work test by enabling individuals aged 65 and 66 to make up to three years of non-concessional superannuation contributions. The change to the work test was legislated via the Superannuation Legislation Amendment (2020 Measures No 1) Regulations 2020, the alignment of the bring-forward rule via the Treasury Laws Amendment (More Flexible Super) Bill 2020 and subsequent changes to the Income Tax Assessment Act 1997. These changes combined with the condition of release of attaining the age of 65 provides for a unique opportunity of implementing the recontribution strategy. The recontribution strategy basically involves withdrawing money from the member’s unrestricted non-preserved component and recontributing it as a non-concessional contribution. The withdrawal amount must come out in proportion of its tax-free/ taxable component from its original source, that is, the pension/accumulation account. Being over the age of 60, and the fund being a taxed fund, the member would not be liable for any tax on the withdrawal. The amount recontributed will form part of the tax-free component of the fund. One of the main advantages of this strategy is to increase the tax-free component of the members’ super accounts. This is especially important when it comes to death benefits tax. In simplistic terms, the taxable component of any death benefit payments paid to a tax non-dependant can attract a tax liability of up to 30 per cent plus Medicare levy. This higher tax rate applies to the untaxed taxable component, while the standard 15 per cent plus Medicare levy applies to the taxable component. Therefore, the tax saving to a typical fund is the amount recontributed x taxable component (%) x 17%. Let’s consider an example: Bob turned 65 on 10 January 2022. He is retired and has an account-
based pension (ABP) valued at $1 million. He has no other super accounts. The taxable components are as follows: Tax free 15% $150,000 Taxable 85% $850,000 He has a binding death benefit nomination in place and wishes for all his super to go to his three financially independent adult children. As it currently stands, on his death, the fund would be required to withhold and remit to the ATO $144,500, representing the death benefits tax of 17 per cent on the taxable component. However, if Bob was to implement the following recontribution strategy over the next couple of years, there would be a significant reduction in the death benefits tax: 2022 financial year:
Withdrawal and recontribute $110,000. Start an additional ABP. (Tax-free: $16,500, Taxable: $93,500)
2023 financial year:
Withdrawal and recontribute $100,000. Start an additional ABP. (Tax-free: $16,500, Taxable: $93,500)
2024 financial year:
Withdrawal and recontribute $330,000. Start an additional ABP. (Tax-free: $49,500, Taxable: $280,500) Look to consolidate the above three additional ABPs.
Each withdrawal would be a partial commutation of the original ABP. It is also important to note Bill must contribute the $330,000 prior to turning 67, that is, prior to 10 January 2024. The result of this strategy is that there is a savings on death benefits tax of $79,475 (that is, $467,500 x 17%). The ATO has previously given the green light to this strategy, stating: “It is unlikely the commissioner would apply Part IVA to a recontribution arrangement given that a key policy thrust of the simpler super amendments was to provide individuals with greater concessions and more flexibility to manage their superannuation in retirement.” However, it is always important that prior to implementing this strategy, all relevant legislative aspects are considered.
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