self managed super: Issue 34

QUARTER II 2021 | ISSUE 034 | THE PREMIER SELF-MANAGED SUPER MAGAZINE

INDEXATION IMPACT FEATURE

COMPLIANCE

STRATEGY

COMPLIANCE

Indexation Its added complexity

ECPI method What advisers want

Year-end plan Why FY21 is unique

Knowing your client The advice recipient

SMSFPD DIGITAL 2021

24-25 MAY 2021

NICHOLAS ALI

GRAEME COLLEY

ANTHONY CULLEN

MELANIE DUNN

SUPERCONCEPTS

SUPERCONCEPTS

SUPERCONCEPTS

ACCURIUM

MARK ELLEM

PHILIP LA GRECA

TIM MILLER

DARIN TYSON-CHAN

ACCURIUM

SUPERCONCEPTS

SUPERGUARDIAN

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COLUMNS Investing | 20 How property and inflation interact.

Investing | 24 The role of real estate debt.

Compliance | 28 Practitioner sentiment about ECPI.

Strategy | 32 Unique considerations for the end of 2020/21.

Compliance | 36 Residency rules and their renewed relevance.

Strategy | 39 Single trustee SMSFs part three.

Compliance | 42 Audit referrals and their problems.

Strategy | 46 Indexation beneficiaries.

Compliance | 50 Identifying the advice recipient.

Strategy | 53 Death and the super component.

Compliance | 56 Unit trusts and NALI.

REGULARS INDEXATION IMPACT Cover story | 12

What’s on | 3 News | 4 News in brief | 5 SMSFA | 6 CPA | 7 SISFA | 8 IPA | 9

FEATURE

CAANZ | 10

A stake in the ground | 16

Last word | 60

Regulation round-up | 11

The real value proposition of SMSFs.

QUARTER II 2021 1

FROM THE EDITOR DARIN TYSON-CHAN INAUGURAL SMSF ASSOCIATION TRADE MEDIA JOURNALIST OF THE YEAR

Time for some parliamentary Drano I attend just about every SMSF technical presentation held throughout the year and I know a good number of you, our readers, do too. An update on the regulation and legislative amendments that have occurred recently in the sector is a common and popular topic covered during these sessions.

Now, of course, it’s always useful to get a quick summary of the new rule changes that will govern SMSFs into the future. But there is one element of these seminars I’m getting a little sick of and I’m wondering if you are too.

That is the almost never-changing list of pending legislation yet to be passed. I mean some of these items awaiting formal introduction via legislation have been put on the back-burner since the lead-up to the last election.

Specifically, I’m referring to the amendment to the law that will see an increase in the maximum number of members an SMSF is allowed to have from four to six. When announced it was widely speculated this was a measure to potentially combat Labor’s disastrous franking credit policy proposal.

Well I’m sure I don’t have to remind the federal government there is an election looming that will take place either sometime this year, and if not, definitely in 2022. I would remind Scott Morrison and Jane Hume, though, that if the legislation addressing this change is not passed before then, it means the government will have completed a whole elected term, a time frame of three years, without putting this law in place.

Is that good enough? I think not.

Worse still there are a number of other pending changes to the SMSF and superannuation landscape also stuck treading water. These include allowing 65 and 66 year olds the ability to access the non-concessional contribution bring-forward rules and finalising the method by which exempt current pension income can be calculated.

Add to this list the ATO’s decision to continue to kick the final interpretation of the non-arm’slength expense rules can down the road and we really do find ourselves in a holding pattern when it comes to putting in place effective SMSF strategies to steer funds into the future.

Perhaps the most concerning aspect of this situation is many of the aforementioned items have a retrospective effect either by design or due to the fact the associated implementation dates have now since lapsed. Nothing is more disconcerting than that characteristic.

In Australia when we have a drain or sink blockage, we traditionally get out a can of Drano to have the plumbing systems in question flowing effectively again and I think it’s time to apply the same theory to the blockage of legislation and regulations currently affecting the SMSF sector.

We all know the key to success, SMSF related or not, comes with being able to properly plan for the future. With so many of these legal balls still up in the air, how can advisers and their clients do this?

Human beings crave certainty and it’s time the government and other agencies got their acts together and delivered this aspect to the SMSF sector. Surely they’ve had enough time to do so.

Editor Darin Tyson-Chan darin.tyson-chan@bmarkmedia.com.au Senior journalist Jason Spits Journalist Zoe Fielding 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

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WHAT’S ON

To have an upcoming event featured on the What’s On page, please contact darin.tyson-chan@bmarkmedia.com.au.

SMSFPD Digital 2021

DBA Lawyers

Accurium

Inquiries: Jenny Azores-David (02) 8973 3315 or email events@bmarkmedia.com.au

Inquiries: dba@dbanetwork.com.au

Inquiries: 1800 203 123 or email enquiries@accurium.com.au

24-25 May 2021 12.00pm-5.00pm AEST

SuperGuardian Inquiries: education@superguardian.com.au or visit www.superguardian.com.au

The many faces of SMSF property development 18 May 2021 Webinar 12.30pm-1.30pm AEST

SMSF Online Updates 4 June 2021 Webinar 12.00pm -1.30pm AEST 9 July 2021 Webinar 12.00pm-1.30pm AEST 6 August 2021 Webinar 12.00pm-1.30pm AEST

Institute of Public Accountants

Pension workshop

Inquiries: Liz Vella (07) 3034 0903 or email qlddivn@publicaccountants.org.au

VIC 16 June 2021 Melbourne

Contribution opportunities for SMSF clients in 2021

SA 17 June 2021 Adelaide NSW 23 June 2021 Melbourne

Self-managed Independent Superannuation Funds Association Inquiries: jane@sisfa.com.au or visit the website.

Professional education half day VIC 20 May 2021 BT 150 Collins Street, Melbourne Live streamed event

Smarter SMSF Inquiries: www.smartersmsf.com/event/

Changing Face of SMSF 17 June 2021 Webinar 12.00pm-1.00pm AEST

14 May 2021 Cahoot learning webinar

SMSF back to basics series – recorded 30 June 2021 (last day) Cahoot learning webinar

Deadly super death benefits – recorded 30 June 2021 (last day) Cahoot learning webinar

SuperConcepts Virtual SMSF Specialist Course

Federal budget and year end issues 13 May 2021 GoTo webinar 2.00pm-3.00pm AEST

How to choose the right audit partner 24 June 2021 GoTo webinar 2.00pm-3.00pm AEST

Heffron Post budget 2021 webinar 12 May 2021 Webinar 3.00pm-4.30pm AEST

Quarterly technical webinar 20 May 2021 Webinar Accountants-focused session 11.00am-12.30pm AEST Adviser-focused session 1.30pm-3.00pm AEST

SMSF Clinic 8 June 2021 Webinar 1.30pm-2.30pm AEST

Death benefits masterclass 2021

1-3 June 2021 10.00am-2.00pm AEST

10 June 2021 Webinar 12.00pm-4.30pm AEST

Face to Face SMSF Specialist Course

SMSF and related parties masterclass 2021

7-9 Septmber 2021 9.00am-5.00pm AEST SuperConcepts Level 17, Chifley Tower 2 Chifley Square, Sydney

24 June 2021 Webinar 1.30pm-2.30pm AEST

SMSF Association Tech Summit 2021 QLD 21-22 July 2021 RACV Royal Pines Resort Ross Street, Benowa Gold Coast

QUARTER II 2021 3

NEWS

No TBAR obligations from LRBAs

By Darin Tyson-Chan

A technical specialist has advised it is highly unlikely for any transactions involving a limited recourse borrowing arrangement (LRBA) to have the ability to trigger the need to lodge a transfer balance account report.

“In order to have a situation where [an LRBA transaction] is a TBA (transfer balance account) event, where it would be a credit towards the member’s transfer balance account, you’ve got to have a fund which has an LRBA, so an asset under a borrowing arrangement that would have to be segregated,”

Accurium head of education Mark Ellem said.

“So that rules out all of the funds that have disregarded small fund assets and all the funds that haven’t elected to use segregation.”

Further, Ellem noted the asset would have to be segregated to the member’s pension account.

“From a tax viewpoint, why would you do that, because if you segregated to the pension side you’re not going to get a tax deduction for the interest on the loan? [Instead] you would segregate it to the accumulation side [of the fund],” he noted.

“What [the ATO is]

Mark Ellem concerned about is [if] you’ve got an LRBA asset segregated to the pension side of the fund, but you’re taking the money from the accumulation side to repay the loan and therefore the net asset is going up by the amount of the loan repayment.

“The other issue there is you’re taking money from the accumulation side,

which actually means you wouldn’t be complying with [Superannuation Industry (Supervision)] reg 5.02 or 5.03 [as to] making sure that costs and earnings are allocated on a fair and reasonable basis because effectively the accumulation member would be paying all of the loan repayment.”

He pointed out he can understand why practitioners and trustees would be concerned about this situation in theory, but admitted he has yet to see an issue like this in practice and is unlikely to in the future.

“Look, be aware of it, but I’m yet to see one,” he advised.

Cryptocurrency still only an investment

By Darin Tyson-Chan

Cryptocurrency currently continues to be classified as an investment with regard to SMSFs, meaning its use is limited from a strategic perspective, a technical expert has said.

“Cryptocurrency from a superannuation point of view is not currency – it is an investment. So we cannot make a contribution to super via cryptocurrency,” SuperGuardian education manager Tim Miller told delegates at a recent practitioners’ workshop he hosted in Sydney.

However, Miller predicted this situation is likely to change some time in the future when the associated systems increase their use in conventional transactions.

“There has to be some point in time in the future where we all eventually accept blockchain technology and cryptocurrencies because some of us will

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actually start to understand it, and so the capacity to contribute and the definition of cash will expand when governments recognise cryptocurrencies as a means of exchange rather than as an investment,” he noted.

According to Miller, the role cryptocurrency will eventually be allowed to play in the retirement savings arena, and how quickly any change to the framework will come, is all dependent on the actions of the regulator.

“We’re going to be in this real regulatory oddity over the next few years I think because we have to wait for [our] regulators to catch up with the rest of the world and [the relevant] technologies,” he added.

“But right now, what I can tell you is you cannot contribute to super via cryptocurrency. You can invest in it, but you can’t contribute via it,” he confirmed.

The ATO is already being asked about the role cryptocurrency can play in employment agreements.

Opportunities still possible outside of contributions.

For example, it has confirmed individuals can receive cryptocurrency instead of Australian dollars as part of a valid salary sacrifice arrangement. The only condition the ATO has placed on these types of transactions is that the payment of cryptocurrency to an employee be treated as a fringe benefit, meaning the employer will be subject to the provisions of the Fringe Benefits Tax Assessment Act 1986 in these situations.

NEWS IN BRIEF

COVID advice relief extended The Australian Securities and Investments Commission (ASIC) will allow financial advisers to continue to use records of advice (ROA) when providing advice to existing clients where it is related to the impact of COVID-19 until midOctober 2021.

The regulator said it was extending the relief, first issued on 14 April 2020 for a one-year period, for a further six months, but other relief measures also announced on that date have expired.

Under the relief extension, financial advisers will be able to use ROAs instead of statements of advice (SOA) with existing clients where their personal circumstances had changed as a result of COVID-19 and the client had already dealt with that adviser or another adviser from the same Australian financial services licensee or practice until 15 October.

ASIC stated it had decided to extend the relief measure after consulting with industry and identifying that some financial advice practices have found the measure helpful.

Pension-phase NALI clarified The SMSF Association has secured confirmation from the ATO as to how the rules governing nonarm’s-length capital gains tax (CGT) triggered by assets used solely to support an income stream will be applied.

To this end, the regulator has stated the amendment to Treasury Laws Amendment (2020 Measures No 6) Act 2020, granted royal assent in December last year, will take effect from 1 July 2021 and means all non-arm’s-length capital

gains in relation to segregated current pension assets will be treated as nonarm’s-length income (NALI) from that date.

The existing legislation had been changed to rid it of the anomaly created by section 118-320 of the income Tax Assessment Act 1997, which dictated any capital gain made from a segregated current pension asset can be disregarded, making any capital gains from these assets exempt from the NALI provisions.

However, conflicting information regarding the legislation change had until now existed, with the amendment indicating it had come into effect immediately, while the relevant explanatory material specified the new provisions would only apply from 1 July 2021 onwards.

As such, the SMSF Association sought clarification from the ATO about this matter and has now received the regulator’s categorical position on it.

Admin service adds documents SMSF administration provider Mclowd has expanded its services to include the provision of documents through a partnership with listed financial services business Sequoia.

Under the arrangement, Mclowd will offer its adviser and trustee clients access to white-label SMSF and company documents and deeds produced

by Sequoia-owned Docscentre and created by qualified practitioners.

On its website, Mclowd stated the document service will be available via its platform and an Australian Securities and Investments Commission compliance solution using the document service was currently in development, but technical support and billing for the document service will still be handled

by Docscentre.

Mclowd managing director Ashley Porter said the ability for the firm to provide the establishment and management of SMSF deeds increased the benefits on offer to its clients at minimal cost.

Early release a success The federal government has described the initiative that allowed individuals to access their superannuation early due to financial hardship caused by COVID-19 as a success after the recent release of the Australian Bureau of Statistics’ (ABS) Household Financial Resources report.

The ABS report indicated the majority of Australians who took advantage of the measure, 55 per cent, used the money to pay their mortgage, rent or other household bills. The data showed an additional 15 per cent of individuals accessed their retirement savings early to pay down debt, while a further 13 per cent used it to add to their savings.

According to the government, the statistics are consistent with the finding of the Retirement Income Review that providing superannuants with limited and prudent early access to their retirement savings helped balance pre and post-retirement living standards.

Further, the coalition government stated the report demonstrated the relief measure as a response to the financial hardship caused by the coronavirus pandemic definitely provided people across the country with significant support in a period of financial uncertainty.

Superannuation, Financial Services and the Digital Economy Minister Jane Hume said the ABS figures demonstrated the early release of super scheme was an unquestionable success.

QUARTER II 2021 5

SMSFA

A good start, but more needed

JOHN MARONEY is chief executive of the SMSF Association.

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The federal government has released draft legislation which, if implemented, will establish a new disciplinary system for financial advisers – a recommendation of the financial services royal commission.

Calling for consultation on releasing this announcement, Superannuation, Financial Services and the Digital Economy Minister Senator Jane Hume said: “The draft legislation will strengthen oversight of financial advisers while simplifying the regulatory framework governing the provision of financial advice, helping to reduce complexity and cost for advisers.”

The SMSF Association concurs. The draft legislation implements a recommendation of the Independent Review of the Tax Practitioners Board (TPB) by removing the requirement for tax (financial) advisers to be registered with the TPB. In one fell swoop, it introduces a single disciplinary and registration system for financial advisers, who also provide tax (financial) advice services, by having: • a single point of registration, • a single code of conduct, and • continued oversight with relevant tax experts to be appointed to the Financial Services and Credit Panel to hear disciplinary matters that involve taxrelated advice.

It’s a reform the association has long been calling for: a practical measure that simplifies the registration and regulatory framework for advisers, removing complexity and red tape, while ensuring appropriate standards and oversight are in place.

But more needs to be done to simplify the system to ensure SMSFs can receive quality advice that is cost-effective. From the association’s perspective, there needs to be a solution to the vexing issue of accountants providing only SMSF advice and still needing to be licensed by the Australian Securities and Investments Commission.

We have previously stated the limited licence regime has failed and there needs to be an alternative way to allow accountants and others to limit their advice around SMSFs without all the licensing red tape they now experience. As we said in our submission to ASIC Consultation Paper 332: “We believe the limited licence regime has failed and should be removed and transitioned to a new consumer-centric framework. This may be in the form of a strategic advice offering.

“We believe SMSF and superannuation advice lends itself to strategic advice. In fact, the limited licence framework was built upon this premise.

That is, advice is usually centred around making

contributions or starting a superannuation pension.

We hope ASIC explores opportunities on how this could be implemented in the advice profession.”

This issue has a long history. Before the introduction of the limited licence regime, an accountants’ exemption existed that authorised a recognised accountant to provide advice in relation to the acquisition and disposal of an interest in an SMSF. However, it was determined all financial advice should be afforded the same level of regulatory protection, irrespective of who delivers the advice.

Under the prior exemption, accountants were able to avoid regulation in dealing with SMSFs, which were not defined to be a financial product.

Therefore, the accountants’ exemption, which was introduced as a temporary measure, was removed to align with the Future of Financial Advice intention to enable consumers to obtain access to more affordable and competent financial advice.

So, from 1 July 2016 advisers have had to hold an Australian financial services licence (AFSL) or operate as an authorised representative of the holder of a full or limited AFSL to provide SMSF advice services.

However, the expected take-up under the limited licence regime simply did not happen. In 2015/16, only 228 limited AFSLs were approved, followed by 512 in 2016/17 and 23 in 2017/18, numbers far removed from the government’s intention to have 10,000 accountants licensed to provide a much broader range of financial advice.

The association is anecdotally aware of many advisers currently leaving or choosing not to enter the limited licence regime going forward. Not only is this because they find the framework complex with scoping difficult to achieve, but those limited licence advisers who saw the benefits in the intent of the framework are now being forced out by licensees who do not see it as a profitable venture.

In short, the limited licensing regime has failed and the losers are SMSF trustees who cannot obtain the basic advice they need in a convenient and affordable manner. Currently, trustees wanting basic SMSF advice are either required to spend significant money seeking financial advice from a licensed adviser or must act without advice. This means there are important unmet SMSF advice needs in the market.

The draft legislation to streamline the oversight of advice is an important step forward and will benefit SMSF trustees if it comes to fruition. Removing and transitioning to a new consumer-centric framework should be the next reform item on the agenda.

CPA CPA

A looming policy sandwich for trustees

RICHARD WEBB is financial planning and superannuation policy adviser at CPA Australia.

Greater transparency and accountability for Australia’s $3 billion superannuation sector is a net benefit, right? But what if the cure is worse than the disease? The new ‘best financial interests’ obligation sounds good, but could put well-intentioned SMSF trustees in a bind.

The passing of the Your Future, Your Super Bill, currently before parliament, will implement the government’s commitment to make the Australian superannuation system more transparent and accountable.

Among other changes, the bill removes the statutory duty for trustees to act in the best interests of members. In its place, trustees will have a duty to act in the best financial interests of members. It is unclear whether the duty to act in the best financial interests of members in relation to non-financial matters will continue to operate in common law.

In addition, the bill reverses the burden of proof for Australian Prudential Regulation Authority fund trustees. Although this change does not apply to SMSF trustees, they will need to be able to justify fund expenditure in the event the ATO decides to investigate. Moreover, there are no materiality thresholds.

Also relevant is the recently passed Hayne Royal Commission Response Bill, which extends the indemnification provisions in the Superannuation Industry (Supervision) Act to prohibit the payment of criminal, civil or administrative penalties incurred by trustees or trustee directors.

Add these legislative developments together and it is clear trustees of all super funds are on notice.

All of this sounds very good for members since trustees are having to act in their best financial interests. However, there is a sting in the tail for SMSFs members who also happen to be their fund’s trustees.

The requirement that payments be in members’ best financial interests brings trustees squarely into conflict with the requirement to comply with the non-arm’s-length income (NALI) requirements.

Essentially, the NALI requirements operate as a brake on ‘mate’s rates’ arrangements. Such arrangements could be used to achieve artificial results in relation to income or expenses recorded by the fund. These results could in turn be manipulated

in order to arbitrage between tax environments.

By recognising normal commercial arrangements, the NALI requirements ensure an appropriate rate of tax is applied. However, sometimes the NALI requirements can have severe outcomes.

Ordinarily if there is a connection between a specific item of fund income and a breach of the NALI rules, only that item of income is impacted.

A higher level of tax is applied to that item accordingly. But in some circumstances there may be no nexus between a NALI breach and a specific item of fund income. In that case, the entire income of the fund may be taxed at a rate of 45 per cent.

The decision to undertake fund expenditure in line with members’ best financial interests is a prospective requirement. By contrast, any meaningful financial benefit derived by members is assessed in hindsight as an absolute benefit without a ‘best financial interests’ qualifier. This means the new requirements can and will come into conflict.

Take, as an example, a training course undertaken by the directors of a fund. The trustees of the fund determine a particular course may improve their operational decision-making in respect of the SMSF. However, they are unable to quantify how the course is in members’ best financial interests. Consequently, they don’t charge the cost of completing the course to the fund.

As the costs have been met by trustees themselves, it is possible the ATO may assess this as NALI by the fund. Furthermore, given the training may have a nexus to improved fund income, the ATO may determine the trustees’ decision to not indemnify the training expense has a nexus to the fund income in total, thereby incurring the punitive NALI tax rate on all income recorded by the fund.

It is worth mentioning NALI is an emerging area of work at the ATO, with significant resources presently dedicated to finalising a draft law companion ruling in this area, which has been contentious.

It is hard to argue against a policy objective of providing additional accountability and transparency for Australia’s $3 trillion superannuation sector.

However, if the end result produces absurd outcomes such as this, it would be a clear policy failure. The time to prevent issues like this is now, not once SMSF members and trustees find themselves in a lose-lose situation after the new requirements commence.

QUARTER II 2021 7

SISFA

NALI, NALE draft ruling needs work

MIKE GOODALL is a board member of the Self-managed Independent Superannuation Funds Association.

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In 2019 the ATO issued a draft law companion ruling (LCR) setting out, for public comment, clarifications to how amendments to sections of the Income Tax Assessment Act 1997 would operate in a scheme where the parties do not deal with each other at arm’s length.

Specifically, the LCR covered situations where the trustee of a complying superannuation entity incurs non-arm’s-length expenditure (NALE), or where expenditure is not incurred, in gaining or producing ordinary or statutory income. It determined these circumstances would trigger the non-arm’s-length income (NALI) provision of the act, resulting in the SMSF being taxed at the top marginal tax rate. Due to the severity of the penalty, it is unsurprising there is much interest in these amendments.

However, there is the view, held by the Tax Institute, and with which the Self-managed Independent Superannuation Funds Association (SISFA) agrees, that there are a number of flaws in the amendments. The institute has been engaging the ATO since the issuance of its draft rulings to point out the difficulties in their application.

A key item is the ATO’s view in relation to some fund expenses, which under the draft ruling could result in the entire earnings of many SMSFs being exposed to the NALI penalties. This could happen if the nexus between the expenses in question cannot be matched directly to a specific source of income.

The ATO takes the view such expenses taint all of the fund’s income. This interpretation has been the most controversial aspect of the regulator’s position on the NALI changes, resulting in its first draft ruling, LCR 2018/D10, being withdrawn and replaced with the revised draft LCR 2019/D3.

The regulator’s view, that a general expense taints all of a fund’s income as NALI, also ignores the fact the taxable income of a complying superannuation fund is made up of two components: namely a low-tax component and a non-arm’s-length component. If the ATO’s view was correct, that is, a general expense can taint all income, there would subsequently only be one component: namely the non-arm’s-length one. The nexus of what expense gives rise to NALI needs considerably more technical analysis as the Tax

Institute’s and ATO’s views still differ considerably.

Both the institute and SISFA consider there are substantial grounds for the ATO to delete references to general expenses being able to taint all income. For an expense to give rise to NALI, there must not only be a nexus, but it must also be a nexus to the relevant income, not just the assessable income, and it must be a sufficient nexus to that income. As it stands, the ATO’s current view would result in an SMSF with a $10 million diversified asset portfolio consisting primarily of blue-chip Australian equities being exposed to NALI due to a $100 discount in an accounting fee – an outcome that can only be described as absurd.

A logical solution is the deletion of general expenses from the concept of NALI, which would likely simplify the application of it. This will also overcome of a lot of the controversy that has hampered the finalisation of this ruling to date.

With the ever-increasing compliance requirements of our superannuation system, SMSFs are becoming more complex to administer. In a rather heavy-handed approach, the proposed LCR also does not allow for an opportunity to rectify a genuine mistake due to an oversight or human error that may trigger NALI or NALE as if there is an assumption the mistake or oversight was intentional.

SMSFs need to be given the opportunity to rectify an error in line with arm’s-length terms as soon as practicable after the mistake is detected.

Given the significant impact a NALI assessment can have, the Tax Institute and SISFA believe there should be further oversight of the application of any NALI allegation or assessment. This would involve establishing a NALI board that would operate in a similar manner to the General Anti-Avoidance Rules Panel. Such a group could bring the same level of consistency and independence to the application of rulings in relation to NALI assessments.

The discussions between the professional bodies representing the interests of SMSFs and the ATO have been ongoing for nearly 18 months. The approach of the draft ruling to non-arm’s-length income and expenses is just one of a number of issues and resolution of this situation is clearly some way off yet.

IPA

Making financial advice affordable

VICKI STYLIANOU is advocacy and policy group executive with the Institute of Public Accountants.

Finally, it has been acknowledged Australian consumers are unable to access the financial advice they need at an affordable price. The price gap is significant, $2000 to $3000 for comprehensive personal advice and around $1000 for limited personal advice, between what consumers are prepared to pay and what it costs advisers to produce the advice.

Supply is dwindling, with many advisers having either left the industry or intending to do so.

The Australian Securities and Investments Commission’s (ASIC) consultation paper, “CP 332 Promoting access to affordable advice for consumers”, seeks to tackle this issue. The Institute of Public Accountants (IPA) lodged a submission partly based on survey results from members who currently or previously worked in or have experience in the financial advice space.

The objective was to seek information from industry participants on the issues and impediments that exist around them delivering affordable personal advice, and are within ASIC’s power to address. Previous research undertaken by the regulator and various other stakeholders found consumers want better access to good-quality, limited and affordable advice, but that many advisers and licensees find it challenging to provide this type of advice at an affordable price. So we know demand exists, but the supply side needs to be addressed.

Exiting financial advice sector Given the difficulties in providing advice at a profitable or even viable price, it is not unexpected many advisers have chosen to exit the space. This also applies to IPA members and it is extremely concerning to see the rate of decline in adviser numbers. It is also ironic given qualified accountants are well placed as trusted advisers to provide advice to clients and to assist in meeting the growing demand for affordable advice. In this regard, the IPA continues to advocate a preferred model for the provision of financial advice that would satisfy the demand and supply sides.

According to our own internal data, about one-quarter of IPA members who hold professional practice certificates also hold full or limited Australian financial services licences or are authorised representatives of licensees. In line with declining adviser numbers, our latest data indicates the income derived from financial advice overall is diminishing across all licence types and also for authorised representatives.

The survey results for CP 332 indicate the overwhelming response to the question of impediments to accessing affordable advice for consumers is that compliance is the main driver of cost in providing advice, and that meeting these compliance costs is making it unprofitable to provide advice to a cohort of consumers who will not pay what this advice costs. A significant rebalance is needed if the unmet advice needs of consumers is to be satisfied.

However, this is a challenge that needs a holistic solution and which cannot be solved by ASIC alone. To this end, we acknowledge CP 332 states ASIC will pass on feedback and comments on suggestions for law reform to the government.

The IPA believes to seriously tackle the affordability issue, compliance requirements will need to be changed in terms of legislation, regulation, interpretation and implementation. We appreciate ASIC’s role is in interpreting, implementing and enforcing the legislation and regulation, which are developed and decided by Treasury and the government. However, fees, such as those imposed by the ASIC industry funding model, are within the control of the regulator and are part of the increasing cost of doing business suffered by many IPA members and other advisers. The IPA has joined with the other professional accounting and financial planning associations to advocate for review and reform of the ASIC industry funding levy. Our joint statement called them “shameful”.

In the meantime, we are hopeful consultation on CP 332 will result in meaningful change for the sake of all consumers.

See the full IPA submission to ASIC on affordable advice to consumers.

QUARTER II 2021 9

CAANZ

Take heed of key changes

TONY NEGLINE is superannuation leader at Chartered Accountants Australia and New Zealand.

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There are some key changes coming to the superannuation industry regulatory environment and everyone working or involved in the super sector needs to know about these issues.

The first change is in relation to the non-arm’slength income and expense anti-avoidance provisions. These legislative provisions were re-cast in 2019 with a 1 July 2018 commencement date. At first blush these new rules were said to be targeting super funds not acquiring assets for an arm’s-length price and for SMSFs using non-arm’s-length limited recourse borrowing arrangements.

However, a 2019 draft ATO Law Companion Ruling, LCR 2019/D3, casts these provisions very widely and says many relatively benign arrangements could potentially be caught. For example, super fund administration services performed by related entities for anything other than an arm’s-length price will likely see all the income of a fund, including pension income, face penalty tax of 45 per cent.

This wide interpretation potentially impacts many super funds where trustees, or their related parties, provide services to those funds. To be more specific, it will potentially impact many Australian Prudential Regulation Authority-regulated super funds. It will also affect many SMSFs that are run by accountants, auditors, solicitors, property developers, tradies and a host of others.

In late March 2021, the ATO announced it would not apply its resources to ensure compliance with its interpretation of the law before 1 July 2022.

However, as it stands now, any non-arm’s-length arrangement on foot after June 2018 should be reviewed to see if the penalty tax rate should apply.

We will hopefully see the ATO’s final interpretation of these rules before July this year. It may be that the ATO believes the black letter law leaves it no choice but to apply higher tax rates on many super funds. If that is the case, then the super industry will need to approach the government to seek legislative amendments to have the law narrowed to no more than its original intention.

The second significant change to the superannuation regulatory landscape is the Your Future, Your Super initiative. In the 2021 federal budget the government proposed three policy changes to the retirement savings environment – socalled employee stapled funds (which would assist in reducing the number of multiple super funds

employees may join as they move from employer to employer), annual performance assessment of super funds and adjustment of the trustee duty to act in a member’s best interest into an obligation to act in a member’s best financial interest.

Chartered Accountants Australia and New Zealand and CPA Australia made a joint submission about these rules to the Senate Economics Legislation Committee. The accounting bodies argued the employee stapled fund policy has merit, but we had concerns about the other two policies, especially because at the time of writing the regulations governing how these provisions will work had not been released in draft form.

We are particularly concerned about the change for trustees to act in beneficiaries’ best financial interest as opposed to best interest because the revised requirement is a lower threshold. For example, it may be in a beneficiary’s best interest to pay a death benefit from a fund, but it may not be in their best financial interest.

The government also proposes to amend the law for regulated super funds to require trustees to prove they acted in beneficiaries’ best financial interest for every trust expense and investment.

For a large fund this will impose significant recordkeeping requirements.

The final significant change to the regulatory framework governing superannuation is the amended auditor independence standards. As many will know, the revised accounting standard has applied from January 2020. By virtue of the Superannuation Industry (Supervision) (SIS) Act and Regulations, the ATO has a duty to check SMSF auditors comply with this new requirement – refer to SIS Regulation 9A.06. The ATO has announced it will commence checking compliance with this duty with effect from 1 July 2021.

The ATO has written a very good guide on how it intends to interpret this revised accounting standard.

Accountancy practices only have a short time frame in which to make any adjustments to how they deal with the audit of their clients’ SMSFs. I encourage SMSF accountancy practices to consider trying different solutions before making a long-term decision. For example, give one-third of your funds to a large SMSF audit entity, one-third to a collective referral source and one-third to a single referral source.

REGULATION ROUND-UP

Indexation

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

Contribution caps are set to increase on 1 July.

The concessional cap will rise to $27,500 and the non-concessional cap to $110,000. Indexation will also apply to increase the transfer balance cap to $1.7 million (impacting other associated measures).

SG amendments Treasury Laws Amendment (Your Future, Your Super) Bill 2021

Changes to superannuation guarantee rules announced in last year’s federal budget have been introduced into parliament.

The key measures of this bill aim to: • avoid creating unintended multiple superannuation accounts for employees by requiring contributions for new employees with an existing stapled fund to be paid into that fund unless the employee chooses otherwise, • make it easier for members to evaluate fund performance to choose a well-performing product, and • increase the accountability and transparency of superannuation providers and require trustees, or directors of a corporate trustee, to exercise powers and conduct duties in the best financial interests of members.

Div 7A, NALI and LRBA loan relief Temporary relief on loan repayments, resulting from COVID-19 impacts, will not trigger non-arm’s-length income (NALI) provisions or breach safe harbour terms, provided the relief reflects similar terms to those offered by commercial banks.

Interest should continue to accrue on the loan.

The ATO will expect to see documentation of the changes and reasons for the amendments.

Where temporary relief has been granted under a limited recourse borrowing arrangement with a private company lender, the ATO has confirmed Income Tax Assessment Act 1936 division 7A consequences will not apply as a result of interest capitalising on the loan.

However, capitalised interest cannot meet the minimum yearly repayment requirements, so to avoid an unfranked dividend being assessed, the SMSF trustee can apply for division 7A administrative relief.

ATO online guidance has been updated to reflect these clarifications.

NALI no-action position extended for 12 months The ATO is yet to finalise its view on non-arm’slength income (NALI) in relation to non-arm’slength expenditure, with Law Companion Ruling 2019/D3 remaining in draft form.

In the interim, the ATO has announced a 12-month extension of its NALI no-action position.

Unclaimed superannuation Data from the ATO shows unclaimed super balances reduced by $7 billion in the 12 months to 30 June 2020, but $13.8 billion still remains unclaimed.

The ATO figures published on the regulator’s website break down lost super by state and postcode. Individuals can find lost superannuation by logging into their myGov account and accessing the ATO online services.

SMSF member verification service The SMSF member verification service (MVS) used by Australian Prudential Regulation Authority-regulated funds to verify membership of an SMSF before rolling over benefits has been replaced by the SMSF verification service (SVS), which commenced in March.

The new service allows for electronic verification of the SMSF complying status as well as member information.

ATO guidance on independence standards for auditors Guidance for auditors on how to comply with the independence standards laid out in the amended APES 110 Code of Ethics for Professional Accountants is now available on the ATO website.

This guidance covers general independence requirements, as well as concerns around inhouse audits and the regulator’s compliance approach.

The ATO’s compliance stance in 2020/21 was to support and assist auditors to comply with the code to allow for time to restructure as necessary. Audits completed from 1 July 2021 will need to comply with the code and breaches will be reported to the Australian Securities and Investments Commission for action.

QUARTER II 2021 11

FEATURE

INDEXATION IMPACT The administration of an SMSF is about to become infinitely more complex and confusing with the indexation of the transfer balance cap and the contribution limits. Zoe Fielding assesses what these changes mean for the superannuation framework.

12 selfmanagedsuper

FEATURE INDEXATION

Indexation is about to be introduced to the superannuation system for the first time to allow super balances and contribution parameters to reflect the effects of inflation on living costs and wages.

This indexation process comes into effect on 1 July 2021 and from that date, the concessional contributions cap will be $27,500, up from $25,000. The nonconcessional contributions cap – set at four times the concessional contribution limit – will as such increase from $100,000 from $110,000.

In addition, for the first time since its introduction on 1 July 2017, the general transfer balance cap (TBC) will be lifted from $1.6 million to $1.7 million.

The basic details may seem straightforward, but Deloitte Private national SMSF leader Liz Westover says the way in which the indexation applies is far from intuitive.

“If the cap is going up, you would think that’s an opportunity. It’s not until you dig around that you realise it’s a lot more complicated,” Westover says.

TBCs limit the amount of super each fund member can move from an accumulation account into a tax-free retirement account.

When the system was introduced, each person’s TBC was set at $1.6 million: the general TBC amount. But after indexation is applied on 1 July, each fund member will have their own personal TBC, which will range from $1.6 million to $1.7 million, depending on individual circumstances.

People who start their first retirementphase income stream on or after 1 July will receive the full indexation and will have a personal TBC of $1.7 million.

But anyone who started a pension between 1 July 2017 and 30 June 2021 – triggering the creation of a transfer balance account (TBA) – will be subject to proportional indexation. And this is where complications arise.

“Unless you have a proactive adviser, unless you are reading the relevant articles that are coming out, you would not necessarily understand how proportional indexation works. Even advisers are challenged in getting their heads around how it works and explaining it to their

“If the cap is going up, you would think that’s an opportunity. It’s not until you dig around that you realise it’s a lot more complicated.”

Liz Westover, Deloitte Private

clients,” Westover notes.

Crunching the numbers According to SMSF Association deputy chief executive and policy and education director Peter Burgess, practitioners need to know how personal TBCs will be calculated on a proportional basis.

“The first step is to calculate how much of the cap the client has already used,” Burgess says.

To do this, advisers must identify the highest-ever balance in the client’s TBA history and divide that balance by $1.6 million, being the original TBC. The result then has to be expressed as a percentage and rounded down to the nearest whole number.

“If you don’t round down, you will end up with the wrong answer. It’s not a big difference, but it will be the wrong answer,”

Burgess warns.

The final step is to subtract the percentage value from 100 to give the unused cap percentage and then multiply that by $100,000 to find the dollar value of the proportional indexation to which the fund member is entitled.

A key point to note is the personal TBC is based on the highest-ever balance in their TBA, rather than the balance as at 30 June 2021.

“That’s to prevent people gaming the system by withdrawing amounts in the leadup to 1 July,” Burgess explains.

“There’s been discussion that you can commute your pension and qualify for a higher personal transfer balance cap. That’s not the way the rules work. It’s not the balance in their transfer balance account on 30 June that matters, it’s the highest-ever balance in their transfer balance account that matters.”

Simplicity is best The SMSF Association is one of many voices in the industry that argue proportional indexation is too complicated.

“We certainly believe the proportional indexation is overly complex. Errors will be made and that will result in breaches of the cap, which will result in extra costs for everyone,” Burgess points out.

The association has discussed its concerns with Treasury and put forward three alternatives to proportional indexation in its 2021/22 budget submission.

One option is to simplify the proportional indexation method by reducing the number of bands of indexation. The industry body argues in its submission that this would be “easier for members to understand and apply in practice” than the existing system.

The other two options would remove proportional indexation altogether.

Either everyone could receive the full amount of indexation regardless of whether they had previously used some of the cap, or each member’s TBC could be locked in when they start their first retirement-phase income stream.

“The second approach of locking in Continued on next page

QUARTER II 2021

13

FEATURE INDEXATION

personal TBCs that are later revised may inadvertently exceed their limits and be liable to pay penalty taxes.

“Indexation does not change an SMSF’s, or any other super fund’s, legal reporting obligations or what happens if a member exceeds their transfer balance cap,” Micale notes.

Continued from previous page

the TBC at pension commencement might sound harsh, but it might not affect many clients,” Burgess says.

The SMSF Association favours removing proportional indexation and is hopeful of a last-minute reprieve.

“There’s a chance that the government will look at this and look for ways to make it simpler for people to work with,” Burgess predicts.

“They could switch off proportional indexation before 1 July this year or defer it for a few years. From what we understand, the ATO systems have all been updated, so they are ready to go, but it would not be the first time this has happened.”

Accurium SMSF technical services manager Melanie Dunn doubts the system will be changed at this late stage.

“Any new system takes time to bed down, but any change now could be more disruptive when we are so close to the indexation deadline. We have to deal with the legislation we have at hand,” Dunn says.

She concedes the way in which indexation is being applied should not come as a surprise to anyone. The legislation that established TBCs on 1 July 2017 spelled out how indexation would work. However, practitioners have been lax in their preparation.

A quick survey at an Accurium technical webinar in March revealed 63 per cent of delegates had not yet determined how many of their clients would be eligible for a higher TBC after indexation. A further 29 per cent were going through the exercise of identifying which clients would enjoy some benefit. Only 8 per cent of advisers had completed the process.

“The good news is that once we get past the initial difference phase, it’s not going to change again until the next round of indexation. So it is not something we are going to have to assess every month or every year,” Dunn explains.

Report early In the lead-up to 1 July the ATO is urging advisers, trustees and SMSF members to report all events that affect the TBA – such as pension commencements and

14 selfmanagedsuper

Keep track

“Any new system takes time to bed down, but any change now could be more disruptive when we are so close to the indexation deadline.”

Melanie Dunn, Accurium

commutations – as early possible to ensure their records are up to date and accurate.

ATO Online will be the primary store of information on an individual’s TBA and personal TBC. “The ATO can only calculate a transfer balance cap based on information reported to us,” ATO assistant commissioner Justin Micale explains.

“Until all events are reported and processed by the ATO, an individual should not rely on their transfer balance cap calculation to make financial decisions.

“If the ATO later receives information that would impact the calculation of the cap, we will recalculate the transfer balance cap and apply it to an individual’s circumstances.”

Fund members who start a pension or make other fund decisions based on

Fund members and their tax agents can check now if the ATO holds the correct information and whether, based on that information, they will be entitled to have their personal TBC indexed.

Unfortunately, SMSF advisers and administrators who are not registered tax agents cannot directly access their clients’ data via the ATO Portal and must instead rely on clients accessing the information through their myGov account, and passing it to their adviser.

Perhaps as a result of this challenge, only about one-third of SMSF practitioners plan to use the fund member’s myGov account to keep track of their clients’ personal TBAs after 1 July 2021, Accurium’s March survey found.

Some 44 per cent of respondents planned to use their current fund administration platform, while 11 per cent said they would rely on spreadsheets to monitor personal TBAs. Dunn says SMSF administration platforms will be able to keep track of SMSF information and also record events in other super funds that the SMSF member may have. This can be reconciled with information held by the ATO. “Anything that you do with retail or notfor-profit funds, they will report. Where you are missing things, it’s most likely to be from the SMSF,” Dunn suggests.

Any gaps would probably be due to the timing of reporting requirements.

SMSFs are required to lodge transfer balance account reports (TBAR) notifying the ATO of reporting events within their fund, such as pension commencements and commutations, but they may not have to submit the TBAR for several months after the event, Dunn says.

“If they have an event that occurs in the last quarter of 2021, the fund would not normally report that until the July

FEATURE

deadline,” she says Westover recognises SMSF trustees may need to get ahead of their reporting responsibilities to ensure members’ TBCs can be calculated accurately on 1 July.

“The key to a lot of this is: do not rely on the longer period of time you have got to report commencements of income streams,” she says.

“Get into the habit of real-time reporting.

It’s not always practical, but to the extent that you can do it, that’s accurate information that the tax office is going to hold.”

SMSF advisers need to be mindful their clients may not provide them with all the information they need, she warns.

“If you take on a new client you may not have all the right information. You can’t know that they have lodged all the TBARs if there are multiple funds involved,” she says.

To get all the details, advisers should be prepared to ask a lot of different questions and the same question in a lot of different ways.

Rather than simply asking: Do you have other super funds? advisers may have to add questions like: Have you had any super funds from a previous employer? Have you ever worked for government? Do you have a defined benefit fund from that work?

“Do not make assumptions. You have to ask relevant questions to make sure you get all the information together,” Westover stresses.

Strategy and timing Amid the complexity, indexation can provide an opportunity for SMSF practitioners to initiate conversations with SMSF clients about timing and strategy.

For SMSF members who are looking to start a retirement income stream and are

eligible for the full TBC increase, it could be beneficial to delay starting the pension until after 1 July. Then, they will be able to add $100,000 more into their tax-free retirement stream than if they started the pension on or before 30 June.

Indexation of the concessional contribution caps will allow fund members to contribute more to their accumulation accounts than in previous years. Some clients who have been salary sacrificing up to the $25,000 limit may want to revisit their arrangements to take advantage of the $2500 increase to that cap.

The increase to the concessional contribution limit has a knock-on effect to the non-concessional contribution cap, which is set at four times the concessional contribution cap. The non-concessional contribution cap is therefore rising from $100,000 to $110,000, or $330,000 over three years under the bring-forward provisions.

Eligibility to make non-concessional contributions is based on a member’s total super balance (TSB). Until June 30 this year, fund members can only make non-concessional contributions if their TSB is below $1.6 million. This threshold will be lifted to $1.7 million from 1 July, allowing SMSF members with a TSB of between $1.6 million and $1.7 million to make non-concessional contributions when they currently cannot.

SMSF members who are planning to make large non-concessional contributions might consider waiting to trigger the bringforward provisions in the new financial year so they can add a larger sum overall, Westover advises.

“If you sold an investment property, you might contribute $100,000 this year and wait until next financial year to

trigger bring-forward provisions after the caps have been indexed, so you could contribute $330,000 over the next three years. If you triggered the bring-forward provisions this year, you would be held to $100,000 this year and the same amount in the next two years,” she says.

The trap to watch for here is ensuring the TSB does not go over the $1.7 million threshold for making non-concessional contributions, she adds.

Confusion to come Burgess acknowledges the index increases may bring advantages to some SMSF members this year, but he expects further confusion down the track.

“The complexity is that the concessional contributions cap is indexed differently to the transfer balance cap,” he says.

Increases in the TBC are linked to the consumer price index, while concessional contributions caps are indexed to average weekly ordinary time earnings.

“This year it turns out that both caps are increasing at the same time. But at some point they won’t and that will lead to confusion,” Burgess explains.

Add to this the fact not all limits that apply to SMSFs are changing. The $500,000 TSB for catch-up contributions, for instance, will remain unchanged.

The fact the indexed thresholds are interconnected, but based on different indexation, could even set up some perverse outcomes in future where the bring-forward thresholds will be less than in previous years, Burgess warns.

“It comes back to the formula that they use to determine how much you can bring forward. You would expect that all caps increase over time, but that’s not what happens in reality,” he concludes.

“Errors will be made and that will result in breaches of the cap, which will result in extra costs for everyone.”

Peter Burgess, SMSF Association

QUARTER II 2021 15

FEATURE

A STAKE IN THE GROUND As the SMSF sector continues to grow, accurate and unbiased data will become more important, making Rice Warner’s 2020 cost analysis central to any discussion about the place and role of SMSFs. Jason Spits takes a look at the impact the research has had already and how it has reset the cost debate.

16 selfmanagedsuper

FEATURE COST ANALYSIS

In a year punctuated by COVID-19 it can be easy to overlook the impact a report into the running costs of SMSFs could have on the superannuation sector, and for those advisers and accountants who deal with Australians interested in or currently running their own super fund.

Yet, in the face of numbers that at times seem to be arbitrarily chosen (see: Setting the Record Straight), the “Cost of Operating SMSFs 2020 Report”, produced by Rice Warner and commissioned by the SMSF Association (SMSFA) and SuperConcepts, puts an important stake in the ground as to the reality of what each SMSF costs to run annually.

What the report found was SMSFs with balances of $200,000 are competitive with industry and retail funds, even where the fund paid for full third-party administration services, and SMSFs with balances of $250,000 became cheaper than their public offer counterparts if trustees undertook some of the administration or used cheaper services when outsourcing.

Conversely, the report found SMSFs with a balance between $100,000 and $200,000 were still competitive with Australian Prudential Regulation Authority (APRA)-regulated funds, but needed to use cheap administration services or carry out much of that activity themselves. Further, SMSFs with balances below $100,000 were found not to be cost-effective unless they could grow to a larger balance within a reasonable time.

SMSFA deputy chief executive and policy and education director Peter Burgess points out these figures were generally assumed within the SMSF community, but the release of the 2020 report provided the independent verification the sector required.

“We were surprised at the $13,900 figure used by the Australian Securities and Investments Commission (ASIC) and understood that it came from ATO data and looked at average expenses, but we don’t believe those numbers were intended to be used as a benchmark,” Burgess says.

“That was the reason we felt the need to update the analysis on SMSF costs because

while the numbers were not made up, they were not the best way to price the costs of running an SMSF.” Interestingly, the latest figures are not entirely new as the 2020 report is an update on a 2013 report into the costs of operating an SMSF, prepared by Rice Warner for ASIC. The findings of this early report are generally consistent with the most recent analysis and a comparison between the two reports shows a reduction in costs over time for funds with balances above $200,000.

Rice Warner senior consultant and author of the 2020 report Alun Stevens says he was also surprised to see the high figures quoted by the Productivity Commission and ASIC given the findings of the 2013 report and that Rice Warner had been in communication with the Productivity Commission about its ‘draft’ $1 million figure.

“We had conversations with the commission because we used the same data and their numbers of $1 million, and then $500,000, were simplified, nonsense numbers and we told them so because they did not pick up the complexities of the SMSF sector,” Stevens reveals.

“So what we put on the table was not a great surprise to SMSF practitioners who may not have had the precision of our analysis, but probably had a gut feeling the public numbers were overstated.”

Creating a wider awareness of the cost of running an SMSF and moving this information from industry knowledge to public knowledge was a key outcome for the SMSFA, Burgess says, to not only benefit its practitioner membership, but also provide consumers with the information required to properly consider holding an SMSF. “We have seen an increase in SMSF investors downloading cost-related information off the back of the research and we know consumers can have a better understanding of the costs related to running their own fund,” he says.

“There was a debate around costs and we are pleased ASIC is no longer using its fact sheet from 2019, and the Rice Warner analysis has shown the problems of using

“The report has moved the cost discussion away from a single number to a consideration of what the advice, administration and investment components are within an SMSF.” Phil La Greca, SuperConcepts

an average cost calculation, which doesn’t factor in the one-off expenses that occur with SMSFs.” SuperConcepts SMSF technical and strategic solutions executive manager Phil La Greca says the impact of the analysis was not direct as the report did not choose to take a single-figure approach, but did allow for comparisons to be made in a more detailed manner.

“The report has moved the cost discussion away from a single number to a consideration of what the advice, Continued on next page

QUARTER II 2021 17

FEATURE COST ANALYSIS

“For the first time we got a comprehensive study looking at the cost of running an SMSF, and that’s been incredibly valuable.”

Neil Sparks, BT Financial Group

Continued from previous page

administration and investment components are within an SMSF and the difficulty of comparing those with a MySuper product from an APRA-regulated provider,” La Greca notes.

“It has also shown that in many cases SMSFs are not as expensive as many people believed and has provided greater traction for accountants and advisers with clients, but also for the wider public because what the regulators say about an issue is usually believed.”

BDO director and SMSF specialist Mark

18 selfmanagedsuper

Wilkinson also notes the positive impact the analysis is having in regards to the administration of SMSFs and that following on from the Productivity Commission and ASIC figures it provides a more grounded perspective.

“It is useful to have a third-party document that has looked at a range of fees and provides confidence with clients and for fund operators that their costs are correct, while also countering claims about the cost of an SMSF on their members,” Wilkinson says.

In reading the report, however, one figure stands out – and is referenced repeatedly – and that is the $200,000 balance at which SMSFs become costcompetitive with APRA-regulated funds.

According to Stevens, the reason behind the emphasis on this figure was not to create another benchmark, but to make some pertinent statements around what has been said about the costs of SMSFs and what was revealed by Rice Warner’s most recent analysis.

He adds SMSF trustees who find arrangements that are on par with the administration costs available to APRAregulated funds, and outlined in the report, can operate in the same cost bands as those funds.

“If a trustee outsources the work, it may not be cheaper, but the point of that figure was for us to state that a $500,000 balance was not the figure that should be quoted at all,” he says.

“It also allows advice practitioners to tell regulators that while a fund may be smaller than the benchmarks they have set, cost is not the only factor to consider and there are other issues at hand, and rebuffs any claims that if a fund has less than $1 million then advice to set up an SMSF is inappropriate,” he says, referencing ASIC Report 575 from mid-2018.

La Greca also regards the $200,000 balance figure as a talking point from which SMSF advisers and providers can address questions around the purpose of the fund and the trustees’ commitment to being involved in its operation.

“I would not want to see that figure used in any campaign to promote SMSFs because it lacks the nuance about the work

involved in running an SMSF and instead any discussion should be around the cost of running a fund at any balance level,” he acknowledges.

“The ATO sector statistics show that more younger people are setting up SMSFs, so this will be an issue for more people in the future.”

Wilkinson highlights that while the Rice Warner analysis provides an external confirmation on the costs of running an SMSF, its focus on at what point do they become cost-competitive with APRAregulated funds also emphasises the legal obligations placed on trustees.

He says the $200,000 figure notes clearly some administration work is required by the trustees to ensure an SMSF is cost-competitive with an APRA fund, but these tasks include the duties required of trustees.

“By running an SMSF they have assumed responsibilities even if they don’t have a plan to grow and develop the fund, at which point they may be exposed to liabilities as well,” he says.

“So the $200,000 or $250,000 balance is not just about comparing costs, but also requires consideration of whether the trustees and members are capable of meeting their obligations under the SIS (Superannuation Industry (Supervision)) Act, and this analysis has confirmed the necessity of both activities.”

In considering the Rice Warner analysis, BT Financial Group SMSF strategy national manager Neil Sparks regards it as having come at a good time for the sector, which is leveraging technology in greater ways than ever to deal with the cost concerns and trustee obligations.

“The research examined more than 100,000 SMSFs and for the first time we got a comprehensive study looking at the cost of running an SMSF, and that’s been incredibly valuable,” Sparks says.

“I think it’s come at a good time where we’ve had now many years of improvements in technology running SMSF administration on the cloud, and we are in a more mature phase where systems are really running well.”

He feels the SMSF sector is at the point where mature technology and

FEATURE

comprehensive cost research have both demonstrated the costs of running an SMSF have come down and are more affordable, but notes this has not changed the advice landscape.

“While technology has helped drive costs down, complexity hasn’t gone down.

It’s gone up, so we need to be cognisant of those people that are unadvised and are out there dealing with the most complex system in superannuation and are fully responsible for the compliance,” he says.

“We need to get that message out

there about the support that advisers, accountants and platforms can give to SMSF trustees and make sure they stay compliant and reap the benefits of the Australian superannuation system.”

Burgess sees the report contributing to that effort, that is, to show consumers the actual cost of running an SMSF, the need to take hands-on ownership and the benefit of seeking value-for-money services from third-party providers.

“Our members have been appreciative of this work and of the news that $13,900

SETTING THE RECORD STRAIGHT The impact of the Rice Warner SMSF cost analysis cannot be overstated in setting a stake in the ground for any future discussion about SMSFs and their use

by Australians.

However, the numbers used to describe the cost of running an SMSF prior to the release of that analysis have a chequered history, and have created concerns from the SMSF sector around their provenance and validity.

In its most recent review of the superannuation sector released in early 2019, the Productivity Commission also examined SMSF expenses and concluded, in a draft report, the most suitable balance for an SMSF to be cost-effective was $1 million. This figure was reduced to $500,000 in the final report following input from the sector, but SuperConcepts notes this figure did not differentiate between the balance of the fund and that of the members.

Additionally, Class, which had provided the commission with guidance around calculating SMSF costs, noted after the release of the final report that the government agency had combined expenses unique to SMSFs, such as insurance, interest, and capital works and depreciation, with operating fees in setting its benchmark.

is not representative of the numbers they are discussing with their clients,” he says.

“We wanted to make sure SMSF advisers and consumers have access to the most accurate information so they can choose the best superannuation vehicle for their needs and we expect to see reference to this research for years to come.

“That happened with the 2013 data, and the 2020 report provides more data than any other research in the market, so it will continue to be useful for the SMSF sector well into the future.”

More concerning for the SMSF sector was the publication of an ASIC SMSF Fact Sheet in October 2019 that stated the average cost of running an SMSF was $13,900 a year and required 100 hours of members’ time to manage.

This figure, promoted by the regulator, was widely picked up by media outlets, prompting the SMSF Association to question the methodology that arrived at that figure and claiming the actual running costs per member were around $5000.

The fact sheet also attracted attention in parliament where it was the subject of questioning at a hearing into the oversight of the regulator conducted by the Parliamentary Joint Committee for Corporations and Financial Services in July 2020 and a hearing of the House of Representatives Standing Committee on Economics in August 2020.

These appearances led ASIC chair James Shipton to admit the figures were inaccurate, but were not misleading, as they were drawn from ATO data and it was the best available information to hand at the time the sheet was created.

Shipton also committed ASIC to revising the figure, which it did in August 2020 without any fanfare, using a median figure of $3900 drawn from ATO data and a simple note added to the fact sheet media release stating it was now an historic document and information contained in it was no longer accurate.

QUARTER II 2021 19

INVESTING

Property and inflation: do they mix?

Many economic forecasters are flagging inflation as an adverse development of which investors must be wary. Chris Bedingfield refutes both the likelihood of rising prices and the belief such a scenario would disadvantage property holdings should it occur.

CHRIS BEDINGFIELD is principal and portfolio manager at Quay Global Investors.

20 selfmanagedsuper

There’s been a lot of talk lately in investment markets about inflation and whether it is likely to increase – and if it does, what this means for investors.

This discussion is especially relevant for investors in property, in particular, listed real estate. Real estate investment trusts, or REITs, are generally seen as a yield investment, and many people believe a rising inflation environment is bad for yield and so they should sell out of such investments when inflation is increasing.

Therefore, for SMSFs with investments in listed real estate, there are two key questions to consider.

If we do start to see inflation, is this a good time to liquidate listed property holdings? But also, are we really likely to see rising inflation over the short to medium term?

Inflation and real estate So, is high inflation a negative for real estate? If we do start to see a sustained increase in inflation,

100K

20K

Is inflation imminent?

This leads to our next question: just how likely is it that we are going to see rising inflation?

Graph 1: Buying at or below cost preserves real value of capital no matter the inflation outcome

$ Pricing cycles Replacement cost – high inflation Replacement cost – low inflation

time

Source: Quay Global Investors.

Graph 2: US labour force participation rate: 25-54 years

83 82 81 80

Jan 21

Mar 20

May 19

Jul 18

Sep 17

Nov 16

Jan 16

Mar 15

May 14

Jul 13

Sep 12

Nov 11

79 Jan 11

the usual first step by central banks is to increase interest rates. In the short term, this could lead to unsophisticated investors selling out of their listed real estate investments, which would have a negative impact on the value of REITs. But over the longer term, our research has shown rising inflation is actually good for real estate. For instance, between 2003 and 2006 when the United States Federal Reserve was raising interest rates and inflation was averaging around 3 per cent a year, US REITs outperformed equities. The same was true in the 1970s and early 1980s when inflation was at a historical high – averaging between 7 per cent and 8 per cent a year. Again, during this period, REITs significantly outperformed the index.

To many investors this will seem counterintuitive. But there are very good reasons why this is the case.

One reason is inflation means replacement costs are pushed up, so any new supply will come onto the market at a progressively higher price.

What this means is that over time most real estate trades around replacement cost.

However, in periods of higher inflation the replacement cost rises faster, pulling up the capital value of existing assets.

For investors, this results in their real purchasing power being protected from the impact of rising inflation.

Another reason is some investors make the mistake of believing real estate is a proxy for bonds and can be treated as a yield instrument. This is not the case. Real estate delivers a return based on both yield and capital growth. Therefore, assumptions about how inflation or interest rates will affect REITs need to take more than just yield into account.

We believe rising inflation is in fact good for real estate investors and the asset class represents one of the best avenues to protect against erosion of purchasing power.

0

Aug 08 Jan 10 Jun 11 Nov 12 Apr 14 Sep 15 Feb 17 Jul 18 Dec 19

0

Jul 01 Dec 02 May 04 Oct 05 Mar 07

40K

Jan 93 Jun 94 Nov 95 Apr 97 Sep 98 Feb 00

200K

Source: St Louis Fed (Fred), Quay Global investors.

This is perhaps a bit more challenging to predict. As global investors, we are particularly concerned with what’s happening in the US as rising inflation there500K will likely trigger similar outcomes in Single family economies suchMulti-family as Australia.

400K Without doubt, we have just come 300K 200K 100K

through one of the most, if not the most, extraordinary years in our lifetimes following the outbreak of the COVID-19 pandemic and subsequent lockdowns around the 100K world. It will take some time for the effects 80K

Continued on next page 60K 40K QUARTER II 2021 21 20K

81 80

INVESTING Jan 21

Mar 20

May 19

Jul 18

Sep 17

Nov 16

Jan 16

Mar 15

May 14

Jul 13

Sep 12

Nov 11

Jan 11

79

Graph 3: US residential construction in place

500K

100K

Single family Multi-family

400K

80K

20K

0

Nov 12 Apr 14 Sep 15 Feb 17 Jul 18 Dec 19

100K

Aug 08 Jan 10 Jun 11

40K

Dec 02 May 04 Oct 05 Mar 07

200K

Nov 95 Apr 97 Sep 98 Feb 00 Jul 01

60K

Jan 93 Jun 94

300K

0

Source: US Census Bureau, Quay Global Investors.

Continued from previous page

As investors in real estate we are not concerned about the risk of inflation, instead we would welcome it.

of this to play out and the economic numbers to cycle out of the annual consumer price index (CPI) calculation.

It is therefore likely we will see some periods of rising prices over the next year or two. But is this true inflation? We believe not. In fact, the$ definition of inflation is a Pricing continuing increase in prices fromcycles one cost – high inflation period to the next, that is, aReplacement sustained rise Replacement cost – low inflation in prices over time.

Certainly bond markets are currently suggesting a concern about rising inflation and bonds are often seen as a predictor labour available to respond to demand of economic data. However, this doesn’t pressure as the market improves, which will mean they are always correct. It’s important help reduce inflation. to look more deeply.

It is also useful to look at the different Another data point to consider is drivers of inflation. The CPI basket, which unemployment levels. In the US, the official time pools the prices of a number of items into unemployment rate is still at a relatively a single index in order to measure price high level. In addition, it is probably changes, is very informative. One of the somewhat suppressed as it doesn’t include biggest elements of the US basket, rent, people who currently aren’t actively is showing almost no change at all. This looking for work, but would be if the covers both rent paid to landlords, and the environment was more positive. equivalent ‘rent’ paid by owner-occupiers.

As Graph 2 highlights, prime-age Indeed, if we look at US apartments in the workforce participation remains at a big coastal markets, rent is actually falling. cyclical low.

Furthermore, in those places where This suggests there is more than enough

22 selfmanagedsuper

rents are rising, the supply levels are not just rising as well, but accelerating. This would not be the case if inflation was likely to be a problem.

Finally, let’s look at government debt.

This is often believed to be a trigger for inflation and certainly history has shown high levels of government debt can be a problem for inflation.

There’s no doubt we are seeing very high government debt around the world.

The US alone approved a $1.9 trillion US government COVID relief package early in the year and Australia’s stimulus package was one of the biggest in the world, behind the US and Canada, as a ratio of gross domestic product (GDP).

So how likely is this to drive inflation?

Despite the size of the numbers, it’s worth keeping in mind the ratio of US government debt to GDP is still less than half of Japan’s and, as a reminder, Japan continues to fight deflation.

One of the keys to this is whether households start spending. A major issue in Japan is that Japanese households since the 1990s have focused on saving rather than spending, in effect deleveraging from the 1980s credit boom.

We believe this is unlikely to be the case during the next year or so. It seems more likely, as people emerge from COVIDinduced restrictions, we will see a reaction more akin to that of the Roaring Twenties – consumers keen to get out, spend money and enjoy themselves.

Role of central banks It’s worth emphasising the fact that central banks have limited impact on inflation.

The evidence suggests interest rates, the primary tool of central banks, do little to help them achieve their inflation targets.

Indeed, for the past 20 or so years, most central banks have battled to elevate inflation to their target band.

So as investors in real estate we are not concerned about the risk of inflation, instead we would welcome it. However, we won’t be holding our breath for its arrival.

SAFAA 2021

INVESTING

An income alternative to consider

The continued low interest rate environment has made fixed income investments look very unattractive. Omar Khan argues allocations to real estate debt can improve this part of a portfolio.

OMAR KHAN is head of wholesale capital at Alceon Group.

Deriving income, particularly from traditional fixed income investments, remains an ongoing challenge for investors in the prevailing low interest rate environment. This has increasingly led many investors, including SMSF members, to make real estate debt allocations – an asset class that offers regular income with capital secured by the underlying asset.

In this article, we delve into real estate debt as an investment and, importantly, the key factors to consider about this asset class.

The sector Australian Prudential Regulation Authority statistics for lending by authorised deposit-taking institutions across the December quarter 2020 show the banks and mutuals are continuing to reduce their

24 selfmanagedsuper

commitment to the residential development sector and increasingly foreign banks and non-bank lenders are stepping up to meet the demand and fill this lending gap (see graph).

Current figures, at 30 December 2020, show the banks and mutuals sit at $18.3 billion, indicating lending by these organisations has dropped a considerable 28 per cent over the past five years from $25 billion in 2015. Looking longer term, in September 2008 lending levels were at their peak at almost $29 billion. On the other hand, foreign banks and branches have gradually increased their market share to just over 15 per cent with an exposure of almost $3 billion.

We reasonably estimate the total funds under management of the bigger non-bank lenders in residential development finance to be around $11

experience of the team managing the fund and their expertise in real estate.

Graph 1: ADI exposure to real estate development

1. Leverage ratios $b

25

20

15

10

0 2004

2006

2008

2010

billion as at 30 June 2020. This suggests the non-banks have carved out a market share of about 38 per cent over the past decade.

The main investment benefits of real estate debt With total lending to the residential development sector currently at over $29 billion, what are the benefits to investors?

Why should it form part of your income strategy?

Over the past 10 years a significant amount of capital has been invested in direct real estate to derive income in a low interest rate environment, to access the opportunity for capital appreciation and benefit from the perceived security or stability in the underlying asset value.

For similar reasons, real estate debt is an attractive segment within the private debt market. Notably, these investments offer investors superior risk-adjusted returns, or regular income, with capital secured by the underlying asset. Of course, real estate debt is particularly attractive in the current market where traditional fixed income assets are delivering minimal net returns.

For example, a conservatively managed fund, like the Freehold Debt Income Fund, managed by Alceon, continues to deliver

2012

2014

2016

2018

2020

monthly net returns above its targeted 7 per cent to 8 per cent a year.

Considerations when investing in real estate debt As with all asset allocation and investment decisions, there are key considerations when investing in real estate debt: how the investment fits in your portfolio, what percentage of the fixed income allocation should be directed toward this incomegenerating asset and the associated risks.

Strategist Maarten van der Spek has written extensively on private assets and real estate. In his 2017 paper in the Journal of Accounting, Finance and Business Studies, he contends that senior secured debt is most akin to fixed income given investors receive a fixed or floating return that has very little correlation, if any, with investment outcomes for the underlying real estate or the equity component.

From a funds management perspective, the key points we consider when looking at real estate debt are leverage ratios, the construction contract, protecting against builder insolvency and the quality of the development partner as discussed below. Beyond these considerations, it is equally important to look at the depth of

When investing it is easy to focus on the peak leverage ratio (LVR). Loans based on conservative LVRs, which are usually less than 65 per cent for construction loans with pre-sales, provide greater security for investors and the returns investors receive bear very little correlation to the end value of the underlying real estate or security.

Let’s consider an example.

Using the assumptions below, we’ve modelled a scenario (see table) illustrating the impact on investment outcomes for debt holders based on a reduction in the asset value at completion (row) and pre-sale defaults (column).

Assumptions: 1. A construction loan with end asset value of $100 million.

2. Loan size: $65 million (65 per cent peak LVR).

3. Gross interest: 11.75 per cent a year (interest capitalised).

4. Pre-sales: 45 per cent of total borrowed capital (including interest where capitalised).

5. Term: 18 months with delays resulting in a 24-month term.

6. Penalty interest: 3 per cent a year (payable after the initial 18-month term).

The results show there’s minimal impact on the return until the end value drops by at least 40 per cent and there is no principal loss until values drop by more than 45 per cent. Conservative LVRs help protect investor capital in the event of a default.

2. T he construction contract and overruns

There is no capital appreciation in a debt investment. This means our focus is entirely on downside protection.

We undertake proper due diligence to ensure the right contractual structure is in place, as well as financial due diligence on the counterparties – the asset being developed, the developer and the builder.

Continued on next page

QUARTER II 2021

25

INVESTING

Table 1 IRR

Reduction in end value of lots, units or apartments %

Pre-sale defaults %

30.00

35.00

40.00

45.00

50.00

55.00

30.00

12.41

12.41

9.24

5.11

0.82

-3.66

35.00

12.41

12.41

8.45

4.23

-0.17

-4.77

40.00

12.41

11.82

7.67

3.35

-1.15

-5.86

45.00

12.41

11.14

6.89

2.48

-2.12

-6.94

50.00

12.41

10.47

6.13

1.62

-3.08

-8.01

55.00

12.41

9.80

5.38

0.78

-4.03

-9.06

Continued from previous page

The construction contract should be a fixed-price contract, meaning the builder should absorb cost overruns due to labour, building material increases or weather delays. A good builder will generally have locked in as many of their costs as they can with their suppliers and sub-contractors at the time of signing.

Even with a fixed-price contract in place, construction costs can still increase due to, for example, unexpected complications in ground works and variations in build specifications at the request of the developer. Any increase in build costs that are outside of the fixed-price contract are the responsibility of the developer.

As an experienced lender, we require the developer to fund out-of-scope cost increases at the time they are identified, generally by increasing its equity contribution and before any additional construction facility drawdowns can occur.

3. Protecting against builder insolvency

The most significant risk in any residential construction project financing is builder solvency. It is very difficult and expensive to replace builders part way through a project.

26 selfmanagedsuper

We generally have a multipartite deed in place between the fund as financier, the borrower and the builder, and in some instances, the builder’s subcontractors.

Such a deed has several functions, including: • ensuring construction assets, once they are fixed to the site, become the security of the lender, and • the senior lender can quickly take control of the asset if there is a serious default.

Additionally, we appoint an independent quantity surveyor to the project. They provide an independent due diligence assessment of the project, drawdown and cost-to-complete reports, ensuring sufficient funds are always available to compete the project and additional drawdowns only occur when the relevant conditions are met.

4. Quality of development partner

If you only compare loans based on internal rates of return (IRR) and LVRs, it’s likely you’ll risk missing some key assumptions that go to supporting the security of the loan.

The strength of both the development partner and the building partner is particularly important for construction

loans. Strong development partners demonstrate a solid track record of success, have strong balance sheets and are leaders in their areas of specialty. While pre-sales do provide significant protection, clarity on exit mechanisms and protection against real estate price falls, they can only be enforced when a project is completed.

Conclusion Real estate debt continues to offer attractive risk-adjusted returns for yield investors.

There are now a number of options available for investors to gain exposure to this asset class.

Deals or portfolios with conservative LVRs can sustain significant reduction in end values before there is a principal loss for investors.

It is difficult for investors to undertake due diligence on the underlying contractual arrangements in a deal or counterparties.

This is also where most of the risk sits for investors.

As an investor, it is important you get comfortable with a manager’s approach and typically an open-ended vehicle can provide good diversification. Alternatively, if you have the capacity, you can diversify by participating in multiple deals.

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COMPLIANCE

Where to from here for ECPI

Changes to the way exempt current pension income is calculated are pending, but the industry does not seem to be in total agreement on the final method that should be implemented. Mark Ellem reveals the surprising sentiment practitioners have expressed on the subject.

MARK ELLEM is head of education at Accurium.

28 selfmanagedsuper

The proposed changes to the exempt current pension income (ECPI) rules are slated to come into effect from 1 July 2021, after being delayed 12 months from an original implementation date of 1 July 2020.

With no draft legislation released by mid-April, it’s possible there will be a further delay to the start date.

These latest proposals are intended to reduce complexity. However, some commentators have noted they have the potential to do the exact opposite. Whatever changes are proposed, the industry is hopeful sufficient consultation time is provided to ensure that firstly, they achieve a

reduction in complexity and secondly, service providers have adequate time to make any necessary changes to administration platforms and processes to implement changes.

Given the current implementation date is just around the corner, it is very possible a further delay of 12 months, until 1 July 2022, could occur.

There is also the possibility after nearly four years of application of the current ECPI approach, the federal government deems the proposals are not required and they are withdrawn, resulting in a continuation of the status quo.

The proposed ECPI changes – a reminder The government announced, back on 2 April 2019, as part of the 2019/20 budget, the following ECPI-related proposals: 1. The government will allow superannuation fund trustees with interests in both the accumulation and retirement phases during an income year to choose their preferred method of calculating ECPI. 2. The government will also remove a redundant requirement for superannuation funds to obtain an actuarial certificate when calculating ECPI using the proportionate method, where all members of the fund are fully in the retirement phase for all of the income year.

The second proposal appears fairly straightforward – remove the need for an actuarial certificate where the SMSF has disregarded small fund assets (DSFA), but consists wholly of retirement-phase pensions for the entire income year. This leaves the first proposal as the one of some contention in relation to its implementation or actual need.

Where the complexity arises with current ECPI methodology The concept of DSFA, which determines whether an SMSF can claim ECPI using the segregated method, appears to present the most significant challenge to the current ECPI rules. The DSFA test must be applied for each year of income, resulting in an SMSF potentially having DSFA for one particular year of income, but maybe not another.

Whether an SMSF has DSFA is important not just because it determines whether it is eligible to segregate assets, but also because in some circumstances it will have to use the segregated method. Where a fund doesn’t have DSFA and it has a period during the income year where its only member interests are account-based-type, retirement-phase income streams, then its assets will be deemed to be segregated.

The concept of DSFA, which determines whether an SMSF can claim ECPI using the segregated method, appears to present the most significant challenge to the current ECPI rules.

Income earned during this period is ECPI under the segregated method. However, if an SMSF in that same situation has DSFA, then deemed segregation does not apply and ECPI can only be claimed using the proportionate method.

Further, an understanding of how the administration platform or actuarial service determines whether the SMSF has DSFA is important. Does the platform or actuary ask whether the SMSF has DSFA or does it ask if the SMSF can claim ECPI using the segregated method? Answering yes to each question has different outcomes: 1. Yes – the SMSF has DSFA and consequently cannot claim ECPI using the segregated method.

2. Yes – the SMSF can use the segregated method to claim ECPI. The SMSF must not have DSFA. Another potential area of confusion in relation to DSFA is if the platform asks about the SMSF’s eligibility to segregate assets.

The question refers to whether the SMSF has DSFA and is eligible to use the segregated method to claim ECPI and not whether the SMSF actually has segregated assets.

Data provided by SMSFs applying for actuarial certificates from Accurium shows 56 per cent of SMSFs using the proportionate method to claim ECPI state they have DSFA. We estimate this to be around 14 per cent of all SMSFs. Interestingly, an analysis of these funds shows over one-third of SMSFs, or around 5 per cent of all SMSFs, stating they have DSFA have no members with an opening balance of over $1.6 million.

The definition of DSFA looks at members’ total superannuation balances, including balances held outside their SMSF. It is possible therefore for an SMSF to have DSFA and yet all its members have balances in the fund below the $1.6 million threshold. However, it is certainly surprising this figure is so high.

An alternative interpretation of these statistics is some SMSFs may be misreporting their DSFA status, which could lead to an incorrect ECPI calculation if the SMSF has periods in the year of income that wholly consist of retirementphase pensions.

What do the practitioners want?

Accurium surveyed its SMSF practitioner clients on want they want to see in relation to ECPI and Chart 1 reflects their opinions.

Changes accountants want to see to ECPI – the options explained 1. Nothing: The significant changes made in 2017 to how ECPI is claimed have now had plenty of time to be bedded down. Accounting software and actuaries’ online systems have been updated to apply the new rules relatively seamlessly for most funds. However, the rules are complex and cumbersome and are still causing enough problems for practitioners such that only 21 per cent are happy for them to remain as they are.

2. Return to the pre-2017 approach: A lot of the lobbying from professional Continued on next page

QUARTER II 2021

29

COMPLIANCE

Continued from previous page

bodies following the introduction of the 2017 changes was for things to go back to how they were. Pre-2017, unless a fund was 100 per cent in retirement phase for the entire year, the default approach was to use the proportionate method for claiming ECPI for all income.

Funds still had the choice to segregate assets if they did so in advance. Despite the familiarity, having had a taste of something different, only 20 per cent of practitioners surveyed are keen for a return to the old regime.

3. Remove segregation altogether: Despite all the talk and industry presentations on the topic, using deliberate asset segregation strategies remains a very niche option for SMSFs. Accurium’s analysis shows that fewer than 0.1 per cent of funds are using an

30 selfmanagedsuper

Despite all the talk and industry presentations on the topic, using deliberate asset segregation strategies remains a very niche option for SMSFs.

elected segregation strategy alongside a separate pool of unsegregated assets. However, the introduction of deemed segregation in 2017 forced thousands of funds into using this combined approach by default. Add the

complexity of determining whether a fund has DSFA and it is understandable many practitioners are keen to do away with the segregated method for SMSFs altogether.

This option was the overwhelming favourite, with 41 per cent of practitioners surveyed saying removing segregation for SMSFs altogether was the change they most wanted to see.

4. Give SMSF trustees a choice: The government’s proposed changes say trustees will be given the choice over what method they wish to use to claim ECPI. Practically, it would be difficult to regulate a system that provided this choice unless it was available in arrears.

That is, trustees and their advisers would be able to choose which method, or combination of methods, to use when completing their tax return based on the approach that gives the best tax outcome. Obviously, this could be good for trustees’ tax bills, although for most the differences are likely to be small.

Only funds that do not have DSFA and have periods of deemed segregation will have this choice. We estimate this will impact around 3 per cent of SMSFs. A downside to providing this flexibility is the likelihood of creating more work for SMSF practitioners. Calculations would be needed under each possible option, and for some funds there could be four or more, to determine which gives the best outcome. Rather than reducing red tape, this is likely to end up increasing complexity. SMSF practitioners certainly seem to think so, with only 18 per cent wanting to see this change introduced, the least popular option.

How would you remove segregation for SMSFs? Given the government’s proposed change to ECPI is the least popular and, according to our survey, the most popular option is to eliminate segregation for SMSFs altogether,

Chart 1: Changes accountants want to see to ECPI

4. Give trustees the retrospective choice of whether to use deemed segregation or include periods where the fund is 100% in retirement phase in the proportionate method calculation.

3. Remove segregation altogether for SMSFs together with an exemption from the requirement for an actuary certificate if the fund is 100% in retirement phase for the entire income year.

how would this be implemented?

Firstly, note in relation to a removal of the segregated method, the survey results qualify this by restricting the removal of this method to SMSFs. It would also be envisaged small Australian Prudential Regulation Authority (APRA) funds, also referred to as SAFs, would be included.

However, other APRA-regulated funds would still have the option to use the segregated method. Secondly, any removal of the segregated method would be only for the purpose of claiming ECPI. An SMSF would still be able to offer members multiple investment strategies and consequently segregate assets for investment purposes.

A removal of the segregated method for

1. Nothing – after three years, we’re across the new rules now and don’t want more changes.

18%

21% 20%

41%

claiming ECPI for SMSFs could be achieved by simply applying the DSFA definition to all SMSFs, not just those with members with total super balances over $1.6 million. This could be implemented by amending subsection 295-387(2)(c)(i) of the Income Tax Assessment Act 1997 (ITAA) and reducing the figure of $1.6 million to nil.

Remember, the $1.6 million in this section does not change in line with increases to the general transfer balance cap, another contributor to ECPI confusion and complexity. Further, sub-section 295387(2)(c)(ii) of the ITAA would need to be removed, otherwise a scenario could arise where an SMSF would not have DSFA in the income year it commences its first retirement-phase pension and would

2. Return to the pre-2017 approach where deemed segregation only applies when a fund is 100% in retirement phase for the entire year of income.

therefore be able to use the segregated method to claim ECPI. Provided SMSFs that are 100 per cent in retirement phase are exempted from the requirement to secure an actuarial certificate, this could significantly simplify administration. It would potentially come at the expense of higher tax bills for the small minority of SMSFs that are using segregation strategies to minimise their tax, but it seems this is a price many practitioners are willing to pay in return for reducing red tape and complexity.

Whichever approach the government takes for ECPI, we hope when it comes to deal with the proposed changes, Canberra engages with the SMSF industry to ensure it is an improvement on the current system.

QUARTER II 2021 31

STRATEGY

The nuance of 30 June 2021

Changes to the law and threshold adjustments have given certain standard year-end strategies new dimensions for the 2021 financial year, Meg Heffron writes.

MEG HEFFRON is managing director of Heffron.

The end of the financial year inevitably brings a flurry of activity and planning. And let’s be honest, it is particularly difficult to find time for this in 2021 when most SMSF practitioners are still dealing with the fallout from 2020.

So what are the headline items that should be exercising our minds as 2020/21 winds down?

First some of the obvious things – make sure minimum pensions are paid and get contributions in.

But what are the particular quirks this year?

Pensions When it comes to pensions, remember the rule allowing pension payments to be reduced to 50 per cent of the normal level is still in place for

32 selfmanagedsuper

2020/21. However, bear in mind that: • the way the calculation is done is that the normal drawdown rates are halved (that is, 4 per cent becomes 2 per cent, 5 per cent becomes 2.5 per cent and so on). It’s not the normal minimum payments themselves that are halved. This appears esoteric until the way in which rounding works for pensions means the two calculations don’t produce the same answer. And no one wants to underpay their minimum pension.

• the halving rule doesn’t apply to defined benefit pensions (complying lifetime, life expectancy or flexi pensions). Make sure these are paid at the normal levels (and indexed if required).

• it also doesn’t apply to maximum payments

from a transition-to-retirement income stream – these can remain at the normal 10 per cent.

Once upon a time it was common to see a flurry of pensions starting on 1 June each year for obvious reasons – the minimum payment required is $nil, but the tax exemption on investment income (exempt current pension income or ECPI) starts immediately.

This year the environment is different. As has been flagged in many articles recently, the general transfer balance cap increases to $1.7 million from 1 July 2021, but not everyone benefits from the full $100,000 increase. People who have ever used some or all of their transfer balance cap in the past get less – and in fact someone who has ever used the full $1.6 million cap will get no indexation at all.

Hence, there is a very real prospect that starting a pension now, before or during June, won’t make sense for at least some clients. They will need to weigh up: • the tax exemption available on their fund’s investment income if they commence a pension now (a one-off benefit) versus • waiting until 1 July 2021 to commence a pension to get the full $100,000 indexation (rather than just some or none of this increase). How valuable will it be to have an extra amount in a super pension for the rest of their days (probably a smaller but more long-term benefit)?

For some, the answer will be straightforward whereas for others it will not.

Contributions The usual rules about making contributions before the deadline apply – remembering that contributions aren’t made until they are received by the fund. For cash, this will often mean actually appearing on the fund’s bank statement. Those who leave it too late might need to dust off the fund’s cheque book. The one advantage of good old-fashioned cheques these days is that a contribution made by cheque is made as soon as it’s physically in the hands of

There is a very real prospect that starting a pension now, before or during June, won’t make sense for at least some clients.

the trustee as long as it is presented and cleared promptly and the contributor had enough to cover it in their bank account at the time.

But there are some extra decisions to make this year when it comes to contributions.

These are particularly acute for those around the 65 to 67 age bracket.

A great example is those turning (or who’ve already turned) 65 in 2020/21.

Traditionally, 65 was the year of thinking carefully about bring-forward rules for non-concessional contributions because it was the last year in which this tool to get large amounts into super could be used.

And under current law that’s still the case as the rules to move this age up to 67 are still stalled in parliament and may not make it through before 30 June 2021.

Funnily enough, the 65 year olds can actually be a little relaxed about that legislation.

Thankfully, they can now contribute up until their 67th birthday without needing to meet a work test. That means someone turning 65 in 2020/21 has both 2021/22 and 2022/23 to make more non-concessional contributions. If they can’t meet a work test (or make work test exempt contributions), they will need to make the 2022/23 contribution before their 67th birthday. But the fact they now

have until 67 means the decision to use the bring-forward provisions in 2020/21 isn’t quite so important, even if it does turn out to be their final chance to do so. They could still contribute $100,000 in 2020/21, $110,000 in 2021/22 and $110,000 in 2022/23. That’s $320,000 in as little as 15 months (April 2021 to July 2022). In a lot of ways that’s actually better than diving into a three-year bring-forward this year as doing so would lock them into only $300,000 over those three years, and rule them out of any further bring forwards in the event the new rules do eventually come in as expected.

The important caveat is that to make each of those contributions in 2021/22 and 2022/23, their total super balance at 30 June 2021 and 30 June 2022 will need to be less than the new threshold of $1.7 million.

But as long as their balance is low enough, the uncertainty about bringforward rules is not actually much of a concern for them.

What about those who turn 66 in 2020/21?

In some ways their lives are even simpler.

Under current laws they are not allowed to use the bring-forward rules this year. But they can contribute $100,000 as long as their total super balance was less than $1.6 million at 30 June 2020 and they were not already in the middle of a bring-forward period. They don’t need to worry about a work test until next year when they turn 67.

If the rules are changed to allow bring forwards up until the year in which they turn 67, they would probably look to do this next year in any case to maximise their contributions, with the classic pattern being $100,000 now and $330,000 in 2021/22. The key for them will be making sure that at 30 June 2021 their total super balance is less than $1.48 million, the new threshold for those looking to make three years’ worth of non-concessional contributions at once. And if the rules don’t change as expected? This won’t Continued on next page

QUARTER II 2021 33

STRATEGY

Continued from previous page

matter as they can still contribute $100,000 this year and $110,000 in 2021/22 before their 67th birthday if they can’t meet a work test or make work test exempt contributions. That’s certainly a better result than it used to be.

The only group who really are in a bit of a bind are those turning 67 this year who can’t meet a work test next year. Whether or not the new bring-forward rules come in will make the difference between a $300,000 contribution in 2020/21 or being limited to $100,000. For them, we just have to wait and see with fingers crossed.

Doubling up One point on contributions worth singling out is the particular quirks in 2020/21 for those who are using a particular strategy often referred to as the double deduction strategy. This is where an individual uses their normal concessional contributions cap throughout the year, but then makes an extra concessional contribution in June.

The SMSF rules allow that contribution to be held in the fund, but not allocated to the member until the following financial year (any time up to 28 July 2021). The beauty of it is that the contribution is tax deductible in 2020/21 (when it is made), but not checked against the concessional contributions cap until 2021/22 (when it is allocated).

For years, we’ve talked about this as being $25,000 throughout the year plus an extra $25,000 in June, resulting in a $50,000 deduction in total. This year, however, the extra amount in June can be $27,500. This is because the cap it will use is next year’s concessional contributions cap, which is increasing to $27,500 from 1 July 2021.

The rule also works for non-concessional contributions. And the considerations get even more nuanced for those contributions.

Again the principle is simple: an individual can make non-concessional contributions of $100,000 throughout

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The only group who really are in a bit of a bind are those turning 67 this year who can’t meet a work test next year.

2020/21 and an extra amount in June, which is not allocated until July 2021. The extra amount will be checked against the 2021/22 non-concessional cap of $110,000. But there are a few more twists to consider when doubling up on nonconcessional contributions in 2020/21.

As usual, the cap of $110,000 only applies for those with a total super balance of less than the relevant threshold at 30 June 2021. This will be $1.7 million, being the new general transfer balance cap after indexation has been applied, for everyone, even those who are not entitled to the full $100,000 indexation when it comes to their pensions.

The fly in the ointment is the $110,000 contribution in June 2021 will be counted

in the total super balance amount at 30 June 2021, even though the member hasn’t actually received it in their account at the time.

For example, Jim is 68 and met the work test this year. He won’t meet it next year. At 30 June 2020, his total super balance was $1.55 million and he made a $100,000 nonconcessional contribution in August 2020.

His balance today is around $1.68 million, including this $100,000 contribution, some earnings and less some pension payments.

He’s thinking of using this strategy to put an extra $110,000 into his SMSF while he can because he won’t be able to contribute next year. If he does, however, his total super balance at 30 June 2021 will be around $1.79 million, the balance now plus this extra $110,000. That means his non-concessional contributions cap next year is actually $nil.

The contribution will be excessive even though Jim feels like his balance is only $1.68 million at 30 June 2021.

Conclusion Planning for 30 June 2021, like any year, is important and requires attention now. In some ways the issues are familiar ones – get pension payments out and contributions in. However, the changing thresholds for both the general transfer balance cap and contribution limits do introduce some unique nuances this year.

COMPLIANCE

Revived residency importance

A new data-matching program has given superannuation residency rules greater significance.

Nicholas Ali takes a look at these rules and provides some solutions available to SMSF advisers and members to avoid falling foul of them.

NICHOLAS ALI is SMSF technical support executive manager at SuperConcepts..

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The Department of Home Affairs will now provide the ATO with arrival and departure records of travellers to and from Australia for the 2017 to 2023 financial years.

The new data-matching program announced on 13 April will allow the ATO to verify the identity and residency status of individuals, ensuring they comply with their registration, lodgement, reporting and payment obligations for tax and superannuation purposes.

The regulator expects the personal information of about 670,000 individuals to be analysed each financial year, with the data to include, among other things, their arrival and departure date, passport information and residency or visa status.

What does this mean for members of SMSFs who reside or spend extended time overseas? While the regulator says data collected through the program will not be used directly to initiate automated compliance activity, it will help develop risk detection models to help the ATO profile, determine and assess taxpayers and their tax residency status.

With this recent announcement in mind, it is important to remember the residency requirements for superannuation funds and the penalties for funds that fail the tests.

For SMSFs to receive tax concessions, they must be considered complying super funds. To be a complying super fund, an SMSF must satisfy the residency test. To satisfy the residency test, an SMSF must meet the definition of an Australian superannuation fund. If a superannuation fund ceases to be an Australian super fund, the taxation concessions available to it will be lost.

For a fund to be considered an Australian superannuation fund it must satisfy all three of the following tests at all times during a financial year: • the fund was established in Australia, or any asset of the fund is situated in Australia,

• the central management and control of the fund is ordinarily in Australia, and • either the fund had no member who is an active member or at least 50 per cent of: i. the total market value of the fund’s assets attributable to superannuation interests held by active members, or ii. the sum of the amounts that would be payable to or in respect of active members if they voluntarily ceased to be members, is attributable to superannuation interests held by active members who are Australian residents. The definition of active member is a member who makes contributions to an SMSF.

Central management and control Assuming the first test can be readily satisfied, ATO Taxation Ruling (TR) 2008/9 communicates the tax commissioner’s interpretation of what constitutes central management and control. This centres on the strategic and high-level decision-making processes, which must be made in Australia.

Such activities would include: • formulating the investment strategy for the fund, • reviewing and updating or varying the fund’s investment strategy, as well as monitoring and reviewing the performance of the fund’s investments, • if the fund has reserves, the formulation of a strategy for their prudential management, and • determining how the assets of the fund are to be used to fund member benefits.

The day-to-day operational side of the fund’s activities, such as administrative duties, do not constitute central management and control. Examples of such activities provided in the TR include the physical investment of the fund’s assets, the fulfilment of administrative duties and the preservation, payment and portability of benefits.

For example, if the trustees are overseas and their financial planner executes investment decisions in line with the fund’s investment strategy, the central management and control will reside with the trustees of

the fund, not the financial planner.

The central management and control of the fund can be outside Australia temporarily and will still be considered within Australia, however, even if the trustees are overseas. Subsection 29595(4) of the Income Tax Assessment Act (ITAA) 1997 states: “To avoid doubt, the central management and control of a superannuation fund is ordinarily in Australia at a time even if that central management and control is temporarily outside Australia for a period of not more than two years.”

TR 2008/9 goes on to say: “Subsection 295-95(4) of the ITAA 1997 does not otherwise restrict the meaning of ‘ordinarily’ so that the CM&C (central management and control) of the fund can only be outside Australia for a period of two years or less. If the CM&C of the fund is outside Australia for a period greater than two years, the fund will satisfy the CM&C test if it satisfies the ‘ordinarily’ requirement in paragraph 29595(2)(b) of the ITAA 1997.

“While the CM&C of a fund can be outside Australia for a period greater than two years, the period of absence of the CM&C must still be temporary.

Furthermore, if the CM&C of the fund is not temporarily outside Australia, it will not be ‘ordinarily’ in Australia at a time even if the period of absence of the CM&C is two years or less.”

A crucial test is whether the trustees and/or members are permanently moving overseas. If it is evident they are moving overseas permanently, then central management and control may likely ordinarily reside outside Australia. Given the ATO’s data-matching capabilities announced, issues of fund non-residency may become more prevalent, with catastrophic taxation implications.

Case study Hamish and Sandy are trustees and members of the Senator Superannuation Fund, which is an SMSF. Hamish is seconded to work for an extended period in Japan, and Hamish and

Sandy have no planned return date to Australia. Hamish and Sandy earn income in Japan and are residents of Japan for tax purposes. Neither Hamish nor Sandy intend contributing to superannuation while they are overseas.

In this instance, central management and control – the high-level and strategic decision-making – of the Senator Superannuation Fund will most likely be conducted outside Australia by Hamish and Sandy. Tasks performed by accountants, administrators or investment managers would not normally constitute high-level central management and control, but rather operational and day-to-day management of the fund’s activities.

This may mean the fund is not considered an Australian superannuation fund as it has not satisfied all of the tests at all times during the financial year and thus it may be made non-complying.

The Senator Superannuation Fund had the following value and components at the end of the financial year: Fund value $1,200,000 Less non-concessional contributions $200,000 Total $1,000,000 Tax at 45% ($450,000) Therefore, the fund will lose $450,000 in tax. The tax commissioner is unable to exercise any discretionary powers where a fund is made non-complying due to it failing to meet the definition of being an Australian superannuation fund. As can be seen from the above example, this is a disastrous outcome for Hamish and Sandy.

An effective way to ensure central management and control remains in Australia is for members to execute an enduring power of attorney. This is simply an instrument that enables a person (the donor) to empower another person (the attorney) to make financial and property decisions on their behalf. Therefore, while fund Continued on next page

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members and trustees are outside Australia, they may establish enduring powers of attorney to ensure central management and control remains in Australia (as conducted by the person with the enduring power of attorney) and the fund remains a complying superannuation fund.

The attorney stands in the non-resident’s place and can act as individual trustee or director of the corporate trustee, undertaking the high-level and strategic decision-making in Australia. As outlined in TR 2008/9, it is important the central management and control is being made by the attorney and they are not acting on instruction from the trustee/member while they are overseas. If this is the case, central management and control may be considered to reside with the trustee/ member who is not in Australia and the SMSF may not satisfy the definition of being an Australian superannuation fund.

Implementing an enduring power of attorney is a crucial consideration for those who have their own SMSF and are considering working or residing overseas.

Planning prior to the trustees/members leaving overseas can mitigate against the fund becoming non-complying and the adverse tax consequences that come with it.

Active member test To recap, the active member test will be satisfied at all times during the financial year if either: • the fund had no active members at all during that financial year, or • if the fund has one or more active members at any time during the financial year – the aggregate of the member balances of the non-resident active members must be less than the aggregate of the member balances of all resident active members.

A member is an active member in a financial year if a contribution to the fund has been made for or by them during that financial year.

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In this context, contributions mean benefit transfers and rollovers and not merely new contributions to the superannuation system.

Non-resident members can still make contributions and the fund still satisfy the definition of an Australian superannuation fund if the non-resident member’s account balances are less than the aggregate of the balances of resident active members.

However, this is fraught with danger, as consequences of getting this wrong can be catastrophic.

Given the AT O’s datamatching capabilities announced, issues of fund non-residency may become more prevalent, with catastrophic taxation implications.

Case study The Podil Superannuation Fund has three members – Katya, Tatiana and Vika. Vika is a non-resident member and has a balance of $1 million. Katya has a balance of $750,000 and Tatiana has a balance of $350,000.

All three members are active members, that is, they all contribute to the fund. Vika – the non-resident member – could make contributions to the fund as her member balance is less than the combined member balances of the resident members – Katya and Tatiana. But the contribution cannot result in Vika having a balance greater than the aggregate of the balances of Katya and Tatiana. Remember, the fund must satisfy all three tests at all times during a financial year.

Furthermore, if one resident member, say Katya, was to leave the fund during the year, this would cause Vika’s fund balance, the non-resident active member, to be greater than that of Tatiana, the remaining resident active member. From the time Katya left the SMSF it would have failed the active member test and in doing so it cannot qualify as a resident regulated superannuation fund and would therefore lose its compliance status.

One option would be to ensure non-resident members are not active members or to ensure non-resident members contribute to an Australian Prudential Regulation Authority-regulated superannuation fund while overseas and roll the benefit to an SMSF when they become resident members.

The importance of an enduring power of attorney if members are to reside overseas cannot be overstated nor can satisfying the active member test. A fund not satisfying the residency rules is seriously at risk of being made non-compliant as can be seen in CBNP Superannuation Fund and Commissioner of Taxation [2009] AATA 709.

Plan ahead and seek advice It is important for SMSF members and trustees to appoint an enduring power of attorney when they go overseas for an extended period. If this is not done, the fund may not be considered an Australian superannuation fund for ITAA 1997 purposes. This may lead to the loss of tax concessions enjoyed by complying superannuation funds.

If any of the above conditions are not satisfied, the fund may become noncomplying, with potentially disastrous tax consequences. If the fund cannot meet the definition of an Australian superannuation fund, an amount equal to the market value of the fund’s total assets, less any contributions the fund has received that are not part of the taxable income of the fund – such as nonconcessional or undeducted contributions – will be included in the fund’s assessable income and taxed at the highest marginal tax rate.

STRATEGY

A radical SMSF approach – part three In the third part of this series, Grant Abbott continues exploring the possibility of a multiple-member SMSF with a single trustee structure.

GRANT ABBOTT is founder of LightYear Docs.

In the first two instalments of this series on a new radical way of running an SMSF, I acknowledged some common reasons why SMSF members would be reluctant to act as trustees of the fund. These included nervousness around the ability to be sued and the mental capacity of older individuals.

As I have alluded to there is a solution at hand and it begins with a statement that will change many people’s deep-seated beliefs on what is required to have a compliant SMSF: not all trustees must be members of an SMSF and also not all members must be a trustee of an SMSF. My authority for this statement is section 17A(3) of the Superannuation Industry (Supervision) (SIS) Act 1993 and also numerous ATO guidelines. And let’s face it, who am I, or for that matter any lawyer, compliance officer, accountant, planner or auditor, to argue against it?

The law Section 17A provides a definition of what an SMSF is and provides in subsection (1) that all members must be trustees and all trustees must be members.

So, no joy there to back up the argument. In fact, it is exactly the opposite.

But section 17A(3) provides as follows: (3) A superannuation fund does not fail to satisfy the conditions specified in subsection (1) or (2) [that basically require a member to be a trustee or director of a corporate trustee] by reason only that: (a) a member of the fund has died and the legal personal representative of the member is a trustee of the fund or a director of a body corporate that is the trustee of the fund, in place of the member, during the period: Continued on next page

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Continued from previous page

( i) beginning when the member of the fund died, and (ii) ending when death benefits commence to be payable in respect of the member of the fund, or (b) the legal personal representative of a member of the fund is a trustee of the fund or a director of a body corporate that is the trustee of the fund, in place of the member, during any period when: (i) the member of the fund is under a legal disability, or (ii) the legal personal representative has an enduring power of attorney in respect of the member of the fund.

The definition of legal personal representative in section 10(1) of the SIS Act says: “Legal personal representative means the executor of the will or administrator of the estate of a deceased person, the trustee of the estate of a person under a legal disability or a person who holds an enduring power of attorney granted by a person.”

The ATO’s view Let’s see what the commissioner of taxation has to say publicly on members not being trustees or a director of a corporate trustee.

ATO Community Forum: Trustee question:

My wife and I are the sole members of our family SMSF. Both of us are trustees. My wife is having some health issues where she may not be capable of making her own financial decisions in the future. If she establishes a power of attorney and appoints me as the attorney, what impact will this have on our SMSF if I invoke the power of attorney? Specifically, can my wife remain as a trustee? If she is not able to remain as a trustee, can she remain a member of the fund? Is it possible to appoint another family member as

40 selfmanagedsuper

Not all trustees must be members of an SMSF and also not all members must be a trustee of an SMSF.

a trustee without that person being a member of the fund?

ATO response:

Generally speaking, a legal personal representative who holds an enduring power of attorney granted by a member may be a trustee of the SMSF, or a director of the corporate trustee of the SMSF, in place of the member without causing the fund to fail to satisfy the definition of an SMSF. Self-managed superannuation funds ruling SMSFR 2010/2 – Self-Managed Superannuation Funds: the scope and operation of subparagraph 17A(3)(b)(ii) of the Superannuation Industry (Supervision) Act 1993, explains the commissioner’s views. In particular, paragraph 17 states: “A member can execute an enduring power of attorney in favour of an existing member who is a trustee, or director of the corporate trustee, in their own right.

In that case, the donor member can cease to be a trustee, or a director of the corporate trustee, and the legal personal representative will be considered to be appointed in their place for the purposes of sub-paragraph 17A(3)(b) (ii).”

In other words, the donor member must resign as trustee, but can remain a member of the SMSF. This does not contravene subsection 17A(1) because it is considered that there are two trustees as the trustee is replacing the donor trustee.

The resignation of the member as a trustee must be in accordance with the trust deed. The SMSF’s trust deed must allow

for the appointment of the legal personal representative, holding the power of attorney, as a trustee.

SMSFR 2010/2 The commissioner states the following: Under sub-paragraph 17A(3)(b)(ii) a legal personal representative who holds an enduring power of attorney granted by a member may be a trustee of the SMSF, or a director of the corporate trustee of the SMSF, in place of the member without causing the fund to fail to satisfy the definition of an SMSF. A person who holds an enduring power of attorney for a member qualifies as a legal personal representative. In order to comply with sub-paragraph 17A(3)(b)(ii), the legal personal representative must be appointed as a trustee of the SMSF, or a director of the corporate trustee of the SMSF. The member must cease to be a trustee of the SMSF or a director of the corporate trustee except where the legal personal representative is appointed as an alternate director.

The appointment of the legal personal representative as a trustee and the removal of the member must be in accordance with the trust deed, the SIS Act and any other relevant legislation. The appointment of the legal personal representative as a director of the corporate trustee and the removal of the member from this position, must be in accordance with the constitution (if any) of the corporate trustee, the SIS Act and the relevant provisions of the Corporations Act 2001.

Where an enduring power of attorney is executed in favour of multiple attorneys, one or more of those attorneys can be appointed as a trustee, or a director of the corporate trustee, in place of the member.

Similarly, multiple members can execute an enduring power of attorney in respect of the same legal personal representative who can be appointed as a trustee, or a director of the corporate trustee, in place of each of those members. (This means we can have a four-member superannuation fund with only one trustee who holds the others’ enduring powers of attorney and the fund would still meet the membership

Next time it comes around to client review time, take a long hard look at each of the trustees or corporate directors of the SMSF.

of attorney in respect of each of them.

In addition, Trevor is now the trustee of the SMSF in place of both Andrew and Jane. Once appointed as trustee, Trevor is subject to civil and criminal penalties in the event he breaches his duties. Provided the enduring power of attorney remains valid during the period Trevor is the trustee and given that the other requirements of sub-paragraph 17A(3)(b)(ii) are satisfied, the superannuation fund continues to satisfy the definition of an SMSF in subsection 17A(1), notwithstanding that Andrew and Jane are no longer trustees.

Example 2

requirements of an SMSF.) Finally, a member can execute an enduring power of attorney in favour of an existing member who is a trustee, or director of the corporate trustee, in their own right. In that case, the donor member can cease to be a trustee, or a director of the corporate trustee, and the legal personal representative will be considered to be appointed in their place for the purposes of sub-paragraph 17A(3)(b)(ii).

Example 1

Andrew works for a large international group of companies. He and his wife, Jane, are trustees and members of their SMSF. From 1 February 2009, Andrew is transferred to an overseas company for an indefinite period of time. In accordance with the relevant state legislation, Andrew and his wife each execute an enduring power of attorney in favour of their friend and retired accountant, Trevor. In addition, Andrew and Jane both resign as trustees of their SMSF and appoint Trevor as the trustee. The appointment of Trevor as trustee is in accordance with the terms of the trust deed. Other than the fact that Andrew and Jane are not trustees of the SMSF, the superannuation fund satisfies the other requirements of the definition of an SMSF in subsection 17A(1).

Trevor is a legal personal representative of both of the members, Andrew and Jane, by virtue of holding an enduring power

Clare runs a single-member SMSF. The trustees of the SMSF are Clare and her daughter, Jan. Clare has found that, as she nears retirement, the responsibilities of being a trustee of the SMSF have become too difficult and time consuming for her. She executes an enduring power of attorney for Jan in accordance with state legislation. Clare resigns as a fund trustee, leaving Jan as the sole remaining trustee.

Other than the fact Clare is not a trustee of the SMSF, the fund satisfies the other requirements of the definition of an SMSF in subsection 17A(1).

Putting it into practice There you have it, not all members must be trustees and not all trustees must be members. So next time it comes around to client review time, take a long hard look at each of the trustees or corporate directors of the SMSF and offer them the opportunity, after explaining how the commissioner is becoming increasingly demanding of trustees and that they may be better off leaving only one or two members in the firing line as trustee or director. This also saves you as an adviser as you will only be dealing with those individuals in the fund who have the understanding and ability to act as a trustee.

But to do it put everything else in place: 1. Check the current deed and if it is inadequate around legal personal representatives acting as trustee, then upgrade it. The last deed I wrote for

LightYear Docs was worded as follows: “If a member of the fund becomes incapacitated, or chooses to no longer act as trustee while remaining a member of the fund, the member’s legal personal representative is to be automatically appointed as a replacement trustee if there is no corporate trustee.”

2. For a corporate trustee, an enduring power of attorney cannot install a replacement director by the donor member. It must be in the constitution.

The special purpose SMSF corporate trustee constitution I authored for LightYear Docs provides for a successor director to act on behalf of the member. It also requires a special binding resolution by current directors to install the successor director in the event of incapacity or resignation of the member as director.

If there is no current procedure in the fund’s special purpose company constitution, then upgrade it to allow for the successor director to take the place of the current director during their life and on their death. This is a successor director solution, not the alternative director solution noted by the commissioner in SMSFR 2012/2, due to the fact the alternative director role ceases on death and we still want continuity after death to pay out death benefits immediately.

3. The enduring power of attorney should have a specific clause, after G v G (No 2) [2020] NSWSC 818, enabling a replacement trustee to be put in place such as: “The attorney is authorised to act on behalf of the principal for the superannuation fund or superannuation funds, including acting as a replacement trustee or replacement director while this enduring power of attorney is valid and the principal has consented to them acting as such.”

The issue of having only cognisant, aware and savvy members acting as trustee or director of the corporate trustee is as much about asset protection as it is about estate and incapacity planning.

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The fee dependency dilemma

Under the amended version of APES 110, referrals represent a threat to the independence of SMSF auditors. Kevin Bungard outlines the risks and safeguards of which these practitioners need to be aware to meet the new fee dependence requirements.

KEVIN BUNGARD is Australian general manager at MyWorkpapers.

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The audit of SMSFs is unusual when compared to other audit engagements. In most cases, despite being responsible for engaging the fund’s auditor, trustees do not select the auditor themselves, but instead typically engage the auditor their adviser, accountant or administrator has referred to them.

Under the amended independence standard, APES 110 Code of Ethics for Professional

Accountants (including Independence Standards), November 2018, APESB, these referrals can be considered a threat to an auditor’s professional conduct.

The associated guidance material, Independence Guide – Fifth Edition, May 2020, APESB, outlines the risks and safeguards auditors must consider to avoid breaching the

fee dependence provisions of the independence standard.

In this article we are only examining the risk of fee dependence from referrals.

There are other threats you should also consider that can result from the nature and the importance of any particular client or referrer. You should refer to APES 110 to understand those other risks.

Fee dependence likely to be a big issue in the coming financial year The amended independence standard is expected to lead to a massive reallocation of audits post 30 June 2021. An estimated 200,000 to 300,000 SMSFs, representing around half if not more of the total number of funds in the sector, are expected to have to change auditor in the coming financial year.

This disruption is going to see existing firms, new firms and firms exchanging previously in-house audits taking on large inflows of new audits from referral sources.

Understanding and managing the threat these referrals represent to a firm’s independence is critical to ensuring your practice complies with the new standards during this disruptive period.

What is fee dependence?

An auditor’s independence is at risk of being compromised, or perceived to be compromised, if a referral source accounts for a large proportion of their revenue.

The threat being the auditor, out of self-interest and/or due to intimidation from the referrer, may not perform an audit adequately if they fear losing the business of the referrer. For example, the auditor may overlook reporting an adverse finding on a fund because the accountant has threatened to take their business elsewhere if the auditor keeps bringing up particular issues the client considers to be unimportant.

In commercial relationships it is common for larger key clients to leverage their value to a supplier and receive more

favourable commercial terms and other concessions.

For instance, if a large auditor is approached by a large administrator with say 5000 SMSFs, the administrator is likely to extract significant commercial concessions from the audit firm. Such an arrangement could be worth $1.5 million even at a volume discounted price of $300 per audit and even if the audit firm is auditing say 25,000 funds, this could represent around 20 per cent of the firm’s revenue.

Clearly the revenue from the arrangement in the example above is very important to the audit firm, but does it represent a threat to audit independence?

Every large client has some commercial leverage over an audit firm, but at what point, or under what circumstances, does that leverage become a threat to audit independence?

An estimated 200,000 to 300,000 SMSFs, representing around half if not more of the total number of funds in the sector, are expected to have to change auditor in the coming financial year.

What percentage of fee dependence represents an acceptable risk?

Scenario 6 in the APES guide best highlights the risk the independence standard is trying to avoid. In this scenario an auditor is offered referrals from an administration firm that would effectively double the fee base of the auditor. If no safeguards are put in place, the guide makes it clear a situation where the auditor receives 50 per cent of its revenue from one referral source would not be acceptable.

It should be noted this scenario is just an example from the guide and the standard itself does not mention any specific percentage that would apply in these situations.

Nonetheless, most people are likely to agree 50 per cent or more of revenue from one source represents a significant threat to the viability of a business or a business unit, and by inference, this could be a risk to the independence of an audit. As we will see later, this rule of thumb measure

based upon what most people would agree on is actually more important than you might think.

So, if we follow the guide, we have a clear ‘50 per cent rule’, that is, 50 per cent or more of revenue from one source is generally too much.

Acceptable risks and public interest entities v SMSFs The independence standard holds the auditors of public interest entities, such as banks and large superannuation funds, to a higher standard than that of auditors for other organisations.

The actions of banks and large super funds can impact millions of people, so this is appropriate. Although it is not generally advisable to apply these standards to nonpublic interest entities such as SMSFs, we can, in the absence of anything else, use Continued on next page

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Continued from previous page

them as a guide.

The independence standard requires the auditors of public interest entities to apply safeguards to ensure independence if a client represents 15 per cent or more of revenue over two consecutive years.

Unfortunately the standard does not set an upper limit on what percentage of single-source revenue is acceptable in the case of SMSFs. There is no clear statement in the standard on whether 49 per cent of revenue is acceptable or 40 per cent or 20 per cent. Nor is there any guidance as to whether the action should be taken after one or two years.

So what should an auditor do if revenue from a single referral source accounts for between 15 per cent and 50 per cent of total income? In short, they should use their professional judgment.

The standard provides a kind of pub test except in this pub, which I imagine would be called The Tick and Flick, everyone is a “third party who has relevant knowledge and experience to understand and evaluate”. Essentially, if

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an auditor reasonably believes that other, independent, informed people agree they have applied the “reasonable and informed third-party test”, then they have met the requirements of the standard.

What fee base is used when calculating fee dependence?

We know 50 per cent of revenue is too much, but 50 per cent of what? If the auditor is part of a large firm, does it mean they should calculate their dependency as the SMSF referral fees against total firm revenue? No, the fee base to be used for this calculation is that attributed to the partner or the business division the auditor works in.

In a small practice, the entire revenue of the firm is likely to be shared and the practice is unlikely to have any formal separation of revenue by division, so the total fee base of the firm would be used.

For larger firms if the revenue is split by partner, division or office, then the revenue of the applicable part of the business should be used. For example: • if the firm has a dedicated audit partner, then the revenue attributed to that

An auditor’s independence is at risk of being compromised, or perceived to be compromised, if a referral source accounts for a large proportion of their revenue.

partner should be used, but would include any non-SMSF audit fees, or • if a firm has a separate, specialist, SMSF audit division, then only that division’s fees would be included.

A convenient way to think about this is in terms of how the performance of the partner is measured. If the partner is measured only by the amount of SMSF

work or audit work that they bring in to the business, then that is the revenue pool that should be considered, however, if they have broader responsibilities, then you should include all the other areas they also oversee.

What safeguards can be applied?

Several of the other risks included in the independence standard cannot be made acceptable via any safeguards. For instance, the risk from in-house audits cannot be eliminated and an auditor performing them will always be in breach.

Fortunately, in the case of fee dependence, the guide firstly suggests you grow your business to reduce the threat. Of course, growing a business takes time so in the short term you may still be in breach, particularly if the situation occurs over two or more consecutive years.

Thankfully, you can also reduce this risk

to an acceptable level by using a thirdparty reviewer. This involves having the work reviewed by a “professional with the necessary knowledge, skills, experience and authority to review, in an objective manner”. The guide notes this may include external quality reviews or external consultation on key audit judgments.

Timing is important The one-to-two-year timing consideration is important because the standard does recognise that “whether the firm is well established or new” is a factor that needs to be considered when evaluating the risk that any fee dependence represents.

A “reasonable and informed third party”, and a regulator for that matter, is far more likely to consider a fee dependence threat as acceptable if it occurs at the start of a relationship and if the firm is taking steps to grow their way out of the situation.

The longer this situation persists, the less likely it becomes a firm will be able to justify its independence.

Summary Referrals represent a significant risk under the amended independence standard.

Given the massive disruption and reallocation of work expected to occur in the coming financial year, it is important to understand the scale of that risk to your practice and, where necessary, firms need to take steps to eliminate this threat by applying safeguards such as external reviews in the short term.

Longer term, the audit partners in firms should have a goal to grow their audit business to encompass a broad client base and to have enough funds to ensure independence, not just because of the standard, but also because it is good business practice.

KEY POINTS •

You must use the correct revenue base when calculating fee dependence.

•

The revenue base to use is that of the partner or the business division the auditor works for or of the entire firm if there is no separation.

•

Having one client referring less than 15 per cent of your revenue is generally acceptable.

•

If a client is referring 15 per cent to 50 per cent of revenue, and particularly if this occurs in two consecutive years, you should use your professional judgment and apply the “reasonable and informed third-party test” and decide if you should apply safeguards such as external reviews.

•

Having one client referring 50 per cent or more of your revenue is unacceptable unless safeguards can be applied.

•

Growing your SMSF audit business to reduce fee dependency on a referral source to less than 50 per cent at least and ideally to less than 15 per cent should be a priority.

QUARTER II 2021 45

STRATEGY

Indexation – winners and losers

The application of indexation to several superannuation thresholds will take effect in the new financial year. Tim Miller examines the associated complexity and identifies who the beneficiaries will be from the move.

TIM MILLER is education manager at SuperGuardian.

46 selfmanagedsuper

From 1 July 2021, the general transfer balance cap will be indexed to $1.7 million, which is great news for any individual who hasn’t started to receive a retirement-phase income stream prior to that date.

Similarly, the concessional contribution cap will be indexed from $25,000 to $27,500, which in turn means the non-concessional cap gets a boost from $100,000 to $110,000 as well, and this has given us plenty of contribution strategy food for thought.

However, not everyone should get excited because while change brings opportunity, it comes with a requirement to understand what that change means for everyone, and in this instance it’s different for everyone.

The positives of the higher transfer balance cap are clearly there for those still in accumulation

phase with less than $1.7 million. You can put more into retirement phase and ultimately you can put more contributions into a fund. Similarly, those in a transition-to-retirement income stream (TRIS) who are yet to trigger a condition of release to move them to retirement phase will also be satisfied as they may need to commute less of their TRIS when they do trigger a condition. Of course, there are also benefits for those chasing spouse contribution rebates and government co-contributions.

However, for individuals who have already used their full cap, there is little joy, and for those who have used part of their cap, welcome to the world of the indexed personal transfer balance cap.

Indexing the personal cap This is where the fun starts. For those who have already started a pension with $1.6 million, it’s about sitting back and not even bothering to think about further pensions. What they can think about is whether they are eligible to make more contributions because of their total superannuation balance and then whether it is worthwhile putting those extra

contributions into the fund. The problem with contributing once an individual has maxed out their personal transfer balance cap is that all earnings on the contributions will be taxable as they will not form part of exempt current pension income, but also those earnings will count towards the individual’s taxable component, meaning there may be some estate planning considerations if the proceeds are paid to a non-tax dependant.

For those who previously started a pension for less than $1.6 million, there is the allure of indexing the personal transfer balance cap based on the unused cap space. While this sounds exciting, it really doesn’t leave much scope for indexation if the previous pension was commenced with any amount just shy of $1.6 million. Sure, if someone commenced a pension for $800,000, then they are going to get at least half of the indexed amount and this is why it is critical people understand how the indexation works.

Impact on personal transfer balance cap As identified above, the amount of indexation available to an individual is calculated proportionately based on their unused cap space. When the cap is met or exceeded, there is no entitlement to any indexation.

Where the cap isn’t met, proportionate indexation is available, and then the situation becomes more complex. When the general transfer balance cap becomes $1.7 million on 1 July 2021, an individual can have a personal transfer balance cap anywhere between $1.6 million and $1.7 million.

To reiterate the initial comment, if a member commences a retirement-phase income stream for the first time after 1 July 2021, their personal transfer balance cap will be $1.7 million.

If a retirement-phase income stream commenced before indexation, the personal transfer balance cap will be: • $1.6 million if at any time between 1 July 2017 and 30 June 2021, the highest balance of the transfer balance account was $1.6 million or more, or • between $1.6 million and $1.7 million

Table 1 Unused proportion (%)

Indexed value ($)

1.6 million

0

0

1.5 million

7

7000

1.2 million

25

25,000

1 million

38

38,000

800,000

50

50,000

500,000

69

69,000

Pension commencement ($)

for all other cases, based on the highest balance in the transfer balance account.

Therefore, if an individual’s transfer balance account was $1.6 million or more between 1 July 2017 and 30 June 2021, they will have a personal transfer balance cap of $1.6 million regardless of whether they subsequently reduced their transfer balance account balance before indexation via a commutation. Where the full cap has not been used, the transfer balance account is used to calculate the proportional increase and thus determining the new personal transfer balance cap that applies to the individual’s affairs.

One thing to note is if a reversionary pensioner starts to receive a pension during the 2021 financial year, but has no other retirement-phase pensions, their highest transfer balance account value will be nil ($0) at 30 June 2021 and they will be entitled to full indexation of $100,000, resulting in their personal transfer balance cap being increased to $1.7 million.

How to calculate the proportionate increase The proportionally indexed transfer balance cap is calculated by the following process: • determine the highest-ever balance in the transfer balance account,

• use the highest-ever balance to calculate the proportion of the cap used, as a percentage (rounded down to the nearest whole number), and then subtract from one to determine the ‘unused cap percentage’, • multiply the unused cap percentage by the indexation increase of $100,000, and • this dollar figure is then added to the original personal transfer balance cap to represent the new cap.

In very simple terms, as highlighted above, if someone starts a pension in 2020/21, or prior, with $800,000, then they have a personal cap of $1.6 million with an unused proportion of 50 per cent, meaning when the general cap is indexed by $100,000, they get an extra $50,000 added to their personal cap. Table 1 gives a range of examples.

Example 1

An individual commences their first retirement-phase pension on 1 February 2020 for $1.1 million. This represents the highestever balance of the transfer balance account as no further transactions have occurred.

• The unused cap percentage is ($1.6 million - $1.1 million) / $1.6 million = 31% Continued on next page

QUARTER II 2021 47

COMPLIANCE STRATEGY

Continued from previous page

(rounded down) • The personal cap will be indexed by 31% x $100,000 = $31,000 • Personal cap after indexation = $1.6 million + $31,000 = $1.631 million It is also important to note that in the above example, if there had been a commutation from the pension, it would have been ignored and the highest-ever balance of the transfer balance account would still be used to calculate the proportionate indexation increase to the cap. The following example highlights this.

Example 2

An individual commences their first retirement-phase pension on 1 July 2019 for $1.6 million. They then take a partial commutation of $800,000 on 1 July 2020.

Their transfer balance account is currently looking as in Table 2.

The following happens when indexation comes in on 1 July 2021: • indexation of the general cap occurs, • the personal cap indexation is nil as the highest account balance is $1.6 million, • personal cap stays at $1.6 million, and • available cap space is $800,000.

In this example, there is no indexation available to the personal cap as they have already commenced a pension using 100 per cent of their cap at that time, therefore, they have no future entitlement to indexation. They are entitled to commence a further pension to bring their transfer balance account up to their cap, but it won’t be indexed.

As they say, every bit helps and so if an individual can squeeze a few extra thousand dollars into a retirement-phase pension and have the capacity to make a contribution to get them there, then what’s to say there is no real benefit. It’s just a matter of understanding how the caps work.

The contribution kick While on the subject of real benefit, the real benefit for contributors came with the

48 selfmanagedsuper

Table 2: Example 2 Event

Credit

Debit

Balance

1/7/2019 Pension commencement

$1.6m

$1.6m

$800,000

$800,000

1/7/2020 Pension commutation

confirmation the concessional contribution cap will be indexed from 1 July 2021. We now have clarity that the concessional cap will rise to $27,500 and the non-concessional cap to $110,000, and along with it the maximum bring-forward increases to $330,000.

The contribution cap increase is a positive, but there is an even greater contribution benefit with an increasing transfer balance cap. Anyone with a total superannuation balance of less than $1.7 million on 30 June 2021 will be able to make non-concessional contributions, subject to satisfying the contribution rules. With an age increase, up to 67, and a balance rise, up to $1.7 million, some SMSF members, who otherwise would have missed out, will be able to make the most of this benefit from 1 July. Of course, the icing on the cake would be if the bring-forward rules eventually pass through parliament as this would be a boost for those aged 65 or 66 on 1 July 2021 as they will be able to fully maximise the bring-forward provisions with a balance under $1.48 million, assuming the caps are also indexed.

Arguably there are more contribution benefits to an increased cap than there are pension benefits.

The segregation dilemma If there is one glaring anomaly with the introduction of the transfer balance cap and the total superannuation balance provisions, it is the disregarded small fund asset rules. Not to suggest that these don’t have the capacity to change in time, and acknowledging that some changes are on

the horizon, but to create segregation rules for SMSFs based on a fixed amount when the amount that can be put into a pension is an indexed amount seems counterintuitive.

That’s without even contemplating growth once a pension commences.

To be clear, the capacity for funds to use segregated assets for exempt current pension income purposes is linked to a total superannuation balance of $1.6 million, not the general transfer balance cap.

It just seems that linking the disregarded small fund asset rules to the general transfer balance cap would be more appropriate and would allow those individuals with a total super balance less than the transfer balance to commence a pension and segregate assets without cause for consideration based solely on an arbitrary figure. Segregation has its pros and cons and there will be winners and losers, but for a concept that confuses so many already, why make it more complex.

In conclusion So we can rejoice that we have a new transfer balance cap, at least some clients will, and we can rejoice it may provide some scope for contribution, pension, asset and estate planning strategies. It will also no doubt provide us with some lessons in understanding the rules. It’s a given some people will not understand how the indexation works, which will result in them exceeding their cap. That makes it our challenge to educate as many of those individuals as possible before that point to save them the angst and, of course, the tax.

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SMSF Cluedo: who, what, when and how

It is critical for practitioners to know if they are providing financial advice to an SMSF member or trustee as this knowledge can also play a part in defining the scope of advice, writes Bryan Ashenden.

BRYAN ASHENDEN is head of financial literacy and advocacy at BT Financial Group.

50 selfmanagedsuper

Sometimes providing advice on SMSFs can feel like a game of Cluedo. Not because you are trying to get away with murder, of course, but because there always seem to be so many unanswered questions.

Two of the biggest questions in providing advice, whether on SMSFs or not, are related to the how and when: how can I provide scaled advice and when can I provide it. This has certainly been a hot topic in recent times, with some confusion existing due to the Financial Adviser Standards and Ethics Authority (FASEA) Code of Ethics,

announcements from the Australian Securities and Investments Commission (ASIC) around COVID19-related relief and Australian financial services licensee policies.

Let’s start by dispelling some of these myths.

The FASEA issues have arisen as a result of Standard 6 of the code, which requires an adviser to “take into account the broad effects arising from the client acting on your advice and actively consider the client’s broader, long-term interests and likely circumstances”. If you have to think

Getting the answer on who advice can be addressed to can actually assist you in the provision of scaled or scoped advice in a compliant manner.

broad and long term, how can you scale advice? Doesn’t this lend itself to a more comprehensive analysis?

To this, I would make the following points. Firstly, we need to distinguish between what we consider and take into account versus what is actually provided to the client. A proper investigation of a client’s circumstances may require us to delve into their affairs to ensure we can provide the right advice. But this doesn’t mean we don’t have the ability to have the scope narrowed, ideally at the direction of the client.

Secondly, the intent of Standard 6 is not to prevent the provision of scaled advice. Indeed, in its latest draft guidance document to the code released in October 2020, FASEA has specifically called out that it recognises the importance scaled advice can play.

Rather, the intent of Standard 6 is to ensure if other matters relevant to the advice at hand are discovered during the advice process, they are not to be ignored. It doesn’t mean they have to be included in the scope, and indeed if their impact is material, they should be and the advice scope widened. What should occur, at a minimum, is that these other matters should be brought to the client’s

attention, their potential implications noted and a plan established as to when these matters should or will be addressed.

In terms of ASIC’s announcements over the past year around COVID-19 relief, the regulator has actually promoted the ability to provide scaled advice. Indeed, it has provided even greater relief, such as the ability to use a record of advice in place of a statement of advice where advice has been provided in relation to certain COVIDrelated matters, such as early access to superannuation. This has demonstrated ASIC’s willingness for scaled advice to be provided, to keep costs down (given there was a maximum fee that could be charged to the client if this relief was to be used) and ultimately to encourage more Australians to seek advice on these matters.

However, despite this relief, the use of scaled advice in these scenarios was perhaps far less common than what the regulator had expected, particularly given many in the financial advice industry had been calling for concessions of this nature.

Why was this the case? Perhaps it was due to many being hesitant and wary of doing the wrong thing. In a post-royal commission environment, ensuring all advice was delivered in a compliant and complete manner has perhaps come at the cost of ensuring advice can be delivered in a way that is easiest for the end consumer to actually consume. In some situations we have seen statements of advice become lengthy due to the level of disclaimers and disclosures being included to ensure nothing has been missed, and that it is clearly called out to the client what constraints or limitations apply to the advice provided. In some cases, the way to reduce the number of those limitations is to actually not limit the advice and broaden its scope.

But does this mean the ability to provide scaled or scoped advice, particularly when it comes to SMSFs, has almost disappeared?

The answer to this has to be no.

When it comes to providing SMSF advice, the questions of who and what are vitally important, and the answers to these

questions can help guide you through the advice process and help work out whether scaled advice is possible, and even more so, if it is preferable. Who are you advising and what are you advising on?

The who sometimes seems obvious on the face of it – I am providing advice to my client. But the real question is in what capacity are you providing the advice.

Are you advising them as an individual/ member of the fund, or are you advising them as an SMSF trustee? In some advice scenarios it could be either, so your decision here becomes important.

To use some examples to illustrate this, consider the following scenarios: • If you were providing advice to a client about the suitability of establishing an SMSF, you have to be providing that advice to the client as an individual.

You cannot be advising them in the capacity as a trustee as the SMSF does not yet exist.

• Advice to roll money into the SMSF, or contribute monies, again would be advice to the individual as it is advice about where the money is coming from, and this is clearly the case where it is the initial monies to help establish the SMSF. What about advice about how the monies that sit within the SMSF should be invested? Here, things may get a bit more complicated because the answer could be either. Trustees of the SMSF have an obligation to formulate an investment strategy that will set guidelines as to how the monies within an SMSF are invested.

However aren’t these guidelines often formulated by considering the risk profile of the members of the fund but the longterm outcomes being sought?

One way to potentially consider the answer to the ‘who’ in a scenario like this is to ask: “What would I do if the client was in a non-SMSF environment, such as in a retail fund?” In a scenario like that, would you address your advice about how your client’s super savings are invested to the Continued on next page

QUARTER II 2021 51

COMPLIANCE

Continued from previous page

trustee of the retail fund? Of course not, you would address you advice to the client directly and, if accepted, then look to implement via the retail super fund. The same logic can be applied when it comes to savings in the client’s SMSF. Address your advice to the client as a member of a super fund, albeit their own SMSF, and then if accepted, implement in the SMSF. It may, however, be a different approach if your client is a member of an SMSF with another person, often their spouse, and their super savings have been invested via the SMSF in a pooled manner. In this case, while you may be dealing with a particular account balance for each client, you aren’t really able to advise them individually on underlying investments in their SMSF, as they only have a portion of each underlying investment due to the pooled nature of the investments inside the fund. Your advice to the clients individually may be about the potential future impacts from their invested superannuation savings in the SMSF, how that affects other plans and the like, but not on the underlying investments themselves.

In a pooled investments scenario, your advice may be better directed to the trustees of the SMSF. Consider how you would approach a situation where a client is about to retire and commence an income stream from super. Again, your advice here would most likely be directed to the member as an individual and not as a trustee. The situation is about how the individual will fund their retirement needs. With no compulsory cashing of superannuation benefits anymore, there is no advice the SMSF trustees would require in these circumstances, other than perhaps regarding how to meet their payment obligations in the event of the passing of a member of the fund.

Closely related to the question of who are you advising or in which capacity is your client receiving the advice, is the question: “What are you advising on?”

Knowing what you are advising on can also

52 selfmanagedsuper

help you determine who your advice is addressed to.

Certain aspects of SMSF-related advice can, arguably, only be addressed to members in their capacity as trustees. If your client was considering undertaking a limited recourse borrowing arrangement in their SMSF, you should be directing that advice to the trustees, or the clients in that capacity, as it is the fund that is undertaking the borrowing rather than the members personally.

Similarly, advice about the investment strategy of the SMSF, including meeting the requirement to consider the insurance needs of the members, is advice that should be provided to the SMSF trustees as they are the ones who have a legal obligation to discharge these requirements.

Advice about a member’s own insurance needs, for example, whether they need increased life coverage in their circumstances, should be addressed to the member as it is about their personal situation. It can be implemented via the SMSF, but should be addressed to the person requiring the cover.

Getting the answer on who advice can be addressed to can actually assist you in the provision of scaled or scoped advice in a compliant manner. The reason for this is that advice to the trustees of an SMSF must naturally be a form of scoped advice.

There are only limited situations in which you would be advising the trustees of the super fund. You would not be advising the SMSF trustees on the ability of a member, for example, to access the age pension.

That is advice to the members in their personal capacity.

Having the ability to separate out who you are advising, and what you are advising on, not only can assist you in the ability to appropriately scale and scope your advice, it can also make it much clearer for your SMSF clients what your advice is and in what capacity they are receiving it. This is turn may assist them in being clearer on how to discharge their obligations as a trustee of an SMSF.

When it comes to providing SMSF advice, the questions of who and what are vitally important, and the answers to these questions can help guide you through the advice process.

Finally, there is perhaps an added benefit from being able to clearly and appropriately scale your advice. Standard 5 of the FASEA Code of Ethics requires you to ensure your clients understand the benefits, costs and risks of the advice you provide. If you can make it simpler and clearer by identifying who you are advising, then this may go a long way to assist you in meeting the requirements under this standard as well.

STRATEGY

The common theme in death: part one

More often than not, superannuation is a significant factor when a person dies. In part one of this two-part series, Jemma Sanderson highlights certain actions that can be taken to ensure death benefits are passed on to the right people.

With our ageing population, superannuation becoming a significant asset for many Australians and the introduction of the transfer balance cap (TBC) provisions effective from 1 July 2017, there are a plethora of considerations when an SMSF member dies. Importantly, things may not always be as they seem within a fund and it is useful where possible to put all the pieces of the puzzle together before death.

JEMMA SANDERSON is a director at Cooper Partners.

BDBNs Fund members may be unconcerned about what happens upon death with their super as they have a binding death benefit nomination (BDBN) in their fund, or the favourite reassuring thought that “it’s okay, it’s in my will”. However, as cases in recent times have shown us, who receives the money

or who makes the decision about the money can rest on the presence or not of a BDBN or similar instruction to the fund.

Issues that are often encountered with BDBNs (or similar binding instructions) include: 1. The nomination doesn’t articulate an eligible beneficiary under the Superannuation Industry (Supervision) Act and therefore it is invalid (as demonstrated in Munro & Anor v Monro & Anor [2015]).

2. If the nomination isn’t executed in accordance with the deed, then it will be invalid.

3. Where a nomination is invalid, the deed will then prescribe the decision-making with respect to Continued on next page

QUARTER II 2021 53

STRATEGY

Continued from previous page

the benefits: a. trustee discretion, b. executor/legal personal representative decision-making, c. payment of a lump sum to the estate.

4. The trustee will need to undertake a claim-staking process to ensure they are exercising any discretion in a fair and reasonable manner (as determined in Marsella v Wareham [2018]).

5. Even if there is a valid BDBN in place, does it conflict with the terms of a reversionary pension, and if this is the case, which documentation takes precedence?

Accordingly, ensuring the instructions to the trustee are robust and complying is an important step.

Where are the original pension documents?

Where there is a pension, or multiple pensions, in place, it is important to understand whether the pensions are reversionary or not. Where there are multiple pensions in place, some could be reversionary and some may not be reversionary. The only way to know for certain is to look at the original pension documents as you cannot rely on the member statement within the financial statements of a fund to be absolute in this regard.

This can be more challenging than it seems as over time many pension documents may be mislaid or lost, as was the case in Re Narumon Pty Ltd [2018].

Unlike the outcome of this case, where the representation of a legacy lifetime pension as reversionary in the financial statements over numerous years was sufficient to confirm the reversionary status of the income stream in question, the accounting treatment in the financial statements or reference in the financial statements that a pension is reversionary is insufficient.

To distinguish from Re Narumon, most pension accounts within an SMSF are account-based and the annual minimum pension payments are based solely on the pensioner themselves, where the

54 selfmanagedsuper

Things may not always be as they seem within a fund and it is useful where possible to put all the pieces of the puzzle together before death.

reversionary beneficiary’s age is irrelevant.

Where a legacy lifetime pension stipulated a reversionary beneficiary upon commencement, that reversionary beneficiary’s age, gender and life expectancy were then determinative of the terms and conditions of the pension itself. Further, actuarial calculations were undertaken at commencement based on those factors and as such the annual representation of such an account as a reversionary pension in the financial statements, particularly given an annual actuarial report was required, was not the ideal evidence, but was considered sufficient.

Therefore, for a non-lifetime pension, such as an account-based pension, it is

not enough for the financial statements or member statements to say a pension is reversionary as that status does not impact on the annual financial status of that pension or the pension payment requirements, and so the original pension documents need to be located.

The decision to make a pension reversionary or not is very important and cannot be undertaken lightly. As outlined in the article entitled “Reversionary or reversionary-not – there is no try”, written by this author and published in selfmanagedsuper issue 027, since the introduction of the TBC there are additional considerations in this regard. Ultimately, it is important all of the issues are contemplated and that a pension is made reversionary to an individual only where they are the intended beneficiary.

It is not uncommon to review pension documents in light of a member’s wishes and unearth the intention that they desire their superannuation benefits be paid to their children upon their death, but their pension is reversionary to their spouse.

This is a recipe for disaster and conflict and needs to be considered, in particular, how to unravel the situation.

Changing a pension in situ It remains an untested area whether the reversionary status of a pension can be altered without ceasing and recommencing it. There are various reasons why changing the status

in situ is preferred to commuting and reestablishing a new income stream, such as: 1. Commonwealth Seniors Health Care Card (CSHCC) – pensions in place prior to the end of the 2015 calendar year, and where the member was in receipt of the CSHCC prior to that time, are eligible for grandfathered incometesting treatment for CSHCC purposes.

Where a pension was ceased and recommenced to change its reversionary status, this would be treated as a new income stream that would lose the CSHCC grandfathering and may result in the member losing this benefit entirely.

If an adviser was to implement such a strategy that ultimately leads to the loss of the CSHCC, they would likely be persona non grata with their client.

2. Minimum pension payments – the new pension could have a pro-rated minimum pension applicable to it. If the member had already taken out their minimum from their previous pension for the relevant year, they would be required to take out further pension amounts prior to the end of the financial year unless the restructure occurred in June of a relevant year.

3. Taxation components – one of the main concerns is the aggregation of taxation components that would arise if a pension was ceased and recommenced (and where the member also has an accumulation account). Pension taxation components are kept separate to those of an accumulation account until that pension is commuted or rolled back to accumulation, at which point the taxation components are aggregated.

The commencement of a new income stream would then have new taxation components and that may jeopardise long-term estate planning strategies.

Considering the above, being able to change this status without having to stop and recommence a pension would be attractive. The ATO has indicated that where the governing rules of a fund allow such a change, then it could be implemented.

However, it is not an area that has been tested through the courts in terms of a

dispute regarding the recipient of a benefit where the reversionary status of an income stream was changed.

As outlined in the selfmanagedsuper article mentioned above, there may not be a substantial difference between an income stream being reversionary or not where the intended beneficiary is the same, such as the surviving spouse. However, one of the bigger issues arises when a pension is reversionary to a second spouse and the intended beneficiaries are the children from the first marriage. Or where there is acrimony between the spouse and their stepchildren, and the certainty of the parent that their new spouse receives the pension’s funds is of utmost importance, but the pension is not currently reversionary.

In these circumstances, there may be alternative methods to achieve the intended outcome without having to cease and recommence a pension for absolute certainty, including: 1. Where a pension is not reversionary, and the intention is for it to revert to a spouse with certainty and without the possibility of children being able to challenge, such a decision has to ensure there are robust documents within the fund to stipulate the spouse is to receive a new pension with the monies upon death.

It could also be worthwhile protecting the succession of the fund to the spouse and potentially establishing a new SMSF to which the remaining accumulation account is transferred and then paid to the children (where that is the intention).

The new fund would then be governed with robust documentation regarding the payment of the benefits on death.

2. As indicated previously, a recipe for disaster is where there is documentation in place making a pension reversionary to a spouse when the intended beneficiaries are the children. This can often be the case in a blended family scenario. One way to rectify this situation without ceasing the pension is to review the trust deed of the fund. Many modern SMSF trust deeds specify which strategy takes precedence when a reversionary

The decision to make a pension reversionary or not is very important and cannot be undertaken lightly.

pension is in conflict with a BDBN. If the deed for the fund stipulated a BDBN has priority over a reversionary pension, then having such a deed in place would provide that solution. In such a circumstance it would be imperative: • that a BDBN was executed correctly under the deed, • that the BDBN was drafted appropriately such that it paid the benefits out to the children and preferably also referenced the relevant clauses of the deed that provided the precedence of a BDBN over a reversionary pension, and • to ensure that any future deed updates did not thwart the intended strategy.

In such a scenario, to ensure certainty and to avoid any litigation, it may be appropriate to acknowledge the issues with the tax components being aggregated, additional pension payments for that year and the loss of the CSHCC concession, and then decide to cease and recommence such a pension.

Everyone’s circumstances are different and the ultimate decision to make a pension reversionary or not is substantial as changing it in the future where the member has benefits in superannuation above their TBC can be challenging without other implications.

Having the right documentation in place is vital and it could be worthwhile deed shopping to ascertain whether the rules of the deed will achieve the intended outcome, and if not, consider having a bespoke deed drafted.

QUARTER II 2021 55

COMPLIANCE

The unit trust NALI factor There is a danger certain arrangements currently in place for SMSFs with unit trust holdings may be penalised under the non-arm’s-length income and expense rules, write Daniel Butler and Bryce Figot.

DANIEL BUTLER (pictured) is director and lawyer and BRYCE FIGOT is special counsel at DBA Lawyers.

56 selfmanagedsuper

There are a considerable number of SMSFs that invest in private unit trusts. These unit trusts may include pre-1999 unit trusts, unrelated unit trusts and non-geared unit trusts under division 13.3A of the Superannuation Industry (Supervision) (SIS) Regulations 1994.

The ATO’s draft Law Companion Ruling (LCR) 2019/D3 outlines, among other things, the regulator’s view in relation to when a loss, outgoing or expense invokes non-arm’s-length income (NALI) under the section addressing nonarm’s-length dealings with fixed or unit trusts. In particular, this article focuses on paragraphs (b) and (c) of section 295-550(5) of the Income Tax Assessment Act 1997 (ITAA).

Where an expense is incurred at a less than

commercial amount it will give rise to NALI. This is commonly referred to as NALE or a non-arm’slength expense.

There has not been much publicity relating to how NALE applies to unit trusts for a number of years, but this does not diminish the importance of the issue.

NALI – fixed entitlements to trust income From 1 July 2018 an important change occurred to section 295-550(5) of the ITAA through the

There has not been much publicity relating to how NALE applies to unit trusts for a number of years, but this does not diminish the importance of the issue.

addition of paragraphs (b) and (c). Broadly, these paragraphs assess distributions from fixed trusts or unit trusts as NALI where a lower (or nil) expense is incurred in relation to acquiring the entitlement in a unit trust or producing the income from the trust.

Section 295-550(5) states: Other income derived by the entity as a beneficiary of a trust through holding a fixed entitlement to the income of the trust is non-arm’s-length income of the entity if, as a result of a scheme the

parties to which were not dealing with each other at arm’s length in relation to the scheme, one or more of the following applies: a. the amount of the income is more than the amount that the entity might have been expected to derive if those parties had been dealing with each other at arm’s length in relation to the scheme, b. in acquiring the entitlement or in gaining or producing the income, the entity incurs a loss, outgoing or expenditure of an amount that is less than the amount of a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm’s length in relation to the scheme, c. in acquiring the entitlement or in gaining or producing the income, the entity does not incur a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm’s length in relation to the scheme.

as NALI under section 295-550(5)(b), the following criteria must typically be satisfied: • the SMSF derives income as a beneficiary of a fixed trust, for example, by holding units in a unit trust, • the parties were not dealing with each other at arm’s length in relation to the scheme, and • in acquiring the entitlement or in gaining or producing the income, the SMSF incurs an expense that is less than an arm’s-length amount. The acquisition of the entitlement would be in relation to the SMSF acquiring the units. The words “in gaining or producing the income” should be read in similar light that the income being produced is the distribution from the unit trust.

Continued on next page

Section 295-550(b) NALE – lower than arm’s-length expense: Broadly, for a distribution to be assessed

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COMPLIANCE

Continued from previous page

Section 295-550(c) NALE – nil expense: The key difference between paragraph (c) and (b) is that paragraph (c) is invoked where the SMSF does not incur any expense. In contrast, paragraph (b) is invoked where the SMSF incurs an expense that is lower than an arm’s-length amount.

Given the similarity between paragraphs (b) and (c), we will not discuss paragraph (c) any further and will focus on paragraphs (a) and (b) for the remainder of this article.

Section 295-550(a) NALI – lower than arm’s-length expense: This is a good time to discuss section 295550(5)(a) of the ITAA and contrast it with paragraph (b).

Broadly, for a distribution to be assessed as NALI under section 295-550(5)(a), the following criteria must typically be satisfied: • the SMSF derives income as a beneficiary of a fixed trust, for example, by holding units in a unit trust, • the parties were not dealing with each other at arm’s length in relation to the scheme, and • the SMSF derives more income from the unit trust as a result of the parties not dealing at arm’s length.

58 selfmanagedsuper

SMSFs that invest in unit trusts, especially closely held unit trusts, need to closely monitor the impact of draft LCR 2019/D3 and ensure they make necessary changes to minimise NALI risks.

• Two typical examples that would invoke NALI under paragraph (a) include: − if a related-party tenant agreed to pay a higher rent for the business real property held by the unit trust compared to its arm’s-length value, − if a related party provided a loan to the unit trust that did not incur interest and was not on arm’s-length terms.

Paragraph (a) has been law for a considerable period; well before 1 July

2018. As noted above, paragraphs (b) and (c) were only introduced as law from 1 July 2018, but have retroactive effect as they apply regardless of when the scheme was entered into.

Draft LCR example Example 8 of the draft LCR involves Scott’s SMSF acquiring $50,000 of units in a stock exchange listed unit trust at market value with a flexible related-party limited recourse borrowing arrangement (LRBA). The LRBA is interest free, the loan is repayable in 25 years and has a 100 per cent loan-to-valuation ratio.

The ATO concludes that, in addition to distributions of income being assessed as NALI, any capital gain from a capital gains tax (CGT) event will also be assessed as NALI to Scott’s SMSF. This example is the only one relating to a unit trust in the draft LCR and does relate to an SMSF “acquiring the entitlement” to units in a stock exchange listed unit trust at market value.

The draft LCR therefore provides limited guidance in relation to how paragraphs (b) and (c) apply to unit trusts. Further, the ATO does not provide any analysis on why any capital gain also derived by Scott’s SMSF should be subject to NALI once a CGT event occurs in relation to the units.

It prompts the question whether there is a relevant nexus between any future capital gain that may eventually arise in respect of the units (which are listed on the stock exchange) and the flexible LRBA provided to acquire the units. For instance, the flexible loan may only last for several years, whereas the units may be held for many years. Moreover, one would think any capital gain that may eventually arise has no strong connection to the flexible LRBA, given the capital gain is entirely subject to the vagaries and volatility of the stock exchange for this type of investment.

Indeed, the Tax Institute made a detailed submission on “Non-arm’s-length income and expenses – LCR 2019/D3”, dated 4 December 2019, that accepts the trust distributions of $8000 derived

by Scott’s SMSF as NALI. However, the institute rejects that there is a sufficient nexus with the capital gain. In particular, its submission states that: if Scott’s SMSF had sufficient cash to acquire the units at market value, there is no sufficient and necessary nexus in relation to the low interest loan and the derivation of the capital gain on subsequent disposal of those units.

The capital gain is merely a function of how those units perform on the stock exchange. In broad terms, the lower interest rate has no impact on the capital growth eventually realised many years later on sale of those units. Indeed, the LRBA loan might be repaid in one to five years.

We agree with the institute’s nexus theory. Rules of statutory construction support the proposition that legislation seeking to extract a penalty rate of tax should be construed strictly and not broadly. Admittedly, the ATO may be relying on certain comments in the explanatory memorandum and such comments are not the law and should generally only be referred to if there is any ambiguity in the legislation. We submit that any ‘connection’ between the flexible LRBA and any eventual capital gain in relation to the stock exchange units is too remote and tenuous to have a 45 per cent tax applied.

However, the Tax Institute’s submission does concede a relevant nexus between the flexible loan and any eventual capital gain could be established if Scott’s SMSF would not have been able to otherwise acquire the units at that time. This view is based on the argument the fund would not have derived any income or capital gain from the units but for the flexible LRBA scheme. We agree with the institute’s submission on this point.

Services provided to a unit trust One important point not dealt with in the draft LCR and ATO material to date on NALI is what happens if an SMSF trustee/ director provides services to a unit trust.

For example, consider an SMSF invested in a non-geared unit trust that owned a factory and the SMSF trustee/director oversaw the collection of rent and dealings with the tenant (which may be a related party where the property constitutes business real property), attended to bookkeeping and instructed the accountant on the trust’s annual financial statements.

First, it is worthwhile noting here that sections 17A and 17B of the SIS Act do not apply to a unit trust.

Broadly, section 17A precludes an SMSF trustee/director from being remunerated for trustee duties in respect of an SMSF and section 17B authorises an SMSF trustee/director to be remunerated for non-SMSF trustee/director duties subject to certain criteria, for example, the person is qualified/licensed, the person carries on a business of providing such services to the public and the remuneration is arm’s length. Thus, sections 17A and 17B only apply at the SMSF level.

The position relating to remuneration for a trustee/director of a unit trust depends on the governing rules, for instance, the unit trust deed and the constitution of the corporate trustee of the unit trust.

Given paragraphs (b) and (c) in section 295-550(5) appear to relate to the SMSF acquiring the entitlement or in gaining or producing the income from the units in the unit trust, it would appear any services

provided by an SMSF trustee/director in relation to a unit trust would need to be dealt with under paragraph (a). That is, if the SMSF trustee/director provided services for lower than market value or for free in relation to the unit trust, then that arrangement would appear to be a scheme and could result in more income flowing to the unit trust.

This issue may relate to a number of SMSFs with investments in unlisted unit trusts where some services are provided.

However, not many advisers have turned their minds to this risk; that is, the penny has not yet dropped for many practitioners regarding this point. Thus, consideration should be given to ensuring there is remuneration for services provided in relation to a unit trust where an SMSF holds units. A careful consideration should be given to the types of services that might be provided because at times such services may include the provision of financial support to the unit trust’s activities in the form of guarantees of borrowings where the unit trust is permitted to borrow.

However, there may be certain formalities that need to be satisfied before remuneration can be paid to a trustee/ director, including a shareholders’ resolution and ensuring there is express power in the trust deed that authorises payment. This point was highlighted in Cuesuper Pty Ltd [2009] NSWSC 981 where the trustee of a large superannuation fund was required to vary its deed to authorise remuneration for its trustees.

Conclusion SMSFs that invest in unit trusts, especially closely held unit trusts, need to monitor the impact of draft LCR 2019/D3 and ensure they make necessary changes to minimise NALI risks. Some unit trusts may need to outsource some of the activities, for example, appoint a real estate agent to manage the property owned by the unit trust, that may currently be performed by the SMSF trustee/directors free of charge.

We anxiously await the finalisation of the draft LCR to determine what else may be needed.

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LAST WORD

JULIE DOLAN EXAMINES WHAT SMSFS MUST DO TO ENABLE AN INVESTMENT IN CRYPTOCURRENCIES.

JULIE DOLAN is enterprise director at KPMG.

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There has been another wave of hype and speculation around cryptocurrencies recently. There only has to be some tweeting from influential people and the price skyrockets. So what is cryptocurrency and what do SMSF trustees need to consider when investing?

Cryptocurrency is basically the ‘internet of money’. The most common and well-known type is Bitcoin. It is a digital currency that allows people to make payments directly to each other through an online system. This online system is deregulated and contains a transparent ledger.

Unlike the banking system, no one computer holds the ledger, but rather every computer that participates in the system has a copy of the ledger. The ledger is pseudo-anonymous, meaning each owner of a currency such as Bitcoin cannot see the personal details of each transaction, but rather has the right to access a specific Bitcoin address record in the ledger and send funds from it to a different address. The order of the transactions on the ledger is based on a cryptographic hash function. This hash function forms the basis of the blockchain.

Authenticity and security are maintained via a private key. This private key is stored in a Bitcoin wallet. This wallet allows for the creation of signatures needed to transfer Bitcoin. Each signature is unique to each transaction.

Bitcoin can be traded via specific exchanges and is very volatile in nature, hence the wild price swings recently witnessed. Its value is not derived from gold or government fiat, but from the value people assign to it.

In relation to SMSFs, the following points need to be considered: • Taxation: Back in 2014, the ATO issued two taxation determinations – TD2014/25 and TD 2014/26 – clarifying the position that cryptocurrencies are capital gains tax (CGT) assets. The Bitcoin holding rights amount to property as per the definition of a CGT asset under subsection 108-5(1)(a) of the Income Tax Assessment Act 1997 (ITAA). The holding rights are not a foreign currency for the purposes of division 775 of the ITAA.

• Investment strategy and trust deed: The investment strategy of the fund must allow for the investment in cryptocurrency. It is critical SMSF trustees factor in the volatility of this type of investment and how it correlates to the overall objectives of the fund so as to comply with the operating standard under regulation 4.09 of the Superannuation Industry (Supervision) (SIS) Regulations 1994. A review of the investment strategy may be required by the trustees/members prior to making the investment. The trust deed must also give the trustees the power to invest in cryptocurrency.

• Ownership and separation of assets: Legislation requires trustees and members to ensure their fund’s assets are held separately from personal assets. The SMSF must have clear ownership of the cryptocurrency.

Depending on the means of purchase, this can cause a problem as not all exchanges recognise SMSFs as an investor.

• Valuation: The ATO requires that SMSFs must ensure their investments in cryptocurrency are valued in accordance with ATO valuation guidelines. The value in Australian dollars will be the fair market value, which can be obtained from a reputable digital currency exchange or website that publishes its rates publicly.

• Sole purpose test: An SMSF must be maintained for the sole purpose of providing retirement benefits to trustees and members, or to their dependants if a member or trustee dies before retirement. Therefore, it is important all aspects of the transaction are at arm’s length. It is also important to note cryptocurrency is not a listed security and hence SMSF trustees cannot acquire these assets from a related party nor can it be used to make an in-specie contribution from a related party.

Therefore, as a summary, if the relevant legislative requirements are met, cryptocurrency can form part of a well-formulated investment strategy of the fund. However, like any high-risk investment, it needs to be done with caution and with the backing of a strong level of technical knowledge or specialist advice.

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REQUIRED READING FOR SMSF TRUSTEES

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