self managed super: Issue 31 by Benchmark Media

QUARTER III 2020 | ISSUE 031 | THE PREMIER SELF-MANAGED SUPER MAGAZINE

DEEP

DIVE EXPLORING THE STATUS OF SMSFS

FEATURE

COMPLIANCE

STRATEGY

COMPLIANCE

The status of the SMSF space A statistical analysis

Breaches of the law How to manage them

Retiree contributions New considerations

FASEA code Applying it to SMSF advice

LIVE-STREAMING SMSF Professionals Day 2020

27 OCTOBER Virtual Event

SMSFPD digital

Shape your client’s future

Aptly themed ‘2020 vision’ SMSF Professionals Day 2020 is moving online Jam packed with technical updates, insights and strategies! Join SuperConcepts experienced and highly regarded team of SMSF experts as they explore, dissect and unearth the latest legislative developments and strategy gems

New additions to the program include a second war stories session, additional speakers and extended ‘open mic’ sessions

COLUMNS Investing | 22

Criteria to uncover the best sources of yield.

Investing | 26

Negative Asian market myths dispelled.

Compliance | 30

How to manage compliance breaches.

Strategy | 33

The machinations of super splitting schemes when relationships end.

Compliance | 36

The nature of the NALE provisions.

Strategy | 40

Options in dealing with trustee mental incapacity.

Compliance | 44

Balancing the COVID-19 rent and loan relief measures.

Strategy | 47

Protecting SMSFs from deceased estate challenges.

Investing | 50

The fiscal stimulus impact on equity markets.

Strategy | 54

Small business CGT concessions and some potential changes.

Compliance | 57

DEEP DIVE Exploring the status of SMSFs Cover story | 12

FEATURE The way forward | 18

Whether the COVID-19 financial advice measures are a future model.

Applying the FASEA Code of Ethics to SMSF advice.

Compliance | 60

An ATO guidance material map.

QUARTER III 2020 1

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

Don’t whinge. DO! Recent discussions about superannuation have been in the main centred on the COVID-19 relief measures, with a focus on the provision allowing individuals to access their retirement savings benefits early and in particular how appropriate, or not, the initiative has been. A lot of the criticism the federal government has copped over this scheme has been the damage it has potentially done to the future retirement savings of Australians. And this argument is being fuelled again with news at the end of July that 2.9 million people applied to access their super early during the first tranche of the measure, with a further million repeating the dose with the second tranche opportunity. So far the SMSF sector has fared better than the rest of the industry with regard to early withdrawals, with less than 1 per cent of the total applications for the measure coming from SMSFs. In raw numbers, 28,000 SMSF members accessed a total of around $280 million from their funds, according to SMSF Association chief executive John Maroney. To put this in context, the latest Treasury estimates indicate $41.9 billion will leave the super system by the time the early access window is closed. This does not mean SMSFs are immune to the current predicament though. But we have heard and continue to hear whinging from pillar to post, mainly from the industry funds, about how bad the initiative has been and how it needs to be shut down immediately. Well I hate to tell the leaders of the large super funds this, but the time for this debate is pretty much over. As they say in the

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classics: shut the gate, the horse has bolted. So rather than look in the rear-view mirror, it’s time for the government and the industry as a whole to keep their eyes forward and come up with ways to repair this drain of funds to ensure the potential damage done to future super balances is somewhat repaired or at least mitigated. This was the subject of discussion during a thought leadership session at the recent SMSF Association Technical Day 2020 and some good suggestions were thrown up. These included ideas such as discounted tax rates on contributions for people who took up the offer to access their super early during the height of the coronavirus pandemic. Another recommendation was to allow some sort of excess contributions without penalty to achieve the same purpose. Or perhaps the restrictive contributions caps could actually be raised to a more reasonable and, in this case, practical level. Remarkably the need for incentives to channel more money back into super will obviously have to be considered and this probably means the old chestnut of generous tax concessions as a carrot to achieve this end will once again come into the spotlight. But even if this seems like it would bring the discussion right back to where we started, it has to be done. As I said before, there is no use complaining about the past; it’s time to do something to ensure the doom and gloom forecasts for people’s retirement savings in the future do not eventuate. To adapt a famous quote from AFL legend John Kennedy Senior to this situation: “Don’t whinge! DO!”

Editor Darin Tyson-Chan darin.tyson-chan@bmarkmedia.com.au Senior journalist Jason Spits j.spits@bmarkmedia.com.au Journalist Tharshini Ashokan t.ashokan@bmarkmedia.com.au Sub-editor Taras Misko Head of sales and marketing David Robertson sales@bmarkmedia.com.au Publisher Benchmark Media info@bmarkmedia.com.au Design and production RedCloud Digital

WHAT’S ON

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

Quarterly Technical Webinar

SMSF Professionals Day Digital 2020

SuperConcepts

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

8-9 September 2020 Virtual workshop

17 September 2020 Webinar Accountants-focused session 11.30am-12.30pm AEST

15-16 September 2020 Virtual workshop

Adviser-focused session 1.30pm-3.00pm AEST

22-23 September 2020 Virtual workshop

Post Budget 2020 Webinar

27 October 2020 8.30am-4.30pm AEDT

DBA Lawyers Inquiries: www.dbanetwork.com.au

SMSF Online Updates 4 September 2020 16 October 2020

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

Superannuation Benefits Payable from an SMSF 17 August 2020 Zoom webinar 11.00am-1.00pm AEST

SMSFs and Estate Planning 24 August 2020 Zoom webinar 11.00am-12.30pm AEST

2020 National Congress ACT 25-27 November 2020 The Hotel Realm 18 National Circuit, Canberra

SMSF Specialist Course

Smarter SMSF

7 October 2020 Webinar 3.00pm-4.30pm AEDT

Inquiries: www.smartersmsf.com/event/

SuperGuardian

Super Unpacked 21 August 2020 Webinar 11.00am-12.00pm AEST

Changing Face of SMSF 9 September 2020 Webinar 12.00pm-1.00pm AEST

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

Prospective Pension Payment Planning 27 August 2020 Webinar 12.30pm-1.30pm AEST

Accurium

COVID-19 Six Months On – Reflect and Reset

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

22 September 2020 Webinar 12.30pm-1.30pm AEST

The latest on complying pensions in an SMSF

The contribution conundrum – navigating potential future indexation traps

27 August 2020 GoTo webinar 2.00pm-3.00pm AEST

Heffron

SMSF Clinic 25 August 2020 Webinar 1.30pm-2.30pm AEST

13 October 2020 Webinar 12.30pm-1.30pm AEDT

SMSF Trustee Empowerment Day Digital 2020 Inquiries: Jenny Azores-David (02) 8973 3315 or email events@bmarkmedia.com.au 15 September 2020 9.00am-4.30pm AEST

QUARTER III 2020

NEWS

Remediation needed for early super access By Darin Tyson-Chan

The superannuation industry must work together to help individuals who have taken advantage of the COVID-19 early super access economic measure once the pandemic has run its course, a retirement income specialist has said. “It’s amazing that the superannuation system’s been able to help [individuals who have lost their jobs due the coronavirus] access what is their own money. Now, of course, that needs to be remediated, because we all know that if you pull money out of the system that’s not compounding, you might end up being on the losing end,” Challenger retirement income chair Jeremy Cooper said during a thought leadership

panel discussion at the recent SMSF Association Technical Day 2020. “To me it’s up to the industry to engage with those people when this is all over and say ‘well, we helped you [then], how can we [now help] you build your savings back up’. “So that’s I think a ball that will be in the industry’s court.” Fellow panellist Investment Trends chief executive Michael Blomfield said he thought the provision of financial advice is also going to be a key factor in restoring people’s retirement savings and to this end policymakers needed to make some necessary changes. “Now we’ve said people can take [their super] out, we’ve not done anything to backfill this hole,” Blomfield said. “If we’re now going to help some of these people get money back in, even by

Assistance the key to long-term recovery. way of contribution or excess contribution or discounted tax rates on contributions for those who have drawn down, we need policy around that, but we need that policy to help people get advice.” According to Blomfield, a

supply problem will need to be addressed at the same time. “If everybody suddenly has access to advice, we don’t have the advisers to give it, but we’ve got to start by at least increasing its availability,” he said.

COVID-19 relief clouds genuine contributions By Darin Tyson-Chan

Individuals whose employment status changes after they have accessed their super early under the COVID-19 financial hardship measure face the prospect of proving they are not employing a recontribution strategy if legitimate contributions to their SMSF are restarted. “It is quite conceivable that you may have an individual or client who has been made redundant or had their [work] hours reduced because of the coronavirus, and has later in the income year entered full-time employment. So they are now in a financial position to be able to make a

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contribution to super,” SMSF Association deputy chief executive and policy and education director Peter Burgess said at the industry body’s recent Technical Day 2020. “If they have accessed their [super] money early … it’s going to be very important that they show evidence that they were in financial hardship when they did apply for that amount to be released and that their purpose in withdrawing the amount was not for the purpose of recontributing those amounts back into super. “So documentation there will be very important.” Burgess pointed out the above scenario was one advisers need to potentially manage given the ATO’s adverse view

toward individuals who have accessed their super benefits early on the pretext of COVID-19-driven financial hardship, only to immediately recontribute those monies back into their fund to gain a tax advantage. “We have to be very clear and very strong with our clients here that this measure is not to be used for withdrawing money and recontributing it back into super,” he warned. The regulator has stipulated it will be scrutinising the applications for the second tranche of the early super release instrument of individuals who have been found to have employed a recontribution scheme from the previous time they accessed their retirement savings under the coronavirus economic relief measure.

NEWS IN BRIEF

Annual return signature still needed A technical specialist has reminded SMSF advisers a fund’s annual return still requires a trustee signature of some kind, regardless of whether practitioners are currently servicing clients on a remote or contactfree basis due to the COVOD-19 pandemic.

Mark Ellem “[The ATO website advises] you could utilise scanning the financial statements and returns, emailing them to clients, [having them] print [the documents] out, sign them and send them back to you,” specialist adviser Mark Ellem said. “Or [there is] the good old-fashioned post, sign and return method,” he noted. Ellem added the use of digital signatures, already commonly used by practitioners for the approval of financial statements and tax returns, has also been ratified for SMSF annual return sign-off. However approving the document by email or over the phone does not meet the proper sign-off protocols, he warned.

Few early release recontributions The ATO has revealed the strategy whereby individuals access their superannuation benefits early under the COVID-19 economic relief measure and subsequently recontribute those proceeds back

into their super fund to gain a tax advantage is of concern, but has not been prevalent during the first tranche of the instrument. “I’m pleased to say we’ve looked at this sort of behaviour and we haven’t really seen a huge amount of it [happening],” ATO SMSF segment deputy commissioner Steven Keating said. However, Keating pointed out while the strategy is not common, the regulator is still concerned about it and will be looking to take action against those who may potentially implement it during the second tranche of the coronavirus relief. “Now that we’re in the second tranche of the early release of super, anyone that we did see that behaviour occur with [in] the first tranche, we’ll soon be having conversations with them,” he cautioned.

Call for market-lined pension adjustment The SMSF Association has called on the ATO to exercise its regulationmaking powers to correct an anomaly that has surfaced due to a technical change to market-linked income stream commutations passed as law during the June parliamentary sitting.

Peter Burgess The amendment in question relates to the transfer balance account (TBA) debit calculation associated with the commutation of a market-linked pension leading to an adverse outcome for superannuants restarting that pension. “We’re calling on the ATO to use [its]

regulation-making powers to create a write-off, a transfer balance debit, and there are already write-off transfer balance account debits in the law. We’re asking for a new debit to apply here for clients who have, prior to this new formula coming into play, started their new market-linked income streams and have reported a [TBA] debit using a different formula,” SMSF Association deputy chief executive and policy and education director Peter Burgess revealed. “We’re asking for a write-off debit to apply so we don’t end up with excess balances here and also to avoid situations where we have a market-linked income stream that is continually in excess.

ASIC defends fact sheet ASIC has defended the numbers used in regards to SMSF operating costs in its controversial fact sheet released late last year, saying they were the best figures available at the time, but recognised the need for updated figures to be included on all its websites and press releases. Addressing a House of Representatives Standing Committee on Economics hearing into the work of the corporate regulator in 2019, ASIC chair James Shipton said the numbers were supplied by the ATO and rejected claims made by committee chair Tim Wilson that the numbers were “false and misleading”. “If I may, with utmost respect, comment that we do not believe the data we were relying on from the ATO was false or misleading. The data, at that point in time, was the best available data from a reputable statutory agency and we treated it as appropriate.” Shipton said the release of the SMSF Fact Sheet, which quoted the average operating costs for an SMSF at $13,900, relied on the ATO data and ASIC procedures in place as part of a pilot program to provide SMSF trustees with data related to the running of their fund.

QUARTER III 2020

NEWS IN BRIEF

Compliance used to combat incapacity The ATO has begun using its compliance procedures as a means of uncovering any potential mental incapacity issues trustees might be experiencing as they get older. “As part of our lodgement program we tend to cluster our non-lodgers into groups [so we can] target our messages, and one of the particular groups that we are looking at are those trustees who are ageing, have moved into pension phase and all of a sudden stop lodging,” ATO SMSF segment deputy commissioner Steven Keating said.

The TPB banned tax agent Edward Mark Purnell-Webb and his company, Superannuation Administration Specialists (Qld) Pty Ltd, after an investigation by the TPB revealed Purnell-Webb had falsely claimed independent audits had been conducted for more than 170 SMSFs for which he had lodged tax returns. TPB chair Ian Klug said: “Mr PurnellWebb has shown himself to be a risk to consumers. The TPB has an important role in consumer protection and maintaining the integrity of the tax practitioner profession. Misconduct of this kind undermines the integrity of the entire SMSF regulatory regime. “This decision serves as a warning to other tax practitioners who may be thinking of engaging in this kind of egregious behaviour.”

Return includes LRBA property count

Focus on mental incapacity issues. “We’re trying to reach out to them to say: ‘Is there an issue potentially with your capability or do you understand your responsibilities in regard to winding up a fund if that is [what is required]?’” The initiative is in line with the regulator’s increased emphasis on having individuals consider their exit strategy from an SMSF at the time of the fund’s establishment.

Tax agent banned for SAN fraud The Tax Practitioners Board (TPB) has banned a Gold Coast-based tax agent for four years for SMSF auditor number (SAN) misuse.

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The 2020 SMSF annual return has included a new field requiring trustees to report a property count for certain real estate assets held under a limited recourse borrowing arrangement (LRBA). The obligation is represented by a new label, Property Count J7 of the annual return, which has been added to Section H covering a fund’s assets and liabilities at question 15b regarding Australian direct investments. “The [assets] we will include in that property count at J7 will only be those where there is actually real property held under the LRBA. So effectively that’s our amounts reported at J1, Australian residential real property, J2, Australian non-residential real property or commercial property, and J3, overseas real property regardless of whether it’s residential or non-residential/ commercial,” specialist adviser Mark Ellem noted. “It will also [need] to include any fractional interest in real property.” He pointed out assets held under an

LRBA that are not real property, such as shares, should not be reported nor should any real property an SMSF holds directly.

Trustee course takes shape The ATO is close to finalising a course for SMSF trustees that will give the regulator more comfort the appropriate individuals are the ones looking to run their own super fund and they understand the accompanying legal aspects of doing so. “We’re actually developing a training program that’s going to have a competency assessment associated with it. We’re calling this our SMSF Trustee Knowledge Assurance Package and it’s going to be there to help trustees and anyone who wants to enter the system to understand their obligations,” ATO SMSF segment deputy commissioner Steven Keating revealed. The course will be provided to trustees at no cost and will focus on five specific modules.

Training for DIY super funds. Topics to be covered include setting up an SMSF, issues relating to running a fund such as contributions and investments, paying benefits such as pensions, winding up an SMSF, and reporting and other general compliance obligations. “At the end of the course [trustees] can complete an assessment and anyone who gets 80 per cent or more will receive a certificate of completion,” Keating said.

SMSFMA

Joint accounts need consideration

JOHN MARONEY is chief executive of the SMSF Association.

The upcoming timing of the Retirement Income Review (RIR) and how it intersects with an economic recession triggered by a global pandemic has the potential to materially shape our superannuation system. Certainly, the RIR is assuming greater significance, being released at a time when trustees, especially those in the pension phase, are struggling with volatile equity markets, record low interest rates, liquidity issues and questions about property investment, both retail and commercial. In these uncertain times, the SMSF Association believes there are important measures the RIR can point towards that will improve superannuation for members through these difficult times and beyond. The introduction of joint superannuation accounts for couples is a prime example. Our thinking is simply this: we believe it’s appropriate for super to be viewed from the perspective of a ‘couple’ where it’s relevant. They make mutual decisions where one partner usually makes sacrifices to support the other and there should be effective mechanisms to facilitate this process. The association’s recent call for a spousal rollover came off the back of the inception of the transfer balance cap (TBC) and the lack of opportunity for couples to adjust to its introduction where most have balances heavily weighted to one member. Women currently retire with less super than men – an ongoing problem for the super system. When referencing retirement age (60 to 64), on average Australian men enter retirement with $336,360, while women do so with $277,880 – a sizeable gap. Typically, it’s the male member who is more likely to have had an uninterrupted work pattern and a higher wage and therefore benefited from larger and consistent super guarantee contributions. The compounding effect of long-term savings sees underlying differences between gender pay, participation rates and other factors make the retirement gap larger. In most families, women are still the primary childcarers, meaning they spend more time out of the workforce and often return to work part-time. There are also larger systemic issues, such as the gender pay gap, rise of the gig economy and design of the super system, which is not as effective for part-time or low-income earners. Recent analysis showed while future superannuation balances at retirement will continue to increase for both genders, women’s balances will

continue to lag men’s balances until after 2060. The association proposes that one individual should be able to choose to transfer part of their balance to their partner when nearing retirement. But looking at the bigger picture, it’s the provision of joint accounts that is the real nirvana. Families typically pool their finances and have joint bank accounts to run the household. When we retire, most of us will receive a full or part age pension and the benefit will be based on our marital status. But when families save for retirement they are required to have separate accounts. SMSFs do this at a proxy level, however, they still need to report separate balances, provisions and undergo inefficient recontribution and spousal strategies to monitor caps and equalise balances. Hence, our call for a rollover. But if joint accounts could be the norm for Australian Prudential Regulation Authority (APRA)-regulated funds and SMSFs, where balances are pooled, multiple accounts could be removed, fees could fall and engagement may increase. The benefits are obvious. As a recent Rice Warner report, titled “What APRA Funds can learn from SMSFs in building a retirement solution”, highlighted, a couple at retirement often requires four linked accounts, being a pension account for each partner, as well as an accumulation account for each partner to accommodate future contributions for any ongoing part-time work and balances exceeding the TBC. So, being able to pool balances and reduce the number of separate accounts is a positive from a fee and investment perspective. Pooling means both partners are aware of the family finances and can work together to budget efficiently. Once members have a single account, they are better placed to focus on important matters, such as the right investment and insurance strategies and how much they should contribute to generate a comfortable retirement lifestyle. Superannuation fund retirement projections would be more accurate and members would get a better picture of how they are tracking for retirement. Single joint funds would also remove the inefficient and ineffective measures that allow members to split their contributions and allocate some to a spouse. These are administrative burdens members avoid until it is too late. Joint accounts should be the future for super and the RIR may just provide the opportunity to implement it. The association hopes so.

QUARTER III 2020

CPA

Time to address non-retirement super elements

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

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One of the most discussed elements of the federal government’s response to the pandemic is the COVID-19 superannuation early release scheme, allowing qualifying Australians to access up to $20,000 of their retirement savings in two tranches up to December 2020. As at the end of the financial year, $18.1 billion had been released from preservation, with an astonishing 2.4 million applications paid. The spike in new applications made in the new financial year shows word has clearly got around, with the Australian Prudential Regulation Authority suggesting a number of applications for this financial year has already been received from Australians who received payment prior to July. However, this one-off opportunity, as it has been presented to Australians, may end up costing them more than that, with estimates suggesting that a $10,000 amount withdrawn by a 25-year-old is likely to cost them nearly $20,000 (in today’s dollars) at age 67. Feedback from CPA Australia members suggests many Australians taking advantage of this ‘opportunity’ have done so without seeking appropriate financial advice. Apart from the many obvious problems associated with this approach, a key problem is once the money has been removed from the superannuation environment, it may be difficult for some to repair the damage done. Contributions caps, for example, do not change just because someone has removed part of their superannuation. Nor do asset prices necessarily revert, meaning one may potentially be permanently out of pocket due to market rallies. Never mind the ATO is aware many of the applications may have been made in error, meaning there may be a potential shock when a tax bill is received by individuals who believed this might have been a tax-free payment. At the same time as this has been going on, the Retirement Income Review has been underway, compiling a fact base regarding Australia’s retirement income system. One key issue, which CPA Australia noted in our submission to the review, is that the idea of retirement has itself not been defined by government. This means the infrastructure and resources used by Australians in order to plan for their retirement, including superannuation, are in danger

of being subsumed beneath other ‘opportunities’. Retirement income systems globally intersect with other policy areas occasionally, with facilities such as health insurance and housing often included in some countries’ retirement income systems. Non-retirement additions have differing levels of effectiveness, but generally have a cumulative effect of reducing the importance of retirement as the objective of savings. These features also provide an additional pressure on the good investment returns Australians would expect from savings invested over decades. Obviously, given the context of the sole purpose test, as well as the government’s policy to enshrine the objective of super within the context of income in retirement, any non-retirement features also communicate a mixed message. Given the $3 trillion of savings in the super system, positioning it as a honeypot potentially adds to the confusion. When the crisis of the pandemic passes, a number of measures will need to be put in place in order to rectify the damage caused to retirement savings due to this measure. One of these may have to be an amnesty of sorts, possibly facilitated via targeted increased contribution limits, to allow Australians who have drawn on their super to accelerate replenishing their retirement savings. Ideally, this should be accompanied by a co-contribution scheme to ensure the time value of money is appropriately factored into these additional amounts contributed. Another initiative may allow for a temporarily higher total superannuation balance threshold (currently $500,000), allowing taxpayers who have accessed their superannuation to have an increased opportunity to use the carry forward of unused concessional contributions, without breaching their contribution caps. But this still leaves the question about support for Australians during crises such as pandemics – and other non-retirement issues – unaddressed: Is this still part of what is considered retirement? The issue of whether superannuation should be supporting crisis relief must be addressed as part of the many other matters likely to affect Australians’ retirement income and should properly be examined as part of a holistic coordinated approach to Australia’s contingency planning framework.

SISFA

Extraordinary times call for extraordinary actions

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

There is no doubt 2020 has become a year no one could have predicted and one that will not be easily forgotten, though perhaps many of us would like to. While the hope was that the initial problem of COVID-19 would be dealt with and pass much like SARS did in Asia in 2003, the realisation now is that it’s here to stay in a series of waves and we’ll have to adapt our lives to accommodate it until some sort of vaccine is in place. While the federal government read the coming pandemic right in quickly addressing the needs of business and individuals impacted by the shutdown of our economy, the ongoing cost of an imperfect system of financial support and where thousands have been allowed to draw down on their super will leave a difficult legacy for both society and the government. Don’t get me wrong. There is no perfect answer to this calamity we find ourselves in and the government has handled the issues of a black swan event better than many countries. We have only to look at our colleagues in the United States to see how things can go terribly wrong. But the total abandon some have exhibited in accessing their super either side of the end of the financial year has long-term and social ramifications not well thought through. Fortunately for many self-funded retirees there have been a number of actions taken that address the pandemic’s impact on asset values. Given the fact COVID-19 will continue to determine the length of the recession, increased flexibility in the superannuation system is still required. To this end, the Self-managed Independent Superannuation Funds Association (SISFA) has joined fellow industry bodies in requesting a sixmonth extension of the superannuation guarantee (SG) amnesty to 7 March 2021. It was introduced on 6 March 2020 at a time when the pandemic resulted in a significant impact on working conditions for many businesses. Eligibility for the SG amnesty remains open for six months to 7 September 2020. With many businesses’ cash flow continuing to be affected, an extension of this amnesty will assist business to cope. Aligned with this change is the need for the ATO

commissioner to be flexible on the penalty applying to employers for their SG liability, known as Part 7 of the Super Guarantee Administration Act 1992. The commissioner has the discretion to reduce any penalties to nil and SISFA, along with many aligned industry bodies, believes an amendment should be made to the act to remove the minimum 100 per cent penalty. There are two other initiatives SISFA is requesting the government consider in offering additional flexibility and relief. These are the return of excess pension payments in 2019/20 and the removal of proportionate indexation of the transfer balance cap. In March, the government announced a reduction in the minimum annual payment required for account-based pensions and annuities, allocated pensions and annuities and market-linked pensions by 50 per cent for 2019/20 and 2020/21. The reduction was welcomed and recognised that for many retirees the significant losses in financial markets as a result of COVID-19 have had a profound negative effect on their super and pension balances. The announcement enabled the preservation of monies within super, a critical measure for maintaining longer-term adequacy of their super savings. SISFA is recommending the government provides for the ability for super fund members to refund their super fund and excess amount, the refund being able to be made up until 30 June 2021. This would only be available to the excess pension payments made during 2019/20. SISFA has also recommended the removal of proportionate indexation of the transfer balance cap. Indexation of the cap is due to occur in the next year or two. Highlighted is the proportionate nature of the cap indexation implementation and especially the complexity and arbitrariness of that regime. Our belief is the proportionate indexation system should be replaced with a much simpler flat indexation method, that is, every person receives a $100,000 increase in their transfer balance cap when indexation is triggered. Providing the maximum flexibility in these difficult times will aid SMSFs to maintain and manage their funds and limit possible reliance on the social welfare system in the long run.

QUARTER III 2020

IPA

The ‘I want it now’ mentality

TONY GRECO is technical policy and public affairs general manager at the Institute of Public Accountants.

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The federal government loosened the rules temporarily for early release of superannuation (ERS) to help individuals facing financial stress brought on by COVID-19. The decision to take advantage of this opportunity is an individual one and there is no black or white correct answer. One hopes before any action is taken, individuals have made an informed decision as there are many factors to weigh up. For some it will be the correct option to take based on their circumstances. The first thing individuals must consider is eligibility. The measure was intended to provide relief to those in financial stress caused by factors related to the coronavirus. One or more of a number of conditions need to be satisfied, such as whether the person is unemployed, is eligible to receive the JobSeeker payment, has been made redundant, had their working hours reduced by 20 per cent and, in the case of sole traders, whether a reduction in turnover of 20 per cent or more has occurred. The ERS initiative provided access to up to $10,000 in the 2020 fiscal year and allows for a further $10,000 withdrawal in 2020/21. While an individual may have previously been eligible for the early release of super for the 2020 financial year, it is vital they have reassessed their circumstances this financial year, before applying for the 2020/21 early release payment. The individual may have qualified at the end of April or early May 2020, however, if circumstances have changed, for example, they have found work or are working more hours, it may cause ineligibility for a further payment from July through to 31 December 2020. The ATO has stressed the importance for individuals to carefully check the eligibility criteria before applying for the ERS and documenting the circumstances allowing them to legitimately qualify for the relief measure. It is a self-assessment process and the ATO can only do a small amount of pre-assessment before funds are released. A lot of the compliance checking happens post-event, so individuals may feel a false sense of security. On the assumption the individual is eligible, some of the factors that should be considered as part of an informed decision are: • if a person’s super balance drops below $6000, they could lose income protection and life and total permanent disability insurance cover, • superannuation is a low-tax environment and enjoys many tax breaks designed to maximise

the compounding effect of savings. The tradeoff for these concessions is to limit access until retirement so that individuals have funds for retirement purposes, • if an individual has an alternative source of funds, then the after-tax cost of alternatives versus accessing super need considering, • funds withdrawn early in an individual’s working life will miss the benefits of compounding, meaning what might seem small today can translate into significant amounts of money in 20 to 30 years’ time. How significant will depend on rates of return, but the compounding effect will be significant, and • early release during significant market volatility can crystallise losses. History tells us markets tend to recover after major falls and remaining in the market enables individuals to benefit from any recovery. If an individual has met the eligibility criteria, then no government agency has control over how the money is actually used. To date, the younger generation have predominantly been overrepresented in the ERS applications. While this cohort are suffering more COVID-19 impacts due to the loss of casual employment opportunities, there is also evidence some of the funds accessed early have been used for discretionary expenditures, indicating some younger people are prepared to unduly compromise their long-term retirement outcomes. The “I want it now” attitude rather than financial hardship seems to be the main motivation. Given the number of applicants who have taken advantage of the ERS, we suspect based on anecdotal evidence that some may have neglected to check their individual circumstances to see whether they have met the eligibility criteria. If a person has any doubts around their eligibility, they cannot just recontribute the money withdrawn. The minimum penalty will be that the amount withdrawn will need to be added to your assessable income and tax paid at the individual’s marginal tax rate. The worst-case scenario if there has been total disregard of the rules will be a fine of up to $12,600, in addition to paying tax on an amount that would not ordinarily be subject to tax if withdrawn in retirement. If in doubt, the best course of action is to make a voluntary disclosure to avoid the imposition of penalties and before a ‘please explain’ letter is received.

REGULATION ROUND-UP Valuation Guidelines for SMSFs

Director identification numbers

ATO Guide

Treasury Laws Amendment (Registries Modernisation and Other Measures) Bill 2019

In the current COVID-19 period, valuing assets of an SMSF may be more complicated, but it is still important to ensure all assets are appropriately valued. The ATO has released a guide to help SMSF trustees, replacing Superannuation Circular 2003/1. The regulator has provided assurance that if the guide is followed, the valuation provided will be accepted.

Downsizer contributions 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 agedcaresteps.com.au

Treasury Laws Amendment (2019 Measures No 3) Bill 2019

If a property is transferred from one spouse to another for nil consideration, market value provisions are applied to create capital gains obligations, but this will not allow other investments to be used to make a downsizer contribution. The Treasury Laws Amendment (2019 Measures No 3) Bill 2019 clarified the ATO opinion previously expressed in Law Companion Ruling 2018/9, which deemed capital proceeds cannot be used.

From 12 June 2022, an extra step will be required when setting up a corporate trustee for an SMSF or appointing a new director. All directors of registered bodies will need to obtain a director identification number (DIN). A DIN will be a unique number issued to the individual person, and once issued will remain with them for life. The same number will be applicable for all director roles held by that person. In the first year of operation, the director will have 28 days from appointment to obtain a DIN. After that time, directors will need a DIN before they are appointed. The requirement will apply to all existing directors, including alternative directors.

Deferred ECPI measures The start date for changes that will allow an SMSF to choose which method of exempt current pension income can be applied and negate the need for an actuarial certificate if the fund is fully in retirement pension phase has been deferred by 12 months to 1 July 2021.

Accounting standards AASB 2020-2

Auditing impacts from COVID-19

Amendments to Australian Accounting Standards (AAS) will impact on reporting requirements for SMSFs that create or amend the trust deed from 1 July 2021. If the trust deed of these funds includes a clause requiring the preparation of financial statements that comply with the standards, the fund will no longer be able to prepare special purpose financial statements, but will instead need to prepare Tier 2 general purpose financial statements. The AAS Board has published a key facts document to explain the implications.

Auditor contravention reporting instructions: addendum

Changes to contribution rules Superannuation Legislation Amendment (2020 Measures No 1) Regulations 2020

Legislation is effective from 1 July 2020 to increase the age at which the contribution work test starts from 65 to 67. The age limit for a spouse receiving spouse contributions has also increased from 69 to 74.

Non-arm’s-length income provisions Practical Compliance Guideline 2020/5

The ATO has released Practical Compliance Guideline 2020/5, which confirms compliance resources will not be allocated to determine whether non-arm’s-length income provisions apply to non-arm’s-length expenditure if it has sufficient connection to all ordinary and/or statutory income. This is a transitional approach that applies for the 2019 and 2020 financial years, but has also been extended to the 2021 fiscal year while the ATO finalises Law Companion Ruling 2019/D3.

Instructions regarding auditor contravention reports have been amended through the addition of an addendum to cover five areas of relief introduced due to the COVID-19 pandemic for 2019/20 and 2020/21. The instructions provide guidance to identify when a breach occurs and when it needs to be reported for providing rental relief, loan repayment relief, in-house asset relief, market valuations, and early release of super on COVID-19 compassionate grounds. The SMSF independent auditor’s report instructions have also been updated to reflect these instructions.

Intermediary LRBAs Superannuation Industry (Supervision) Inhouse Asset Determination – Intermediary Limited Recourse Borrowing Arrangement Determination 2020

An SMSF investment that was acquired under limited recourse borrowing arrangement (LRBA) provisions and is held within a holding trust will be exempt from classification as an in-house asset if the intermediary LRBA meets the requirements described in the ATO’s Superannuation Industry (Supervision) In-house Asset Determination – Intermediary Limited Recourse Borrowing Arrangement Determination 2020. Application has been backdated to apply to all intermediary LRBAs established from 24 September 2007.

QUARTER QUARTERIII III 2020 2020 11

FEATURE

DEEP

DIVE EXPLORING THE STATUS OF SMSFS

Despite a consistent growth rate, and a pool of savings in the hundreds of millions, SMSFs are still regarded by some as niche, and by others as under threat from competing sectors, but do the numbers support that story? Taking a deep dive into the ATO’s latest statistics, Jason Spits investigates.

Australia’s superannuation system is generally regarded as one of the best retirement income savings models in the world and while the degree of SMSF sector growth was probably the last thing on the minds of the system’s creators, it has come to occupy a dominant place alongside retail, industry and public sector funds. According to the ATO’s recently released SMSF statistical overview for 2017/18, the sector held $747.6 billion, or 26 per cent, of the total $2.87 trillion in the Australian superannuation system as at 30 June 2019. This puts SMSFs ahead of the industry fund sector at $718.7 billion (25 per cent), the retail sector at $625.7 billion (21.8 per cent) and public sector funds at $510.6 billion (17.8 per cent), and represents a 40 per cent increase in asset size for

12 12 selfmanagedsuper selfmanagedsuper

FEATURE SMSF STATUS

self-managed funds since 30 June 2014. That growth, however, is tempered by the same ATO data, which shows retail and industry funds experienced a 29 per cent and 91 per cent increase in asset size over the past five years respectively. Based on this growth, SMSFs are likely to be surpassed by industry funds within a few years. They also have fewer members than other parts of the superannuation industry, are believed to cost more to run and are limited in use to the average superannuant due to their complexity and administration obligations. Based on these premises it could be argued, in comparison to the other superannuation channels, SMSFs are a niche idea that have reached their zenith, are an irrelevance to most people and the best days of this sector are behind it. But is that view borne out by the numbers?

Taking a deep dive As the regulator for the SMSF sector, the ATO collates annual data via SMSF annual returns that have been lodged, and where lodgements are outstanding it uses ‘statistically valid formulas’ to estimate results. It is interesting to note the ATO statistics only have one table, out of the 34 tables in the latest data, that makes any comparison to other parts of the superannuation sector. The simple reason for that is the ATO does not have oversight of the other parts of the superannuation system and it is not its task to make those comparisons. What the ATO figures show is the SMSF sector has grown and matured in line with the demographic that first began to use them – the baby boomers – and will continue to serve their needs for many years while a second generation of trustees have already started their own SMSF journey.

The SMSF population While SMSFs hold more than a quarter of all superannuation assets, there are only 1.1 million members spread across around 600,000 funds. It means when compared to retail and industry funds, SMSFs capture a small slice of the population and this proportion has remained relatively consistent, around the 1 million mark, over

Table 1: SMSF and non-SMSF members, by age range at 30 June 2018 Percentage of all SMSF members

Percentage of all non-SMSF members at 30 June 2018

< 25

0.8

11.0

25 - 34

3.2

22.8

35 - 44

11.0

22.3

45 - 49

10.0

11.0

50 - 54

11.5

9.3

55 - 59

14.2

8.4

60 - 64

14.5

6.6

65 - 69

14.2

4.1

70 - 74

11.6

2.4

75 - 84

8.4

1.7

85+

0.8

0.4

Unknown

<0.1

0.3

Total

100

Average member age

59.4

Age range

This data is based on Australian Business Register (ABR), income tax returns and SMSF annual return form data at 30 June 2018. Note: Non-SMSF members’ age data sourced from APRA Annual Superannuation Bulletin June 2018, reissued July 2019 – Table 12

the past five years. However, SMSFs tend to have a more uniform population over age 35, which is also the time when their usage expands among superannuants. The first column of Table 1 shows that each of the 10-year age brackets that begin at 35 held about 11 per cent of total SMSF members as at June 2018. This number climbs slightly higher for those aged over 55, which is consistent with the number of baby boomers moving through the superannuation system, but is also the point where non-SMSF members are less represented in the superannuation population, according to the second column drawn from Australian Prudential Regulation Authority (APRA) statistics. Age 35 also seems to be the time when people begin to engage with SMSFs, with the percentage of SMSF members in the 35

to 44 age band at the time of establishment jumping to about 30 per cent, compared to those aged 25 to 34 at the time of establishment sitting at around 11 per cent of all SMSF members over the past five years (Table 2). It also seems SMSF members are more likely to set up and retain their fund into retirement, which is an advantage they have over retail and industry funds, and which many have exploited. While Table 2 indicates the average age of a fund member at the time of establishment for the past few years has been around 47, the average age for all SMSF members at June 2019 was close to 60 (Table 1). However, the SMSF sector has greater retention of members past that age on a percentage basis, with Continued on next page

QUARTER III 2020

FEATURE

Table 2: Age distribution of SMSF members by establishment year of SMSF Age range

2017-18

2016-17

2015-16

2014-15

2013-14

< 25

1.3%

1.4%

1.5%

1.7%

25 - 34

12.8%

10.7%

11.3%

11.1%

10.6%

35 - 44

31.8%

28.7%

29.9%

29.6%

29.4%

45 - 49

17.8%

17.3%

16.9%

16.4%

16.2%

50 - 54

14.4%

15.2%

15.3%

15.7%

16.0%

55 - 59

11.3%

12.7%

12.6%

60 - 64

6.2%

8.0%

7.8%

7.9%

8.4%

65 - 69

2.9%

3.9%

3.5%

3.8%

3.6%

70 - 74

1.2%

1.7%

1.0%

1.1%

1.2%

75 - 84

0.3%

0.6%

0.4%

85+

<0.1%

Total

100%

Average member age

46.5

47.9

47.4

47.6

This is based on Australian Business Register (ABR) data.

Table 3: Distribution of funds (%) by asset range in establishment year Fund asset range

2017-18

2016-17

2015-16

2014-15

2013-14

$0-$100K

20.7%

0.0%

>$100k-$200k

17.9%

17.1%

19.8%

22.0%

>$200k-$500k

35.4%

32.5%

32.3%

30.9%

31.7%

>$500k-$1m

18.8%

20.5%

16.9%

16.3%

15.3%

>$1m

92.8%

49.6%

69.0%

67.0%

69.0%

Total

100%

These figures are based on SMSF annual return form data for the establishment year.

Continued from previous page

49.5 per cent of all SMSF members aged 60 and above, compared to 15.2 per cent for all non-SMSF members as at 30 June 2018. This ability for SMSFs to continue to

14 selfmanagedsuper

provide accumulation and retirementphase options for members was recently flagged by retirement and superannuation consultancy Rice Warner as an advantage the SMSF sector has over the retail and industry fund sectors. Rice Warner notes

SMSFs hold a high proportion of Australiaâ&#x20AC;&#x2122;s retirement assets as they are structured to allow retirees to manage their own finances and have key advantages in how funds are structured, as well as how they handle tax and make investments.

FEATURE SMSF STATUS

Table 4: Average asset sizes For SMSFs established in that year

2017-18

2016-17

2015-16

2014-15

2013-14

Average assets per member

$214,104

$265,101

$193,637

$190,346

$178,805

Average assets per SMSF

$408,750

$496,869

$374,308

$375,711

$348,150

2017-18

2016-17

2015-16

2014-15

2013-14

$678,621

$636,926

$581,355

$569,988

$543,556

$1,271,356

$1,199,263

$1,096,521

$1,076,894

$1,028,682

For SMSFs at the end of each ﬁnancial year Average assets per member Average assets per SMSF These figures are based on SMSF annual return form data.

Table 5: Average returns for SMSFs and APRA-regulated funds 2013-14 to 2017-18 Fund type

2017-18

2016-17

2015-16

2014-15

2013-14

SMSFs

7.5%

10.2%

3.1%

6.0%

9.7%

APRA funds

8.5%

9.1%

2.9%

8.9%

11.7%

Rate of returns for SMSFs is based on SMSF annual return form data and for APRA-regulated funds is sourced from APRA June 2018 Annual Superannuation Bulletin, Table 9a.

“The key advantage of SMSFs is that they pool family superannuation – more than 85 per cent of these funds have been set up for couples,” Rice Warner says. The firm points out that at retirement a couple with an SMSF could still use four linked accounts consisting of an accumulation and a pension account for each partner, with the former receiving contributions from any part-time work or to hold assets exceeding the transfer balance cap. “This contrasts to APRA funds where the partners are usually not in the same fund and where their accounts cannot be linked due to outdated administration platforms,” it says.

Setting a measure Questions around the efficacy of SMSFs are often linked to balances per fund or member, returns to members and expenses in comparison to an APRA-regulated fund. These areas were considered by the Productivity Commission in its December 2018 report on the efficiency and competitiveness of superannuation, which

took the view SMSFs with balances below $500,000 usually had lower returns and higher expenses until the funds reached that level of assets. There was some pushback to this view, with Class and the SMSF Association both pointing out costs and returns were not directly comparable between SMSFs and APRA-regulated funds, and the commission’s modelling overstated costs and understated returns. The issue of running costs was raised again late last year in the Australian Securities and Investments Commission’s (ASIC) SMSF Fact Sheet, which stated average yearly running costs for the sector were $13,900 per fund. That figure was criticised as being excessively high by the SMSF Association, which noted the average running cost was closer to $5000, now confirmed by the most recent ATO data. According to those figures, the average operating expenses for an SMSF were $6152 for the 2018 financial year and the median operating expenses for the same period were $3923. Interestingly, over the

five years covered by the ATO data, the average and median costs have not risen sharply, with average costs in the 2014 financial year being $5301 and median costs at $3514. Commenting on the ATO data, SMSF Association chief executive John Maroney said: “Previous analysis relied on the use of averages that ignored the significant distortions caused by large SMSFs and funds choosing to use borrowings and buy extensive administrative, insurance and investment services. “What these revised tables clearly show is how SMSFs exceeding $2 million had a significant impact on the weighting of the costs allocated to an average figure. In addition, the impact of expenses such as investment expenses, insurance and interest on investment borrowings were attributed to the average when many SMSFs choose not to use these services.” And what of the issue of SMSFs needing to hold at least $500,000 to reduce the impact of costs to the fund? Perhaps a better question would have been what are the costs per member, which was raised by administration provider SuperConcepts at the time of the release of the Productivity Commission’s report. SuperConcepts noted the report did not differentiate between fund balances and member balances, which should halve the optimal balance figures required as most SMSFs have at least two members. An examination of the ATO statistics Continued on next page

QUARTER III 2020

FEATURE

Continued from previous page

shows the number of funds being set up with an asset balance higher than the $200,000 threshold has been increasing over the past five years and now represents more than 60 per cent of SMSFs being established compared to just over 50 per cent five years ago (Table 3). At the same time, the level of average assets per member, and per fund, at time of establishment has continued to climb as has the overall average assets per member, and per fund, at the close of each financial year (Table 4). This trend has been evident over the past five years, putting SMSFs well within the range described by the Productivity Commission.

Worth the effort Given the work that goes into running and maintaining an SMSF, is it worth it? It is a question ASIC poses on its Moneysmart website, stating “while having control over your own super can be appealing, it’s a lot of work and comes with risk” and then adding “generally, SMSFs don’t perform as well as professionally managed funds”. And ASIC is correct. Table 5 shows that while generally comparable to APRAregulated funds, SMSFs are typically slightly behind even when a five-year average is considered where SMSFs returned 7.3 per cent compared to an average APRA fund return of 8.22 per cent. This return profile was flagged by the Productivity Commission, which notes: “The SMSF segment has delivered broadly comparable investment performance to the APRA-regulated segment, but many smaller SMSFs (those with balances under $500,000) have delivered materially lower returns on average than larger SMSFs.” Later in the report, the commission also makes this observation: “This does not mean that all members in smaller SMSFs will be receiving poor returns. “Some may be earning high net returns, or have tax advantages that are not fully reflected in the net returns data. Some may also have been set up as part of broader strategies to manage members’ financial risks, with regard to their assets outside of superannuation.”

16 selfmanagedsuper

It is this statement that lies at the heart of what an SMSF is about and which is often lost when making pound-for-pound comparisons between SMSFs and other types of super funds. Those comparisons only work if all superannuation funds are viewed as being equal and delivering the same outcomes for every member. That expectation is realistic when comparing a balanced fund with the exact same investments offered by a retail or industry fund, but it falls down completely when making comparisons with SMSFs, mainly because the latter don’t invest in the same way as the former and the outcomes are usually different as well. This is best seen in the asset allocations statistics for SMSFs collected by the ATO, which show that, on the whole, SMSF members invest in the same asset classes as other super fund members, but do so in different ways. Listed Australian shares is the highest ranking asset making up 29.1 per cent of total SMSF assets, followed by cash and term deposits at 21.6 per cent, and then property investments at 19.9 per cent, which is broken into non-residential real property (9.1 per cent), residential real property (4.9 per cent) and limited recourse borrowing arrangements – into both non-residential and residential real property (5.9 per cent), as at 30 June 2018. A comparison with similar data released by APRA for the March quarter 2018 shows the average allocation to Australian shares by an APRA-regulated fund was 23 per cent, cash was 10 per cent and listed and unlisted property was 8 per cent. A significant difference was the allocation to overseas shares at 24 per cent compared to only 1.8 per cent for all overseas investments, including shares, property and managed investments, by SMSFs. It is these differences that are the point of SMSFs and which have attracted people to them, allowing them to decide for themselves what their exposure will be to any asset class but also using the legally available structures to access other investments outside the mainstream.

Loose cannons This ability has attracted some criticism over the years and has also come with a number of

warnings. Prior to it being taken offline, due to the release of more accurate data, ASIC’s SMSF Fact Sheet stated “the buck stops with you” when owning and running an SMSF. It is a message that has been frequently promoted by the ATO as it encourages trustees to know their obligations. Former ATO SMSF segment assistant commissioner Dana Fleming is on the record several times stating the ATO wants to see a greater level of compliance from trustees, but also noted the relatively low level of problems associated with the sector. Speaking at the SMSF Association National Conference in February, Fleming said there were 10,330 SMSFs with 27,719 regulatory contraventions in 2019. “The most common contraventions remain, and have been over five years, loans to members (21.1 per cent), in-house asset breaches (18.5 per cent) and separation of assets (12.7 per cent) where there has not been clear record-keeping to keep the SMSF assets separate from the personal assets of members,” she said, reflecting the numbers in the ATO statistics report. “I do want to remind everybody that this is just 2 per cent of the population and that has been a steady number for many years. We are talking about a very small proportion of the population.” So, far from being loose cannons, or a niche-play by superannuation dabblers, SMSFs have created a well-regulated and compliant alternative likely to retain its place in the retirement income landscape. In light of the issues raised by the Hayne royal commission around the treatment of superannuants in APRA-regulated funds, SMSFs have stood out in comparison, a point which has been noted in Canberra as well. “One of the reasons I like SMSFs is they are a good way of taking control of your own destiny, which is a healthy thing as there has been too much principal agency cost in the super system,” New South Wales Liberal Senator Andrew Bragg said recently. “The SMSFs have done well and not had any major reputational issues and all the reviews of those schemes appear to given them a clean bill of health. It is very hard to find major systemic problems there because people are, effectively, running their own race.”

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FEATURE

THE WAY

FORWARD

The Australian Securities and Investments Commission relaxed some of its compliance activities to allow more Australians the ability to access financial advice to manage the fiscal impact of the coronavirus pandemic. Tharshini Ashokan weighs up the success of these moves and if they potentially are a prelude to how practitioners will deliver advice in the future.

18 selfmanagedsuper

FEATURE COMPLIANCE OUTLOOK

Temporary compliance relief measures were introduced in April by the Australian Securities and Investments Commission (ASIC) to assist the financial advice industry and its clients through the worst of the COVID-19 pandemic and lockdown. As part of the temporary relief ASIC provided, financial advisers were given the ability to issue a record of advice (ROA) instead of a full statement of advice (SOA) when providing services relating to the coronavirus economic relief measure allowing individuals to access their superannuation benefits early. In addition, the corporate regulator permitted registered tax agents to give advice to existing clients about the instrument without needing to hold an Australian financial services licence (AFSL). Industry bodies, including the SMSF Association, Institute of Public Accountants (IPA), Financial Planning Association, Chartered Accountants Australia and New Zealand, and CPA Australia, revealed they had collaborated with ASIC to introduce these initiatives to make the provision of advice less complicated for consumers financially hit by the pandemic. Though the compliance relief implemented by ASIC was largely welcomed by financial advisers at the time, a recent study conducted by the industry body’s found the measure allowing an ROA to be used in place of an SOA had proven impractical for the majority of practitioners providing advice regarding the early release of superannuation. According to SMSF Association policy manager Franco Morelli, advisers who had used the relief measure found it effective, but most of the industry body’s members surveyed had not used the relief provided. “The overall feedback we got from the majority of members is they weren’t able to use the relief,” Morelli says. “Obviously, ASIC tried to move quickly and that meant the relief couldn’t be defined as perfectly as possible. As a

result there were many scenarios where the relief just wasn’t able to be practically used.” The reasons given by members who had not used the measure included a preference for SOAs as a less risky alternative to ROAs. Some members stated they had always had the ability to use an ROA and did not require the relief measure because the client’s circumstances had not changed. Superology director Tracey Scotchbrook believes the compliance relief measures allowing the provision of ROAs was timely, but agrees many advisers appeared to have mixed feelings as to the effectiveness of them. Based on her discussions with other practitioners, most seemed to be of the view that many consumers with a financial need to access their super early were unlikely to have sought advice. “In light of the impact of COVID-19, replacing SOAs with ROAs was a really practical, quick measure that could be implemented using the existing system. It was really about filling that urgent need for advice,” Scotchbrook says. “However, for a lot of people, given the financial pressures they were experiencing, I think advice would have been the furthest thing from their mind.” In addition, there were instances of licensees either not authorising advisers to use ROAs or cautioning against it and indicating an SOA should still be used. This was attributed to licensees’ concerns regarding the need to meet legislative and ethical requirements, such as the Financial Adviser Standards and Ethics Authority (FASEA) Code of Ethics for financial advisers. “There were some licensees that suggested a full SOA was the preferred option and that it was really only under extenuating circumstances that the ROA should be considered,” Scothchbrook notes. “Broadly, from speaking to advisers and licensees, there’s been quite a mixed response – some looked at the ROA as an

“I think ASIC’s relief measures have been very effective. They’ve shown when government and government agencies need to act quickly, and when they need to be reducing red tape, it can be done.” Vicki Stylianou, IPA

opportunity to get out and help people, while others were approaching it with quite a lot of caution because of that compliance burden and risk.” IPA head of advocacy and technical Vicki Stylianou sees the measure as a positive step in the overall approach to compliance within the financial advice Continued on next page

QUARTER III 2020

FEATURE

“It has really been integral in opening the door for being able to have that conversation for reform, which I think is a really positive thing.” Tracey Scotchbrook, Superology

Continued from previous page

industry despite the mixed response as to the move’s effectiveness. “For those who did want the advice, at least the regulatory relief enabled the advisers to give it legally,” Stylianou notes. “I think ASIC’s relief measures have been very effective. They’ve shown when government and government agencies need to act quickly, and when they need to be reducing red tape, it can be done.” She also recognises ASIC’s decision to allow registered tax agents to give advice to existing clients about early access to superannuation without holding an AFSL as a positive move for the industry, despite being temporary. “IPA has been on the record for a very long time to say that tax agents should be able to give this advice – simple, straightforward advice to consumers that doesn’t include product advice or anything like that,” she adds. “I think this particular measure demonstrates that the world is not going to fall apart if you let tax agents legally give advice to their clients.” Morelli also considers the temporary inclusion of tax agents by ASIC as a much-needed step towards allowing a more permanent arrangement for tax practitioners being able to provide financial advice in the future. “I think tax agents appreciated the

20 selfmanagedsuper

ability to at least consider discussions on early release of super as a COVID-19 relief measure,” he observes. “It’s extremely frustrating when a client might come to a tax agent and they want to discuss what measures are available to them, but when it gets to superannuation, that discussion is sometimes stifled. From that angle, it definitely helps to push a more inclusive approach even though it probably wasn’t used on a significant scale. “We think a more inclusive approach is the way of the future for both tax agents and advisers.” From the consumers’ point of view, many practitioners believe ASIC’s compliance relief measures did have the intended effect of helping consumers who sought financial advice in a timely manner. “In terms of benefiting the consumer, the measures were really practical because you had the early release concessions, but you also had the other ROA concessions, which allowed an alternate adviser from the same firm to provide that advice rather than the original practitioner,” Scotchbrook says. “Advisers were quite stretched and it meant people could get that advice piece and quickly.” Morelli echoes this point of view. “For those consumers who needed advice quickly, I think the relief definitely helped

that occur and it probably helped it was offered at a cheaper price point as well,” he says. “The feedback we’re getting is that ROAs can be just as useful as SOAs and that’s something the SMSF Association has been looking at. We find many consumers don’t appreciate long SOAs, they just want good advice, and that’s why we’re continuing to push for improvements to the financial advice framework.” He says an improved and consumercentric financial advice framework could potentially include shorter advice documents and the provision of scaled advice for SMSFs. It might also include the provision of strategic advice without the recommendation of a financial product. “It doesn’t matter if someone is an accountant or a financial planner. We think if they’ve got the appropriate educational standard, the same rules should apply, and then consumers will have more access to advice from a wider range of professionals,” he adds. Stylianou thinks an ASIC survey of individuals who received advice would be the best way to determine the impact of the regulator’s compliance relief measures on consumers and whether the advice was ultimately beneficial. “You would hope that if you went to the trouble of speaking to an adviser, it

FEATURE COMPLIANCE OUTLOOK

would influence not only how you spent the money, but whether or not you should have accessed your super in the first place,” she says. “It would be interesting to know whether the advice made a difference to consumers’ decision-making. You would hope so. “There’s a self-selection process here. If you go to an adviser, it probably means you’re going to listen to them.” Overall, she believes the temporary measures brought into effect by ASIC have highlighted the possibility of a less burdensome compliance regime for the financial advice industry. “It shows that it is possible to have some more streamlined and effective systems that would enable consumers to have choice in terms of who they’re going to get advice from,” she notes. “What we’ve got at the moment, the system we’ve got at the moment, is quite bureaucratic. It’s over-regulated we could say.” While she agrees high education standards are important, she thinks the need for an adviser to produce a 30 to 40-page SOA the consumer is unlikely to read is excessive. According to Stylianou, such standards can only lead to higher costs and will drive away consumers. “There are a lot more people out there who want access to financial advice, but aren’t prepared to pay the kind of prices that you need to pay as a result of the current compliance framework,” she adds. Morelli agrees the measures have been an important step for the industry in terms of demonstrating how a less restrictive compliance regime might operate and hopes it will lead to a more consumerfriendly framework. “I think the temporary compliance measures have started a great discussion,” he notes. “From the association’s point of view, we can definitely see the government

“We think a more inclusive approach is the way of the future for both tax agents and advisers.” Franco Morelli, SMSF Association

and ASIC are looking to engage more on these issues regarding scaled advice and relating to a more extensive use of ROAs, and that can only be a good thing. “The fact there was a need for temporary relief probably indicates the compliance framework needed a review.” Despite not being used widely by advisers in terms of early superannuation access, Scotchbrook does believe the temporary compliance measures have been a good indicator of what a reformed regulatory framework might look like. “It has really been integral in opening

the door for being able to have that conversation for reform, which I think is a really positive thing. It has put us in a much better position than where we were before,” she says. “While the government is still having to deal with the issue of COVID-19, it’s probably not something that’s going to happen in the immediate future, but in the short to medium term I would hope the government will remember this.” According to Morelli, timely reform of the financial advice framework could also help the economy recover from the detrimental effects of the pandemic. “Post COVID-19 and the economic recovery, we know the government is focusing on deregulation and the advice framework is a big part of that,” he says. “This is something the SMSF Association is really going to push so more advisers can give that efficient and affordable advice, and I think advice is a key part of the economic recovery.“ Stylianou agrees the coronavirus relief measures provided by ASIC have shown a less burdensome compliance structure could ultimately work for the financial advice industry in the future. “The IPA is arguing ASIC’s temporary compliance provisions should be implemented for the longer term. It might need a bit of tweaking but the general concept of allowing tax agents to give simplified but strategic advice, not product advice, and having a simplified process and ROA-type situation, is something that is good for the longer term,” she says. “There does need to be a review of the system because the current system is not fulfilling the policy objective of enabling consumers to get access to affordable and competent advice. “There’s been a lot of work done with FASEA and its Code of Ethics to professionalise financial advice, but at the same time it hasn’t quite worked and there’s still a way to go.”

QUARTER III 2020

INVESTING

Sound policies of capital allocation ring true

Finding yield is challenging in COVID-19-affected markets, but there are some measures that can be used to identify solid sources of income, writes Damien McIntyre.

DAMIEN MCINTYRE is chief executive at GSFM.

The COVID-19 pandemic and its effect on the market have brought dividend payouts into sharp focus for SMSF trustees. Will dividend-paying companies be able to sustain their payouts in the face of an economic slowdown? Should these companies bow to political and societal pressure to cut or suspend their dividends? What’s more, with bond yields at historic lows, dividends take on even more importance for investors who are looking for income. How will these pressures affect the outlook for yield?

Paradigm shift A paradigm shift has been taking place in the sources of return for investors in global equity markets for a number of years. The COVID-19 pandemic has accelerated this development, particularly in the areas of deglobalisation, technology and healthcare. William Priest, chair of New York-based Epoch Investment Partners, says it is a shift Australian

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investors and SMSF trustees – who have traditionally focused on Australian-based equities with their taxpaid dividends – cannot afford to ignore. In his book, Free Cash Flow and Shareholder Yield: New Priorities for the Global Investor, co-written with Lindsay McClelland and published by John Wiley & Sons, Priest argues the key to producing superior risk-adjusted returns is not to focus on the traditional valuation measures such as price-toearnings (PE) or price-to-book ratios. Investors often view a company through the prism of these accounting measures. But the key to understanding a company means understanding the cash-generating drivers of the business. Earnings growth and dividends drive shareholder returns, and they come from a single source: cash flow. The important questions investors need to ask are: how does a business generate its free cash flow and how does its management allocate that cash for the benefit of shareholders?

Reinvesting cash flows into internal projects or acquisitions is preferred when those actions will generate returns above the cost of capital. Otherwise, company management should return excess cash to shareholders through dividends, share buybacks or debt repayments – collectively known as shareholder yield. Accrual-based accounting measures, such as earnings, and valuations metrics based on earnings, simply do not provide the relevant information as to whether a company is successfully generating free cash flow and whether management is allocating that cash flow properly. What’s more, historical evidence demonstrates that long-term equity returns are driven by growth in earnings and dividends, with the vagaries of PE multiple expansion and contraction washing out over time. Consequently, those looking for income should be focused on investing in those companies that have a consistent ability to both generate free cash flow and to properly allocate it among internal reinvestment opportunities, acquisitions, dividends, share repurchases and debt repayments. How to deploy free cash flow should be guided by the company’s cost of capital. Acquisitions and reinvestments should only be undertaken when the return on capital is greater than the firm’s average cost of capital. Otherwise, free cash flow should be returned to shareholders via the other three uses: dividends, share buybacks and debt repayments. Good companies are those that create free cash. Great companies are run by people who know how to allocate that excess cash to create value. Build something and buy something. And if you can’t do that, you need to return the money to the owners of the business. Because that’s what businesses are for: to generate capital for their owners. Finding relative value is never easy in times like the present, but it will be visible in those companies generating free cash flow and possessing management that has a

Investing only in certain regions of the world is akin to investing only in companies that begin with certain letters of the alphabet.

history of wise capital allocation. Value will not be found in passive strategies where large proportions of the names have no earnings and no earnings before interest, tax, depreciation and amortisation. Indeed, mispricing opportunities arise in volatile markets and those investors with longer holding periods will benefit. Investors should be looking for companies that can produce excess cash flows and whose management is committed to delivering shareholder returns by paying above-average and growing dividends, buying back shares or paying down debt without taking undue risks.

The Australian experience There are Australian companies producing substantial shareholder yield in the form of dividends, share repurchase and debt reduction, and several of them represent good value. But it would be difficult, if not impossible, to construct a properly diversified portfolio from Australian companies alone without lowering the expectation for shareholder yield and accepting a higher level of portfolio volatility. The Australian equity market is relatively small compared to other global markets and over 60 per cent of the S&P/ASX 200 Index, which covers around 80 per cent of Australian equity market capitalisation, is in the financials and highly cyclical materials sectors. Putting regional constraints in place in a portfolio will limit the diversity of companies

to choose from. Investing only in certain regions of the world is akin to investing only in companies that begin with certain letters of the alphabet. A global portfolio produces the most robust set of stocks from which to choose. Consequently, a global mandate will provide investors with the best outcome.

Current environment An important point being missed by many market commentators during COVID-19 is even in the midst of today’s crisis, companies are not going to abandon sound policies of capital allocation. Companies are certainly tightening their wallets, as they do during all recessions. However, the drivers that have led to strong dividend payouts over the past two decades will remain intact. One of those drivers is the role of technology, with capital-light business. A second driver is the lower-forlonger interest rates, which incentivises companies to maintain lean balance sheets and return excess cash to shareholders. The third is buybacks, which will continue to play an important role, including as a shock absorber, even as they are vilified by the media and many politicians. Finally, in a world of yield starvation, where there is a genuine need for income, bonds just do not provide enough. This means there will continue to be a strong, underlying demand for dividend yield. Over the decades, earnings and dividends have been very highly correlated. Additionally, during downturns, earnings fall by 20 per cent on average, while dividends decline by around 10 per cent, or about half as much. Further, it typically takes three quarters for dividends to rebound to their previous peak. We expect the COVID-19 recovery to be swoosh-shaped, which implies a sharp initial fall and then a gradual recovery going forward. However, there is a wide range of opinions regarding the timing and shape of the eventual recovery for both earnings and dividends.

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QUARTER III 2020

INVESTING

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US recession impact on EPS and DPS Earnings visibility is always terrible in the middle of a recession and, taking the example of the United States, now is no exception. To illustrate, the dispersion among consensus estimates is currently close to the record high set during the global financial crisis, and the global policy uncertainty index is at an all-time extreme. Regardless of these challenges, the consensus expects earnings to be down 30 per cent to 40 per cent during 2020, which is quite a wide range, and in line with the average of the three most recent recessions. Turning to dividends, the consensus view is even more diffuse, with expected 2020 growth of plus 5 per cent to minus 25 per cent. It’s not surprising that earnings per share (EPS) and dividends per share (DPS) go down in recessions, but if we look beyond the aggregate data, there’s a substantial dispersion across industry sectors. The expectation and the experience around EPS in 2020 will vary significantly by industry, and there will be some sectors hit harder than others, and perhaps not surprisingly they are energy, consumer discretionary, industrials, materials and financials.

Sectors to take the biggest 2020 EPS hit In a recent investor presentation, Priest referenced an article in The Economist that suggests one way to think about this is to sort companies into three buckets. Bucket one is companies that have received government assistance, such as airlines, and banks in Europe. These businesses that are receiving government assistance because they have been so negatively affected should be required to cut dividends according to the terms of the assistance programs. Bucket two is cyclical companies with large EPS declines that find themselves required to cut their dividends out of necessity.

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Investors should be looking for companies that can produce excess cash flows and whose management is committed to delivering shareholder returns.

Bucket three is reserved for firms with solid balance sheets and exhibit resilience in their earnings and their cash flows in difficult times. Tech, healthcare and utilities are three sectors fitting into this bucket and where we would expect to see companies having resilience in their earnings profiles and therefore resilience in their dividend profiles.

Two solid sectors in the past recession EPS and declines, peak-to-trough, in the tech sector, are almost 66 per cent, while the decline in DPS is only about 15 per cent. So dividends are much more stable there. As well, healthcare tends to be virtually recession-proof, with very modest declines in EPS over the past three recessions and also very modest declines in DPS. Epoch also comments it has observed variation within sectors. Even in hard hit sectors, there will nevertheless be companies that are more resilient and can pay their dividends uninterrupted. For instance, not every financial services company cut their dividend during the global financial crisis. From the historical record on share buybacks we have learned they act as a shock absorber. Buybacks fell sharply in 2019 and the expectation is they are going to fall sharply again in 2020. If this is a shock absorber, the share buyback activity responds more than the dividend activity.

It’s also interesting to note the dispersion around industry sectors in terms of buyback activity. There are four sectors that dominate US buybacks. Consensus expects this type of activity to fall about 50 per cent this year, although some sectors will be more vulnerable than others. The major banks in the US have announced they will voluntarily suspend their share buyback programs this year. So financials, consumer discretionary, industrials and energy are sectors that will be hit more significantly and more likely to reduce their share buyback programs. Least affected will be tech, healthcare, consumer staples and telecommunications. If buybacks are put on hold and many dividends are maintained, then we would expect to see the dividend yields go up and likewise see buyback yields go down. It is what has been observed in the past; and it is what we expect to see again in this episode we’re living through today. It is also worth noting over the past decade the total equity yield – from dividends and share buybacks – has been well in excess of the yield available from bonds, and that’s a consistent theme from Epoch Investment Partners. In a world starved of yield, a portfolio of high-quality equities is a good place to go for income when the bond market is not offering any. If we look back at history there are significant episodes where dividend yields fell sharply: during the 1893 panic, in 1929, at the end of World War II, during the NiftyFifty era of the 1960s and 1970s, and again in the tech boom. We saw the dividend yields come down and the questions were posed: What’s happening with dividends and are dividends starting to go away? A well-known academic paper, “Disappearing dividends: changing firm characteristics or lower propensity to pay?”, by economists Eugene Fama and Kenneth French, published in 2001, posed that question. What this tells us is we have heard this conversation before and it’s likely we’ll hear it again. But the view at Epoch is that dividends will remain a key component of the capital allocation framework.

SMSF TRUSTEE EMPOWERMENT DAY

2020

DIGITAL EVENT 15 SEPTEMBER

FEATURED SESSIONS SMSF administration and compliance – tips and traps

MARK ELLEM SMSF SPECIALIST ADVISOR

Every year an SMSF is required to prepare a set of financial statements and an SMSF annual return, as well as having an independent audit conducted by a registered SMSF auditor. While many SMSF trustees leave this process up to their SMSF administrator or accountant, it’s worthwhile understanding what is involved in SMSF administration and compliance. This session will cover SMSF administration and compliance issues to provide attendees with an understanding and appreciation of the processes involved in these two areas.

How COVID-19 is shaping the current SMSF landscape

TIM MILLER EDUCATION MANAGER, SUPERGUARDIAN

SMSFs have felt the direct impact of the COVID-19 pandemic, with measures introduced to assist members whose employment has been affected by lockdowns, but also those seeking to preserve their superannuation capital in retirement. However, the impact goes beyond these direct measures and also captures tenancy issues, borrowing matters, reduced parliamentary sittings and a delayed federal budget. This session will cover changes to the contribution rules, minimum pension reductions, rent and loan relief, in-house asset relief and early access to superannuation.

GET YOUR FREE TICKET 

More information at www.smstrusteenews.com.au/events

INVESTING

Five myths of investing in Asia There are many negative perceptions when it comes to investing in Asian markets, but many of them are unfounded, Geoff Bazzan writes.

GEOFF BAZZAN is head of Asia-Pacific equities at Maple-Brown Abbott.

The COVID-19 pandemic has reminded all investors how fast and dramatically markets can fall – and with very little warning. For self-funded retirees, this may well have been a lesson also learnt during the global financial crisis 10 years ago, or other earlier market collapses, but the speed of the March downturn was unprecedented. For those who have relied on the stability and familiarity of Australian equities to form the substance of their portfolio, the downturn will have underscored the fact the Australian market can be vulnerable, including to events and issues in the rest of the world. And despite the recent recovery, volatility and uncertainty continue to be very much in play. Traditionally, Australian investors have displayed a strong home bias and, as such, prefer to invest in companies they know and trust operating out of their home market. The United States market has also been an attractive option for local investors. However, the Asian market, despite its size,

diversity and potential, is often overlooked. There are a number of myths and misconceptions about investing in Asia. But we believe it is an opportunity set that is simply too big to ignore in more ways than one.

MYTH 1 The Asian region is only a small part of the global economy It’s true the Asia ex-Japan region represents a fairly minimal weighting in the MSCI AC World Index at 10.9 per cent. However, we believe this vastly understates both the significance and opportunity on offer. Overall the region accounts for more than a quarter of global gross domestic product and has generated the predominant share of its growth in recent years. On this basis alone, it could be argued its MSCI AC World Index weighting doesn’t reflect the region’s true importance.

Chart 1: MSCI regions (ex-fin) – Net gearing trend 90

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Furthermore, despite accounting for barely 10 per cent of the global benchmark, the region possesses more listed stocks with a market capitalisation greater than US$1 billion than either the US or Europe. Looking ahead, the Asia ex-Japan region is likely to remain the engine room of global growth for many years to come. It is home to more than half the world’s population and two-thirds of its global savings, and Asia’s emerging middle class represents one of the world’s most dynamic and enduring investment opportunities.

the past corporate balance sheets were somewhat stretched in some countries, but management teams across the region have increasingly adopted a very conservative position with regard to their capital structure, particularly since the Asian financial crisis in 1997. While Asia might be accurately described as having high operating leverage, it has decidedly minimal financial leverage, especially compared to Europe and the US (See Chart 1).

The story from Asia, COVID-19 notwithstanding, is positive. Its growth in recent years has been significant and shows no sign of stopping.

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MYTH 2 Balance sheets of Asian companies are stretched, making them a risky proposition Nothing could actually be further from the truth. Balance sheets across Asia are among the strongest in the world. Aggregate net debt to equity, excluding financials, for Asia ex-Japan currently stands at 31.1 per cent – less than half that of the US. It is true that in

QUARTER III 2020

INVESTING

Continued from previous page

MYTH 3 Asian corporates tend to retain their profits, minimising payouts for investors Dividend growth is a secular opportunity for Asian equities. In recent years, corporate management teams across Asia have become increasingly aware of the virtues of growing dividends as well as growing earnings. We are seeing an increasing number of companies seeking to grow dividends per share in advance of earnings and expect the aggregate payout ratio of the Asia exJapan region to rise well above its current level of 40 per cent. Supported by the strongest balance sheets in the world, as described earlier, the scope for rising payout ratios to augment total returns in a lower-growth environment is expected to be a significant factor in driving outperformance from the region in the years to come. For Australian investors who are seeing dividend payouts from domestic companies fall, this may be an attractive proposition.

MYTH 4 Asia has too many state-owned enterprises and family-dominated companies Corporate governance is a perennial theme in markets the world over. It is true Asia ex-Japan is home to a number of majority governmentowned companies as well as familyrun conglomerates. Yet the quality of management teams continues to improve and at the same time better capital allocation, that is, fewer wasteful projects, has been a key feature over the past decade. Rising free cash flow, driven in large part by lower capital expenditure over the past decade, is evidence of this phenomenon. Furthermore, mixed ownership reform continues to evolve in

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China, introducing better incentives for management teams, while instances of minority shareholder abuse have become scarcer across the region.

MYTH 5 Asian countries are struggling to manage COVID-19 and its economic impact The fact the Asia ex-Japan region has outperformed the global benchmark year-to-date is, in our opinion, no accident. Although the region retains favourable valuation support compared to much of the rest of the world, most Asian economies have proven relatively successful in managing the impacts of COVID-19. China is a clear case in point. It retains one of the most rigorous and comprehensive testing regimes in the world, allowing its economy to recover very strongly compared to most others. Unlike much of the rest of the world, Asia typically retains a relatively strong fiscal position that is able to be used for necessary recovery efforts. Likewise, the typically more conservative monetary stance of most Asian central banks has meant more stimulus has been able to be effected than

We believe it is an opportunity set that is simply too big to ignore in more ways than one.

has typically been the case elsewhere. Overall, the story from Asia, COVID-19 notwithstanding, is positive. Its growth in recent years has been significant and shows no sign of stopping. Furthermore, at the time of writing, the pace of the early recovery within Asia has been encouraging, especially within the key North Asian markets of China, Taiwan and South Korea, which were among the first to both enter and exit from lockdown measures. We believe it is still early days in the pandemic and its impact, but there is cause for cautious optimism in the outlook for the Asian region. For investors looking for opportunities, rethinking any preconceptions about Asian equities could be worthwhile.

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COMPLIANCE

Compliance problem solving

It is never a pleasant experience when an SMSF falls foul of the governing legislation. Liz Westover outlines some steps that will make these situations more manageable for advisers and their clients.

LIZ WESTOVER is superannuation, SMSF and retirement savings partner at Deloitte.

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There aren’t many SMSF advisers in the country who have not had a client with some form of compliance issue or breach. Fortunately, many of these are minor and can be relatively easily resolved, but occasionally they are serious and need assistance or intervention to get back on track. These issues could be anything from late lodgement of annual returns through to in-house asset issues, residency matters, illegal early release of funds or simply not getting the timing right on year-end contributions. The more serious breaches are reported to the ATO by auditors via an auditor contravention report (ACR). This type of action typically occurs in approximately 2 per cent of cases. Minor

matters may never get reported and the ones in the middle might give rise to a qualification in the annual return or are raised by the auditor in their management letter to the trustee. The main message is whatever the breach, minor or serious, don’t ignore it. It won’t get better and it won’t go away. Deal with it as soon as you can. An escalation process in assessing a problem usually works well.

What’s the problem? The first thing to do is clearly identify the problem. What is it? What led to it? Can it be easily resolved? An expense paid by the member and not reimbursed can be treated as a contribution or most auditors will allow it to be treated as a sundry creditor at year end if quickly repaid. An underpayment of minimum pension amounts is harder to resolve, but not impossible. How big the underpayment is needs to be determined. The ATO allows for an underpayment of up to 1/12th

Whatever the breach, minor or serious, don’t ignore it. It won’t get better and it won’t go away. Deal with it as soon as you can.

of the minimum amount if it is picked up quickly in the new financial year. Whether there were any extenuating circumstances also needs acknowledging. Perhaps the bank incorrectly dishonoured a cheque or a member suffered a medical episode at the end of the year when they normally make such payments. Often these can give rise to the ATO exercising some discretion to allow the pension to remain on foot and eligible for tax exemptions. Generally, you have to ask for discretion and you have to be on the front foot in pleading your case. A less favourable outcome is likely if the matter has already been identified and/or reported to the ATO. This is particularly so in cases of excess contributions. The regulator is far less likely to accept a mistake was made if trustees and their advisers are responding to an excess contributions determination rather than self-reporting it to the ATO in the first instance.

Legislation When a compliance breach arises it is most important to read the relevant legislation. This is actually the source of truth and contains often forgotten exclusions or exemptions to otherwise commonly known rules for SMSFs. This might be the case when determining whether an asset is an in-house asset or determining if an asset is able to be acquired from related parties. Exemptions and carve-outs exist

and going back through the legislation and regulations with a particular scenario or circumstance in mind can be the fastest and easiest way to work through a problem.

Research The next step is to start researching what others have done. The ATO and professional association websites are a great source of information. They often contain great tips and insights into real-life cases and scenarios and importantly any preliminary views or precedence on ATO thinking on similar situations.

Industry events Attend industry events and discussion groups and use the opportunity to ask questions of the speakers or attendees during or after the sessions. Even if they can’t give you the answer immediately, they can often guide you on whether your approach to a problem is on track or point you to other sources of information.

Get an expert opinion

ATO rulings are a gold mine resource as well. Not only do they articulate the ATO’s position on a particular matter, they almost always have an abundance of examples you can compare with your own situation. They will frequently provide the answer to an issue or help in clarifying your own thoughts on the workings of the law. Rulings are also available on the ATO legal database on their website.

Ultimately, if you can’t find the answer yourself, it may be time to consult with an experienced SMSF adviser for a discreet piece of advice. You can’t know everything all the time. Sometimes it’s worth focusing on your day-to-day work and engaging an SMSF expert for a piece of advice for you or your client. This can be particularly useful if you need an independent assessment of the law and how it applies in a given set of circumstances – especially if it’s a longstanding client and you or your staff may have been involved in advising the client for a period of time. Related-party transactions and investments can be complicated, so it can be worth getting expert advice in dealing with these items too, not only to solve a problem, but help prevent one occurring in the first place. Too many trustees have become derailed by pre-1999 unit trusts, 13.22C trust rules, unpaid dividends, loans and the like because they didn’t get the right help at the right time. The right time is frequently at the front end of a transaction. Setting the foundation for the future can avoid costly mistakes from occurring later on.

Industry contacts

Speak to your auditor

Talk to colleagues, draw upon professional associations or ask the ATO – use the experience of your contacts in the industry. Most are very generous with their time, experienced, can be a great sounding board for scenarios and can direct you in the right direction for rulings or other information.

Auditors can be a great source of information on compliance matters, but, more importantly, they can give you insights into how they are likely to treat a breach during an audit. This can guide you in how and when to rectify an issue. A

Private binding rulings Existing ATO private binding rulings (PBR) are an underutilised resource. Although they can only be relied on by the person who applied for the PBR, they give great insights into the ATO’s thinking or approach on matters. Further, if the need arises to apply for a PBR, they can be of great assistance in using the appropriate structure and wording as well. Sanitised versions of PBRs can be found in the legal database on the ATO website.

Rulings from the ATO

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QUARTER III 2020

COMPLIANCE

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good auditor will help you work through a rectification plan and enable an ACR to be lodged stating rectification has already taken place. The ATO is generally far more interested in unrectified breaches than those that have already been resolved. It is likely an experienced auditor will also be able to talk to similar breaches they have seen and how they were resolved and/or treated by the ATO.

Apply for a PBR PBRs are the perfect way to gain certainty around how the ATO will treat a breach or situation as once received it is binding on the tax commissioner. However, be careful what you ask for as the answer may not be the one you were looking for and, once given, it is much harder to take a different position knowing how the ATO will respond given the exact circumstances. Sometimes, however, an issue is more one of interpretation rather than a breach and seeking ATO confirmation that a matter will be treated a certain way gives comfort to clients. Getting a PBR on the ATO view of whether a family member is a dependant for the purposes of receiving a super death benefit and the ensuing tax implications provides certainty in what can otherwise be a challenging time for clients.

Engage with the ATO Some problems can’t be easily or readily solved. There are a number of areas in which the ATO has little flexibility and some involve breaches that are so egregious, the best course of action is to engage early with the regulator, voluntarily disclose the breach to it and agree on how best to move forward. A voluntary disclosure to the ATO is like a safety switch that can mitigate or prevent what otherwise might occur. In almost all cases, a voluntary disclosure will result in a better outcome than if a breach is found by the ATO or it becomes aware because an ACR is lodged by the auditor. The best approach is to go to them, declare your

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hand and suggest a solution. This way, you get the ATO on board to give you time to resolve matters, but importantly to agree on what that resolution is, rather than trying to guess what will be acceptable. A voluntary disclosure will not provide absolution nor should it be asked for – the best tactic will be to take a reasonable approach to rectification. Make it easy for the ATO to accept what you propose rather than risk them outright rejecting an unreasonable suggestion and coming up with their own expectations for resolution. For example, if a loan is the problem, put forward a reasonable interest rate and time within which amounts will be repaid. If multiple years of outstanding returns are to be lodged, commit to having them brought up to date within a reasonable period of time. In some cases this may mean volunteering to wind up the fund and for the trustees to agree never to act as an SMSF trustee again. Ultimately, you want to demonstrate to the ATO the trustees are committed to rectifying any breaches and getting the fund or their affairs back in order.

A voluntary disclosure will not provide absolution nor should it be asked for – the best tactic will be to take a reasonable approach to rectification.

What to expect from the ATO In the early years of regulation, the ATO had limited options available to it when contraventions occurred. In practice, the regulator could either do nothing or make a fund non-complying, which was largely seen as unreasonable or inappropriate for less serious breaches. The Stronger Super reforms introduced a range of other options to the regulator, allowing it to better deal with different contraventions and breaches. These options were broadly supported by the industry as a useful tool to drive and encourage good behaviours by trustees. The ATO’s arsenal of penalties currently consists of the following: • rectification orders, • education orders, • administrative penalties, • disqualification of trustees, and • making a fund non-complying. To date, the ATO has taken a pragmatic,

and sometimes lenient, approach to imposing them. Unfortunately, even with these new penalties, the behaviour of trustees around non-compliance issues hasn’t shifted and advisers and their clients should expect the ATO to impose these penalties more frequently and to a greater extent. Where full remission of penalties may have been possible in the past, this is not likely to continue. The regulator is expected to release its compliance guidelines on the imposition of penalties imminently. Compliance with relevant laws can be challenging, but is required when acting as an SMSF trustee. Knowing how to navigate issues and resolve them in the most appropriate way is essential.

STRATEGY

Bring-forward contributions state of play

The ability of superannuants aged 65 and 66 to trigger the bring-forward rule for non-concessional contributions is currently uncertain. Meg Heffron examines what the current parameters for this provision are and the strategic opportunities still available to individuals in that demographic.

MEG HEFFRON is managing director at Heffron.

When the contribution rules changed on 1 July 2020 through Superannuation Industry (Supervision) In-house Asset Determination – Intermediary Limited Recourse Borrowing Arrangement Determination 2020 to allow those aged 65 and 66 to make superannuation contributions, and have contributions made on their behalf, without a work test, I hoped the equivalent changes to the bringforward rules wouldn’t be too far behind. The bring-forward rule changes will move the deadline for commencing a non-concessional contribution bring-forward period to the 30 June following the member turning 67 years of age rather than 65. In all other respects the rules will remain as they are today. The federal government’s intention is to still have these in place from 1 July 2020. That said, the

deferral of the first parliamentary sitting dates for 2020/21 until late August means we will have to wait even longer for the legislation to actually be passed.

How does this uncertainty affect someone turning 65 in 2020/21? Consider a retiree whose total superannuation balance is well short of $1.4 million, making her confident the maximum bring-forward opportunity of $300,000 will be available. She would ideally like to make non-concessional contributions (NCC) of $100,000 in each of 2020/21 and 2021/22 and make a final large contribution, consisting of three years’ worth of NCC caps, for 2022/23 – the year in which she turns 67. Continued on next page

QUARTER III 2020

STRATEGY

Continued from previous page

However, at this stage she doesn’t know whether this will be possible because some details remain unknown. Will the rules change to allow bring-forward periods to commence as late as the year in which she turns 67? Or will 2020/21, the year in which she turns 65, remain the last year for a bring-forward period to be initiated? This is where the new rules we already have, that is, allowing contributions after 65 without a work test, are helpful. Someone in this position would be well advised to contribute no more than $100,000 for now and wait until the position on bring forwards becomes certain. If the bring-forward rules are changed as expected, she would not make any further NCCs in 2020/21. She would stick to her original plan of contributing $100,000 in each of 2020/21 and 2021/22 and delay her bring-forward period until 2022/23. If the rules do not change, she would contribute her remaining $200,000 as soon as she knew the change wasn’t going to happen, which is at worst in June 2021. Thanks to the new rules we already have from 1 July 2020, it doesn’t matter whether this contribution is made before or after she turns 65, because there is no work test either way.

What about someone who will turn 67 in August 2020 and retired many years ago? This client also faces some uncertainty until the new bring-forward rules are either passed or ruled out. Someone in his position can already make $100,000 in non-concessional contributions before their birthday in August 2020 without meeting a work test. But should he take a chance, contribute $300,000 and cross all fingers and toes the bring-forward rules will change as planned? He has a more urgent deadline than the previous client – he can’t contribute after August 2020 unless he meets a work test. Hence, he can’t wait and see what happens

34 selfmanagedsuper

with the new rules. It’s worth noting that if the full $300,000 is contributed and the rules aren’t changed, the extra $200,000 won’t be illegal. It will be considered an excess NCC. However, it is not an amount that can simply be refunded within 30 days of discovering the error. This is because the immediate refunding rule only applies when contributions are made illegally, for example, by someone who is over 67, hasn’t met a work test and isn’t eligible to make work test exempt contributions. In this case, the contribution will have been made entirely legally, it just proved to be too large. As such, the usual process for excess contributions will apply: • the individual will need to wait until they receive an excess contributions determination, and • the amount of the excess, in this case $200,000 plus 85 per cent of a notional amount of earnings, will be refunded to the ATO and eventually returned to the member after tax has been deducted from the notional earnings. Some clients may well feel these consequences are an acceptable risk to run because: • there is no compliance breach to be reported, • the excess will be returned to the member eventually, and • the only real loss is tax on the notional earnings amount and the requirement to withdraw 85 per cent of the earnings amount from superannuation. Bear in mind, however, the notional earnings amount is calculated using a very high interest rate, currently 7.1 per cent, and would be applied from 1 July 2020 regardless of when the contribution was actually made. Even if the SMSF’s 2020/21 annual return is lodged very early, say October 2021, the earnings amount could still be nearly $20,000. So the current situation definitely presents some challenges for those turning 65 or 67 this year and we hope that uncertainty is resolved quickly.

Regardless of what happens in terms of the current changes making it through the parliament, the bringforward rules will keep us on our toes in the years to come.

Even once the rules have changed, however, bring forwards generally remain complex.

The inherent complexity of the bring-forward rules The bring-forward rules have not changed since 1 July 2017 and are generally expressed in Table 1. In other words, as well as thinking about age and whether work tests are required, we must also be very aware of a client’s total superannuation balance when planning to bring forward NCCs several years ahead of time. Could our client turning 65 this year in the first example above specifically choose

to initiate a two-year rather than three-year bring-forward period? At first glance this sounds like a great idea. It would mean the contributions for 2020/21 and 2021/22 would be contributed now, but the bring-forward period would end on 30 June 2022. The maximum bring -forward period of three years would then be available for 2022/23 – the year in which she turns 67 and, under the new rules, the last year in which a new bring forward can be initiated. Unfortunately, this is not possible. If the member’s total superannuation balance is less than $1.4 million at 30 June 2020, and she contributes $200,000 in 2020/21, she will automatically initiate a three-year bringforward period that ends on 30 June 2023. She can’t choose a shorter time frame. Could she contribute the remaining $100,000 in 2022/23? Certainly she could. The only requirements she would need to meet would be: • a total superannuation balance of less than $1.6 million at 30 June 2022 (anyone whose total superannuation balance is over $1.6 million as at the previous 30 June automatically has an NCC cap of nil regardless of what is happening with their bring-forward periods), and • the contribution would need to be made before her turning 67 unless she is eligible for a work test exemption or has met the work test earlier in the year. Unfortunately, however, she couldn’t make a higher contribution to bring forward any future years’ contribution caps. She couldn’t start a new bring-forward period until she has finished the old one. What if our hypothetical client turning 67 this year (in the second example above) is still working? Could he initiate his bring forward in 2020/21, but finish it off in a future year? Yes he could. While 2020/21 will be the last year a bring forward can commence, this client could, for example, contribute $150,000 in 2020/21 and the remaining

Table 1 Total super balance at 30 June 2020

Bring-forward rules in 2020/21

$1.6m or more

$0 NCC cap, no bring forward

$1.5m to less than $1.6m

$100k NCC cap, no bring forward

$1.4m to less than $1.5m

$200k NCC cap, 2 years to use it

Less than $1.4m

$300k NCC cap, 3 years to use it

$150,000 in 2022/23. The only conditions he would need to meet in order to make the second contribution are: • satisfy the work test before making the contribution, and • have a total superannuation balance of less than $1.6 million as at 30 June 2022. Interestingly, it is perfectly acceptable to contribute more than $100,000 in 2022/23 even though he will be well over 67 by then. The key is he would still be completing a three-year bring-forward period that has already started. Continuing this example, what if our client had a total superannuation balance of $1.55 million at 30 June 2022 (assume for the moment that there has been no indexation of contribution caps or bring -forward thresholds)? The apparent problem here is that our client wants to contribute $150,000 in 2022/23, but the table above indicates someone with a total superannuation balance of $1.5 million or more is limited to a $100,000 contribution. However, the table of thresholds actually only applies when it comes to initiating a bring-forward period. In our client’s case this happened back in 2020/21. Once the bring forward is locked in, he can finish it off any way he likes as long as the two conditions outlined above are met – a work test and a total superannuation balance of less than $1.6 million as at 30 June 2022. What if the contribution cap increases

(due to indexation) from 1 July 2022? Could the member contribute more to reflect the fact the NCC cap is $110,000 in the final year? Unfortunately no. Once a bring-forward period is locked in, the NCC cap is fixed for the entire period. Indexation has no impact. Would meeting the work test in 2023/24 offer any other opportunities? Yes it would. While he can’t initiate any more bring forwards because he is too old, as he will turn 70 during that year, meeting the work test will allow him to make further NCCs up to the normal one-year cap, currently $100,000. He can keep doing this every year until age 75 as long as he meets the work test each year and his total superannuation balance remains less than $1.6 million.

And in the future? It’s only going to get more complex. The bring-forward thresholds shown earlier are actually not fixed at $1.4 million, $1.5 million and $1.6 million. Instead, they depend on, of all things, the general transfer balance cap and the annual NCC cap. In the next few years, these are both likely to increase due to indexation that will change all the figures in the table. In short, regardless of what happens in terms of the current changes making it through the parliament, the bring-forward rules will keep us on our toes in the years to come.

QUARTER III 2020

COMPLIANCE

The SMSF cost conundrum

The new non-arm’s-length expenditure rules have created great angst and uncertainty over the tax treatment for SMSFs. Tim Miller puts the provisions under scrutiny as they stand and illustrates the significant resulting issues.

TIM MILLER is education manager at SuperGuardian.

36 selfmanagedsuper

Does my SMSF have to pay for that? It’s a pretty innocuous question, but now more than ever SMSF expenditure is under the spotlight. Expenses have for some time created compliance and taxation issues, largely around contributions, but since 1 July 2018 they could add a whole new layer of taxation pain for what could otherwise have been considered frugal operating practices in the best interest of an SMSF. The divide between compliance with the Superannuation Industry (Supervision) (SIS) Act and Regulations and tax

administration has often created issues, but SMSF expenditure appears to be an issue that keeps on giving, or in this instance taking.

The tax disincentive Over time, tax law has evolved to discourage certain income from being diverted into SMSFs or to discourage trustees from engaging in certain practices to enhance their superannuation balance and reduce their tax liability. Having certain income treated as non-arm’s-length income (NALI) and

EXAMPLE 1

SPECIFIC INVESTMENT INCOME – RENTAL EXPENSES NOT ON ARM’S LENGTH The Jones Superannuation Fund holds multiple investment properties as part of its considered investment strategy. These properties were purchased on arm’s-length terms and the rent is also considered to be arm’s length. As part of the ongoing maintenance of the properties, Mr and Mrs Jones engage Mrs Jones’s brother, a qualiﬁed electrician, to install smoke detectors in all properties. He charges the SMSF for the parts, but not the labour. Therefore, a speciﬁc nexus between the expense and the rental income exists and NALI applies as follows:

being taxed at the highest marginal tax rate is intended to be the disincentive in the concessionally taxed super environment. As a flow-on from the 2017 super reforms and resultant reduction in the contribution caps, the federal government had concerns people would look for new ways to get more funds into SMSFs using various schemes or strategies. Anecdotally these concerns were based on the few rather than the many, but rather than address any core issue, a catch-all approach was taken. To broaden the scope of NALI, the government introduced the concept of non-arm’slength expenditure (NALE), which requires a fund to ensure not only is all income

Fund income and expenditure Rental income $100,000 Rental expenses $15,000 Other income $18,000 Contributions $40,000 General expenses $6000 Non-arm’s-length component Rental income $100,000 Rental expenses $15,000 $85,000 Tax at 45% $38,250 Low-tax component Other income Contributions General expenses Tax at 15% Total tax

$18,000 $40,000 $6000 $52,000 $7800 $46,050

derived on a commercial basis, but all expenses associated with fund income are commercial. These NALE provisions apply from 1 July 2018 and ideally target questionable investments. Late in 2019, the ATO released Draft Law Companion Ruling (LCR) 2019/D3 Non-arm’s length income – expenditure incurred under a non-arm’s length arrangement, which is a guide to how the NALE provisions will apply. This document currently remains under review. The ATO recently released Practical Compliance Guideline 2020/5 Applying the non-arm’s length income provisions to non-arm’s length expenditure, which indicates it will not allocate compliance resources in relation to certain general expenses for the

Essentially, when expenditure is less than what would be expected in an arm’slength dealing, NALI can arise.

period from inception up to and including the 2021 financial year. This gives the regulator time to finalise the draft ruling and it also gives industry time to adjust to existing practices if necessary. As NALI can have significant tax consequences for a fund, it is important to understand what arm’s length means, what NALI and NALE are, and what anomalies these new provisions create that need to be addressed at both a regulatory and trustee level. Let’s call Continued on next page

QUARTER III 2020

COMPLIANCE

Continued from previous page

these the common-sense items.

What does arm’s length mean to an SMSF? The ATO states arm’s length is where “a prudent person, acting with due regard to his or her own commercial interests, would have agreed to the terms”. As such, investments must be made and dealt with by an SMSF on a commercial basis in all circumstances and when dealing with all parties, related or otherwise. This is an objective versus subjective conundrum.

What is NALI and NALE? Under subsection 295.550(1) of the Income Tax Assessment Act 1997 (ITAA97), an amount of ordinary or statutory income is NALI if the parties to a scheme are not dealing with each other at arm’s length in relation to the scheme. From 1 July 2018, NALI can apply if the amount of income received is more than what would have been received if dealing at arm’s length or expenses are comparatively low or nonexistent. Under the amended tax provisions, where the loss, outgoing or expenditure is less than what would have been incurred or there was no loss, outgoing or expenditure incurred compared to what you would expect when the parties were dealing at arm’s length, NALI arises. Essentially, when expenditure is less than what would be expected in an arm’slength dealing, NALI can arise.

How do we identify NALE? To identify NALE we need to look at identifying if there is a scheme. Subsection 995-1 of the ITAA97 says: “A scheme is defined as any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.” So ultimately a scheme means any dealings the SMSF trustee may have. Once we have identified a scheme, there must also be a connection between

38 selfmanagedsuper

the expenditure, or lack thereof, and the ordinary or statutory income a fund receives. The expenditure must have been incurred in gaining or producing the relevant income, or acquiring an entitlement to the income of a trust, or alternatively no expenditure occurred. The expenditure can be of a revenue or capital nature. Expenditure linked to specific income is easily identified, such as a rental property expense and rental income. Where NALE arises on expenditure to acquire an asset, there will be a sufficient nexus to all ordinary and statutory income of that particular asset and any capital gain on disposal of the asset. Example 1 highlights how NALI would apply to specific expenditure.

General expenses The biggest issue with these changes is that some expenses, such as accounting fees, have a sufficient connection to all of the ordinary and statutory income of a fund, according to LCR 2019/D3. This is where greater clarity from the ATO is still

required as it has the capacity to impact many funds and is surely not the intent behind big-ticket schemes the government was attempting to stamp out. (See Example 2.)

Perspective To put some perspective on this, the ATO recently released its annual statistical overview for the year ended 30 June 2018. For the first time ever the ATO broke down fund expenses between investment and operating expenses. On average, operating expenses represent less than 0.5 per cent of total fund assets. In the bigger picture this is hardly a scheme by which the average SMSF trustee is trying to funnel money into superannuation to minimise tax and increase savings. Conversely, most funds will pay slightly higher tax by not having an associated deductible operating cost to offset the income. Administrative costs aside, one issue that clouds this matter is under what capacity certain functions are being performed. Another issue is that these changes

EXAMPLE 2

GENERAL INCOME – FUND EXPENSE NOT ON ARM’S LENGTH Let’s revisit the Jones Superannuation Fund. Mr Jones works at an accounting ﬁrm and he prepares and lodges the fund’s annual return using company resources. The company does not charge the SMSF. Its standard yearly SMSF accounting fee is $2500. Based on LCR 2019/D3, in its current form, a nexus exists between the expenditure and all fund income and as a result NALI applies as follows:

Fund income and expenditure Rental income $100,000 Rental expenses $15,000 Other income $18,000 Contributions $40,000 General expenses $6000 Non-arm’s length component Rental income $100,000 Rental expenses $15,000 Other income $18,000 Contributions $40,000 General expenses $6000 $137,000 Tax at 45% $61,650

undermine long-held practices of offsetting market valuation issues with contributions. So where does that leave us?

Trustee v individual capacity The NALE provisions are not intended to apply where a trustee provides services to their SMSF in their capacity as trustee. This requires an objective consideration of the individual’s circumstances to assess their ability to perform an activity. The following factors are provided by the ATO to assist in determining whether a function is performed in an individual rather than trustee capacity: • an individual charges the SMSF for the services, • an individual uses equipment and other assets of their business (or employment), • an individual performs activities pursuant to a licence and or qualification related to their business, profession or employment, and • the activity is covered by an insurance policy related to their business or professions or employment. Where an individual performs services in their capacity as trustee and they do not charge for the service, NALI provisions will not apply. So, if Mr Jones used his home computer and lodged the return personally, then there is no issue. That is a huge tax differential based on which computer was used. Where a trustee performs a service in their individual capacity, the NALI provisions will apply where remuneration is paid by the fund on non-arm’s-length terms. This is also the case where no remuneration is provided. Similarly, where an investment is acquired from a related party, something as simple as the purchase contract could result in a different tax outcome despite all requirements of the SIS Act being adhered to. Herein lies the trustee remuneration and contribution conundrum.

Trustee remuneration v contribution Under section 17B of the SIS Act, a trustee can be remunerated for services

The biggest issue with these changes is that some expenses, such as accounting fees, have a sufficient connection to all of the ordinary and statutory income of a fund.

performed if the services are performed other than in the capacity as trustee and they are appropriately qualified and licensed to do so. Further, section 17A prohibits trustees from being remunerated for acting as trustee. They must also perform the services in the ordinary course of business and on arm’slength terms. This measure was introduced at a time where the industry was questioning how to deal with related-party builders/

contractors and property transactions. Coinciding with the above law, the ATO was defining what a contribution was as well as identifying rules associated with SMSFs acquiring assets from related parties. The upshot and subsequent consensus of these events was that if market value wasn’t paid for an asset or an expense (of significance), therefore increasing the capital of the fund, then contributions to the value of the capital enhancement would be the compliance solution. It is a process that passed the smell test. The LCR states if an asset is transferred to an SMSF and the difference between market valuation and actual consideration paid is treated as an inspecie contribution, that will constitute a NALE event unless the consideration paid and the in-specie contribution are clearly identified in the contract. Seems to be semantics. There is no doubt certain expenses, such as interest on related-party limited recourse borrowing arrangements, should reflect commercial rates, but when we start questioning practices that at most represent 0.5 per cent of fund assets, are we reaching for outcomes that aren’t there?

QUARTER III 2020

STRATEGY

Cognitive decline considerations

Older SMSF trustees may experience a degree of mental incapacity at some point in time, making the running of a super fund unfeasible. Rob Lavery examines some options available to address this situation.

ROB LAVERY is senior technical manager with knowIT Group.

40 selfmanagedsuper

The ATO’s most recent quarterly statistical data shows continued growth in both the number of SMSF members as well as the total number of funds. This continuing trend shows the attraction for people who want to be in control of their own superannuation. But what happens to these members when they turn 75, 80 or even 85? Regardless of age, SMSF trustees must still continue to conduct trustee meetings, monitor their fund’s investment strategy and investment results through differing economic climates, have regular meetings with their fund accountant, financial adviser and possibly actuary, correspond with regulators and auditors and so on.

The ATO’s statistics show that while more younger members are being attracted to SMSFs, more than 60 per cent of all SMSF members are still over the age of 55. At some point, older members may not be able to perform their trustee obligations. While many retirees may continue to have the time and desire to run their own fund, the reality is around 30 per cent of people over 80 experience some level of cognitive impairment. Such impairment can make running the fund as trustee difficult or impossible. If a member of a fund has lost mental capacity, they are no longer eligible to remain a trustee, even if they show a willingness to continue performing the role.

If an ageing member is acknowledged to no longer be able to fulfil the role of trustee, action can be taken at that time to remedy the situation. To ensure the viability of the fund, contingency planning must be considered. This allows for a plan to be implemented when the need arises. Forward planning allows actions and decisions to be undertaken while all trustees still have full mental capacity.

Implications for an ageing SMSF member When a member is about to retire is probably the best time for them to consider how their retirement income should be managed over the longer term and what would happen if they were no longer able to fulfil the role of trustee of the SMSF. This may help to avoid unnecessary expense or conflict. If an ageing member no longer wishes, or is no longer able, to fulfil the role of trustee, some strategies that may be considered include: 1. Continue to operate the fund with no changes in structure. 2. Appoint an enduring power of attorney to take over the member’s role as trustee. 3. Convert the SMSF into a small Australian Prudential Regulation Authority (APRA) fund with the appointment of an independent professional trustee. 4. Cash in the member’s benefit and roll it into a public offer fund. 5. Introduce new members, subject to the four-member limit, to help share the burden of trustee duties. It is important

to note this does not negate each person’s responsibility, but may help share the load.

Be careful who controls the fund Some of these options may include bringing a child or children into the SMSF. This is not an option to be taken lightly and the capability, and responsibility, of any individual who is to be added to a fund as trustee needs to the carefully considered. A case that ended up before the Administrative Appeals Tribunal highlights the risks inherent in appointing an unfit person as a trustee of an SMSF. In the case, the Triway Super Fund was established in 2002 with three members and trustees – two parents and their son. The son developed a drug addiction and began to withdraw contributions made to the fund for his own use. One withdrawal in 2002 was retroactively, and fictitiously, labelled a ‘lost loan’. In 2006, the son was declared bankrupt and thus became a disqualified person, yet was not removed as a trustee. Ultimately, the ATO declared the fund non-complying, which resulted in significant tax bills for the fund – a tough blow considering the losses the fund had already experienced due to the maladministration of its unfit trustee. The case highlights why the choice of trustee is not one to be taken lightly. Option 1 - continue to operate with no changes

This option requires the members to continue to act as trustees of the fund, but depending on capacity and capability this may be a controversial decision. If a member is finding the burden of attending trustee meetings and making decisions onerous, it is arguable there is no requirement for an individual trustee to attend all trustee meetings or be involved in all decisions. Consideration could be given to the use of proxies. The trust deed must provide for this or for a quorum of trustees to act on behalf of all trustees. Fund members wishing to take this

course of action should be strongly advised to seek legal advice. If the legal advice confirms any of these alternatives are legally satisfactory, this may be one option to cut down the workload for the ageing trustee/ member. Persistent non-attendance to trustee duties would, however, normally suggest a basis for removal of a trustee, although in an SMSF context there is usually no arm’slength party with the incentive to enforce such action. It is important to remember nonattendance or non-involvement will not excuse the trustee for any legislative breaches. Each trustee is fully responsible for all decisions and has an obligation to ensure they are fully informed and in control of the fund, which potentially makes this option the least desirable course of action. Option 2 - Enduring power of attorney

Under section 17A(3)(b)(ii) of the Superannuation Industry (Supervision) (SIS) Act, an SMSF will not be considered non-complying if the legal personal representative of a member takes over that member’s role as trustee using an enduring power of attorney (EPOA). This may seem the simplest method to allow the member to continue in an SMSF, but some complications to check are that the: • EPOA allows the attorney to take on responsibility as trustee of an SMSF, • trust deed of the SMSF and constitution of a corporate trustee, if applicable, allow a person to assume the role as trustee/director using an EPOA, and • required procedures are followed according to SIS legislation and the trust deed, as well as for corporate trustees under the Corporations Act and the company’s constitution. The member nominated as the EPOA should be someone the member trusts to carry out their wishes. The member should also check how the balance of power would be affected by the granting of the power to ensure the rights of the member Continued on next page

QUARTER III 2020

STRATEGY

member, or all members wish to exit the SMSF, the fund would have to be wound up, which will incur fees. The trustee(s) would need to determine how much cash should remain in the fund to meet these expenses and then roll over the balance to their public offer funds.

Continued from previous page

and all beneficiaries are protected. The person taking on the role as the EPOA should understand their legal responsibilities. They do not act as an agent of the member, but take on full legal responsibility as trustee, including becoming liable for any penalties brought about as a result of legal breaches. It is also important to note the member needs to have full mental capacity to be able to appoint another person as their EPOA. If the member has already lost mental capacity, it is too late to use this approach. Option 3 – Convert to a small APRA fund

Converting an SMSF to a small APRA fund is a relatively straightforward option the fund’s management can take. However, it may not suit clients who are cost conscious or who have non-publicly listed direct investments. The conversion can be effected under section 106A of the SIS Act and SIS Regulation 11.07A is also relevant. The trustees can decide for the fund to be regulated by APRA as a small APRA fund. The members/trustees need to appoint an approved professional trustee to manage the fund and resign from their trustee roles. The ATO should be notified of the change by lodging the appropriate notification form. The benefit of this approach is that it allows the members to keep existing investments in place, subject to approval by the new trustee. Most trustees of small APRA funds are reluctant to allow the fund to invest in property, collectibles, in-house assets or other non-mainstream investments. The professional trustee will charge a fee to manage the fund, but that may negate some of the other costs members were previously incurring to administer and run the fund. If the election occurs during a financial year, fees in that year may be payable to both the old and the new regulators.

42 selfmanagedsuper

Option 5 – Introduce new members

If a member of a fund has lost mental capacity, they are no longer eligible to remain a trustee, even if they show a willingness to continue performing the role.

Generally speaking, all members of an SMSF need to be a trustee of the fund or director of a corporate trustee. If younger members are introduced into the fund, this may help an ageing member by sharing the burden. As discussed above, it may be possible for the ageing trustee to limit their role in administrating the fund, as well as their involvement in the decision-making. It is important to reiterate, however, that all trustees are responsible for the fund’s actions, regardless of their agreed workloads. If the member has lost mental capacity, and so is no longer eligible to be a trustee, this option does not provide a total solution. In such instances, replacement of the ineligible trustee needs to be part of the approach.

Plan ahead Option 4 – Cash in and roll over to a public offer fund

Another option involves the ageing member cashing in their benefit and rolling over to a public offer super fund. The remaining trustees may choose to close the SMSF altogether, rolling over all members’ benefits to other funds. While this option removes all ongoing trustee responsibilities, it may not be a desirable option if the members do not want to sell existing investments. This could be particularly undesirable in periods of market downturns, if there are large unrealised capital gains in accumulation phase or if a significant investment is commercial property that is used by a related party. If the departing member is the only

If an ageing member is acknowledged to no longer be able to fulfil the role of trustee, action can be taken at that time to remedy the situation. However, as any good scout or guide would know, it pays to “Be prepared”. All SMSFs can benefit by discussing how the fund should respond if a member becomes unwilling, or unable, to perform a trustee role ahead of the event. Such discussions can be noted in formal trustee meeting minutes to ensure all parties involved have a record of the discussion. Trusted professionals are also central to determining the best course of action for an SMSF should the need to amend trustee arrangements arise. By engaging the fund’s financial planner, accountant and/or solicitor, full consideration can be given to all potential outcomes.

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COMPLIANCE

The COVID-19 rent and loan relief interplay

SMSF landlords who have granted coronavirus rent relief for a tenant in a property held under a limited recourse borrowing arrangement face delicate financial management issues, writes Mark Ellem. The regulator’s approach to COVID-19 rent and loan relief measures involving an SMSF has been welcomed by trustees and their advisers. While these measures have provided a level of compliance comfort, there are some issues to consider beyond the initial rental relief and the interplay where the SMSF’s rental property is held under a limited recourse borrowing arrangement (LRBA). MARK ELLEM is a specialist SMSF adviser.

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The longer-term effect of rent relief Where rent relief has been provided in accordance with the National Cabinet Mandatory Code of Conduct (national code), a minimum 50 per cent of such relief must be in the form of a waiver of rent (tenants may relinquish this requirement by agreement). Any form of waiver is rental income the SMSF will never receive or collect. Consequently, post COVID-19 and a return to ‘normal’ trading,

any recovery of the waived portion of the rent relief can only be made via increased contributions. The related-party tenant cannot make additional rental payments, above what is commercial, as this would risk the application of the non-arm’s-length income (NALI) provisions. To mirror the tax benefit of rental payments, made by a related-party tenant, such contributions would be either employer or member deductible, but are subject to the member’s concessional cap. Consequently, they will be restricted to the current level of the concessional cap.

The clock is counting down for relief The COVID-19 rental relief was meant to be temporary, for a period of up to six months, according to the ATO’s auditor contravention report instructions. Further, these instructions state: “The national code is scheduled to expire at the end of September when JobKeeper is planned to expire. So after that time, if the code is not extended, auditors will need to try and obtain sufficient appropriate evidence of what type of arm’s-length rental relief is continuing to be offered in the market at that time.” The impact of the end of JobKeeper would

be more pronounced on the tenant’s business, with a flow-on effect to the SMSF landlord. Subject to an extension of the JobKeeper program and by extension the national code, SMSF trustees will need to consider other evidence of commercial arrangements for extending temporary rent relief beyond the end of September 2020. It’s noted that at the time of writing an extension of the JobKeeper program to 28 March 2021 has been announced.

Accounting and tax consequences Where the SMSF landlord provides temporary rent relief to the tenant, the portion that is waived will never be recovered and consequently will not be disclosed in the SMSF’s financial statements. When accounting for the deferred portion of rent relief, one approach is to not bring the deferred amount to account until paid because: • there is no guarantee the deferred rent will be paid. This will depend on the ability of the tenant to recommence trading and to generate sufficient profit to meet ‘normal’ rent payments, plus any deferral, • deferred rent is a debtor/amount receivable, which is an asset. Consequently, the amount recorded is subject to Superannuation Industry (Supervision) Regulation 8.02B, which requires all SMSF assets to be stated in the annual financial statements at market value. There could be market value substantiation issues with the requirement for this type of asset, and • an SMSF discloses income in the annual return on a cash basis and consequently the deferred amount would need to be backed out of the return. Where this approach is implemented: 1. Do not bring to account the deferred amount of rent relief. It can be recorded outside the financial statements and would be reflected in documentation recording the temporary rent relief provided. 2. Disclose in the summary of significant accounting policies note that the SMSF

has provided temporary rent relief to the property tenant due to COVID-19 and note the terms of the rent relief.

Loan relief provided by a related party to an SMSF LRBA For an SMSF that acquired a rental property under an LRBA, a flow-on effect of temporary rent relief is a reduction in cash flow available to meet loan payment obligations. Where a commercial lender offers loan repayment relief to an SMSF, there would be no question as to the arrangement being on arm’s-length terms. However, this is not the case where the lender is a related party. This type of loan relief was at risk of being caught by the NALI provisions, particularly if the SMSF was relying on the safe harbour provisions for the terms of the related-party loan under the LRBA. The regulator, though, has announced it will accept the SMSF borrower and the related-party lender would be dealing at arm’s length where the loan relief reflected similar terms to what commercial banks were offering for real estate investment loans due to the effect of COVID-19. The Australian Banking Association (ABA) provides on its website an outline of the COVID-19 relief commercial lenders are providing to borrowers. An initial six-month loan repayment deferral was provided, with interest capitalised to the outstanding balance of the loan. This initial six-month deferral period will end soon and consequently the ABA announced on 8 July 2020 phase-two support to assist customers. The association advised in this next phase, customers who can restart paying their loans will be required to do so at the end of their six-month deferral period. This may include a restructure or variation to their loan to allow loan repayments to recommence. If these arrangements are not in place at the end of a six-month deferral, the ABA advises that borrowers will be eligible for an extension of their deferral for up to four months. In the context of extending loan repayment relief provided by a related-

Any form of relief provided by or to an SMSF must be commercial, reasonable and documented, showing it was offered because of the adverse financial impacts of COVID-19.

party lender to an SMSF borrower, the ATO advises: “Any further repayment relief needed due to the continued effects of COVID-19 should be reviewed at the end of the agreed deferral period and remain in line with what the commercial banks are offering at that time.” Consequently, based on the ABA phasetwo guidelines, an SMSF borrower would have to demonstrate they are unable to restart loan repayments at the end of the initial six-month loan deferral period to be eligible for a further deferral of up to four months.

Cash-flow disparity of rent relief v loan deferral relief An SMSF that has a rental property under an LRBA may find a cash-flow disparity where it has provided rent relief, when compared to loan relief provided by a lender. For example, if the rent relief provided included a portion of rent waiver, that cash flow has been forever lost. While there is a mechanism for the cash flow from rent relief provided in the form of deferral to be recovered, there is no guarantee of this as recovery would be dependent on the future viability of the tenant’s business. Further, applying the leasing principles under the national code, any deferred rent cannot be recovered earlier than 24 months after the Continued on next page

QUARTER III 2020

COMPLIANCE

For an SMSF that acquired a rental property under an LRBA, a flow-on effect of temporary rent relief is a reduction in cash flow available to meet loan payment obligations.

Continued from previous page

deferral period has terminated. Comparatively, the ABA loan relief provides no waiver of interest charged to the loan. In fact, a requirement of the ATO’s compliance loan relief measure is that during the loan repayment deferral period interest continues to be charged to the outstanding balance of the loan. Consequently, provided the tenant’s business does recover post COVID-19, the SMSF landlord will have permanently lost income from any rental waiver, but will most likely pay more interest to the lender as no principal loan repayments were made during any loan payment deferral period. Further, the SMSF’s ability to make loan repayments may have been dependent upon a certain level of contributions from members and/or their employer. The future level of contributions will be dependent on the member’s employment circumstances after any loan deferral period has ceased. Consequently, with the pending cessation of the initial loan deferral period, planning and budgeting is required to ascertain if the SMSF’s cash-flow situation with regard to whether rental income, recovery of deferred rent relief and contributions will be sufficient to allow loan repayments to commence at the end of the

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six-month loan payment deferral period. This analysis may indicate either a variation to the loan terms is required or a further four-month extension to the initial loan deferral period, or both.

Safe harbour rule questions The ATO’s COVID-19 LRBA loan compliance relief measure states any further loan relief must remain in line with what the commercial banks are offering at that time. The ABA’s phase-two support for borrowers includes consideration of a restructure or variation of the loan, which, by implication, would include an extension of the loan term. However, currently there is no ability to extend the maximum term of a loan where the safe harbour rules, under ATO Practical Compliance Guideline 2016/5, are used. Consequently, at the end of the loan repayment deferral, the outstanding balance of the loan will be higher than it would have been had loan repayments not been deferred due to the charging of interest. Further, due to the timing of advice of the relevant safe harbour interest rate, the relevant interest rate applicable during the loan deferral period (5.94 per cent for 2019/20 and 5.1 per cent for 2020/21) would actually be higher than what would be expected to be offered under a commercial loan arrangement, again adding to the level of the outstanding loan balance. Currently the ATO’s compliance loan relief measure requires that in addition to the capitalising of interest to the loan during the loan repayment deferral period, the SMSF trustee will ‘catch up’ any outstanding principal and interest repayments as soon as possible. What does ‘as soon as possible’ mean? Does the ATO expect the outstanding loan balance to be in the same position as if the loan repayments were not deferred within six months after the deferral period has ceased? Currently, under the safe harbour loan rules, there is no option to extend the maximum loan term, so once the loan

deferral period has ceased, the ongoing monthly repayments would be higher than they would have been had there been no deferral. However, effectively this defers the catch-up of the principal and interest repayments over the remaining term of the loan. Would this satisfy the requirement to catch up any outstanding principal and interest repayments as soon as possible? Further, is this sustainable for the SMSF borrower and is it in line with commercial practices? As the ABA and the commercial lenders have indicated, a variation to loan terms will be considered in certain circumstances, including an extension to the original term of the loan to lower repayments. Would it not be commercial and reasonable to allow for an extension to the term of a relatedparty loan relying on the safe harbour provision to ensure the NALI provisions do not apply? For example, where the repayment deferral period was limited to six months, the maximum loan term could be increased by the same period. Further, where there is consideration to adjusting the terms of the safe harbour provisions, it would be an opportunity to consider whether the current methodology for setting the relevant annual interest rate is appropriate. A mechanism that would allow a resetting of the safe harbour interest rate to accommodate the financial effect of COVID-19 would have been welcomed and assisted in easing the financial burden on the SMSF borrower, with the outstanding balance increasing at a lower rate.

The road ahead Any form of relief provided by or to an SMSF must be commercial, reasonable and documented, showing it was offered because of the adverse financial impacts of COVID-19. As the plan to deal with COVID-19 continues to develop, so too will the relevant relief measures for SMSFs with property held under an LRBA. As service providers to the SMSF industry we will play an important role in assisting SMSF trustees through these uncharted waters.

STRATEGY

Guarding SMSF wealth – part two

In the second part of this two-part series, Grant Abbott discusses why SMSFs remain a good estate planning vehicle and an optimum solution for wealth protection.

GRANT ABBOTT is director of I Love SMSF.

In the first part of this series we looked at how the courts attacked the SMSF of a defendant in a New South Wales family provisions claim – Kelly v Deluchi [2012] NSWSC 841. In that case, Justice Philip Hallen looked at whether the payment of a death benefit from an SMSF to the deceased’s spouse was a relevant property transaction under the notional estate provisions in Part 3.3 of the NSW Succession Act 2006. Hallen stated: “I am satisfied that the basis of a relevant property transaction for the purposes of section 75 has been established and that it is taken to have been entered into immediately before, and to take effect on, the occurrence of the resolution of the trustee, in February 2010, that is to say, after the deceased’s death … In all the circumstances of this case, I propose to make an order designating part of the property held by the trustee as notional estate.”

This case is mandatory reading for all SMSF practitioners and any estate planning lawyer. Coupled with the decision by the Victorian Court of Appeal in Wareham v Marsella [2020] VSCA 92, where the judge removed the surviving SMSF trustee for paying the deceased member’s death benefits to herself and not the estate, well, all is not well in SMSF estate planning. Perhaps that is why so many lawyers pronounce that binding death benefit nominations (BDBN) are totally ineffective and subject to challenge. So do we simply wind up our SMSFs when our clients get older and put everything into a discretionary or family protection trust to shield the benefits from family provisions claims? Absolutely for some cases, but for 80 per cent of SMSFs, if you know what you are doing and know how to structure a client’s SMSF correctly for succession and estate planning protection, the SMSF as a trust is like the king of the castle. Why?

SMSFs are great estate planning vehicles SMSFs have the tax benefits of a superannuation Continued on next page

QUARTER III 2020

STRATEGY

Continued from previous page

fund as well as the flexibility of the family and testamentary trust (subject to income stream limitations). Each SMSF is different, as they are tailored to the specific and changing needs of the family through the use of a strong and flexible set of governing rules, particularly when it comes to estate planning. The limitations of income stream estate planning for adult children is best handled by an SMSF death benefits trust rather than a testamentary trust, which is subject to state-based family provisions claims, although in NSW we must be mindful of the Kelly case. An SMSF death benefits trust is, simply put, a testamentary trust created by the trustee of an SMSF that garners the taxation benefits for minors under section 102AG of the Income Tax Assessment Act 1936. Importantly, it is not impacted by the recent anti-avoidance provisions instituted for testamentary trusts flowing from a deceased member’s estate and does not need a tax ruling if super is paid into the testamentary trust. Estate planning advantages of SMSFs

• SMSFs are family funds built for lifetimes and thus can provide long-term estate planning solutions, including laying down income streams for future generations in the hands of the right adviser or destroyed by poor legal advice in forcing superannuation benefits into a deceased member’s estate. • If an SMSF will is used, specific actions and requests by a member of a fund may be put in place in respect of their superannuation benefits in the event of their death. An SMSF can have six specific directions to the trustee, one of which is the payment of superannuation benefits as desired. It is a formal contract between the member and trustees and even includes the appointment of an accountant, planner or lawyer to administer the estate. As a

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•

Superannuation Industry (Supervision) (SIS) Act 1993 contract, it is legally protected under section 54C of that act. The element of control is present. Like the family trust, the trustees of the SMSF have control of the fund. Under the SIS Act, there is a requirement that all members of the fund, generally the family, must also be trustees of the fund or directors of the fund’s corporate trustee. This means shared control among fund members. On the other hand, the leading member SMSF (discussed later) puts in place a predefined succession plan to guarantee control between generations. SMSFs provide a wide range of investment choices. Where the member is using an SMSF will, they may designate specific assets to pass to SIS dependants and non-dependants via the estate upon their death. If an income stream option is used, then the trustee will invest the assets of the fund for the benefit of the dependant income stream recipient. An SMSF will may mandate a specific investment strategy for the pension. Assets remaining in the fund are protected from creditors as per the Bankruptcy Act 1966. SMSFs have a significant advantage over entities in terms of taxation with an SMSF death benefits trust, which protects the SMSF estate from a family provision claim, providing adult marginal tax rates on distributions to minors. SMSFs are favourably treated under the social security laws. Until age pension age, they are treated as exempt from the assets test. SMSFs are not complex in terms of administration, with a professional administrator recording all transactions the trustee has made, although compliance with the SIS Act does add to the cost of delivering a fund that complies with all the laws. Income streams in an SMSF can be paid to dependants as allowed under

the SIS Act. If the dependant is a child of the deceased, they must be less than 18 years of age unless financially dependent upon the member, where a child pension can be commenced but no later than age 25. In addition, the pension must cease by age 25 unless the child is disabled. If the dependant is a grandchild or other person who is financially dependent upon the member, the commutation by age 25 requirement does not apply. Estate planning disadvantages of SMSFs

• If an SMSF will or valid BDBN is not used, the passing of superannuation benefits of the deceased member is at the mercy of the remaining trustee of the fund. The most notorious example of this happening was seen in Katz v Grossman [2005] NSWSC 934, although this case appears to conflict with the Marsella case and shows how different jurisdictions apply the laws separately. • The SIS Act weighs heavily on the trustee of the fund and, as a result, the trustee and member must consult a specialist SMSF adviser or lawyer to ensure the fund’s estate plan not only delivers what is required, but also complies with the law. There are significant financial penalties for breaching the law and the commissioner of taxation may replace and disqualify a person as trustee. • The cost of establishing an SMSF estate plan will depend on the size of an SMSF estate. • SMSFs cannot be viewed in isolation but are part of an entire estate and succession plan. • Benefits in a superannuation fund are part of spousal matrimonial property and may be split in the event of divorce. This may be of concern where superannuation benefits are paid as a lump sum to children. • Income streams can only be paid to dependants as defined under section 302-195 of the Income Tax Assessment Act 1997. As noted above, this means

the dependant is a child of the deceased and they must be less than 18 years of age unless financially dependent upon the member, when a child pension can be commenced for a child dependant no later than age 25. In addition, the pension must cease by age 25. It is important to note there are extensive rules and concessions provided in terms of SMSF estate planning under the SIS Act. So to automatically transfer a deceased’s superannuation benefits from a commonwealth-protected SMSF to the deceased’s estate, to be subject to the vagaries of the family provisions claim, is ill-advised professionally and legally.

Structuring the SMSF for succession protection Have you ever built a leading member SMSF?

A leading member SMSF shifts the power and control of the fund to the member designated as the leading member. As a trust, an SMSF can put in place an appointor – a leading member who can appoint and remove a trustee of the fund plus any member. For an example of a leading member SMSF look no further for succession protection than the Windsor royal family where the leading member, Queen Elizabeth II, controls and has ultimate power over it. Of course, the Queen may abdicate or die and in that event succession is built in and leading membership passes to Prince Charles. But what if Prince Charles is not alive at the time of the Queen’s death? Built-in succession planning will see Prince William step in as the leading member, and if he is not alive, then Prince George becomes the leading member and King. It’s safe, certain and secure. A leading member SMSF starts with builtin succession and proceeds from there

The overarching goal of a leading member SMSF is to provide safety, certainty and security for fund members and prevent legal challenges, effectively building a moat

around the SMSF. Following are the three top differences between a leading member SMSF and a standard SMSF: i. In-built control A standard SMSF has little control. I have seen a fund locked up for years in a divorce as lawyers to both parties freeze up the trustee and investments. If there is a property in the fund under a limited recourse borrowing arrangement, and neither party wants to contribute into a squabbling SMSF, disaster awaits. And upon death it is worse if the shares in the corporate trustee are locked into the estate, which is subject to a family provisions challenge. It could result in a two-year and $150,000-plus legal feast. In contrast, the leading member, under the special purpose leading member SMSF deed and constitution if there is a trustee company, has the power to hire and fire the trustee or trustees as well as appoint and remove the members of the fund. If an adult child of the leading member is appointed as a member of the fund, that appointment is at the discretion of the leading member. If that child gets divorced, then they can be removed from the SMSF and transferred to a public offer fund. In addition, subject to any SIS Act requirements, the leading member has power of veto over trustee decisions. Under this arrangement, all trustees get one vote but the leading member, being the chair and veto vote, means the fund is tightly controlled for safety, certainty and security. ii. In-built succession There is no succession in a standard SMSF. With 90 per cent of SMSFs consisting of one or two members, if one of the trustees is incapacitated or dies, there will be uncertainty over what then happens to the fund. If the last remaining member and trustee of the fund dies, what happens? This is a particularly important question when the deed only allows the trustees or members to appoint another trustee. So if the fund has no trustee or power to appoint one, then it is not a regulated super fund under section 19 of the SIS Act. So what is it? For tax purposes it is a non-distributing

fixed trust taxed at 45 per cent on income and capital gains and with horrendous estate planning tax consequences. In setting up a leading member SMSF we need to know the first or main successor, the second successor and if possible the third successor leading member. The fund will last for generations to come with extensions to leading membership to carry on for as long as the fund remains intact, given the rule against perpetuities does not expressly relate to SMSFs. And with the leading member asserting control over the fund, the moat is built. iii. Protecting the fund from family provisions litigation The key to the royal family’s success is that everything is kept in the family. In a standard SMSF there is no such choice. With BDBNs easily challenged, reversionary pensions not effective in many deeds and the desire by estate planning lawyers to shift superannuation to a deceased member’s legal estate, there is built-in family provisions litigation that may see dissipation outside the deceased’s bloodline, even in cases of the best lawyers who promote bloodline trusts, which can be broken down under estate litigation. Not so in a leading member SMSF where the members must be the direct lineage of the leading member, unless the leading member uses their discretion to appoint a non-bloodline member. Any benefits on death are to go to the deceased member’s bloodline as protected by the leading member. This sees the benefits held up in the leading member SMSF and, if need be, paid out to a leading member discretionary trust rather than pass through the estate. This provides protection from family provisions claims subject to NSW notional estate claims. Now I can give you at least another five or more reasons why a leading member SMSF is better than a standard SMSF. However, they are not for everyone. But if your client had a choice on having greater safety, certainty and security, what would they want? What would you want?

QUARTER III 2020

INVESTING

The central bank stimulus eďŹ&#x20AC;ect

Governments around the world have responded to the economic impact of COVID-19 with a variety of stimulus packages. Anthony Doyle outlines the market consequence of these fiscal strategies and where resulting investment opportunities lie.

ANTHONY DOYLE is cross-asset specialist at Fidelity International.

The global economy is in recession. Despite this, risk assets have rallied sharply since the March crash, driven by central banksâ&#x20AC;&#x2122; aggressive, unprecedented monetary response to the COVID-19 crisis. As economies undergo one of the fastest, deepest downturns since the 1930s depression, how long can monetary stimulus enable markets to defy gravity?

Increase in money supply is driving markets The global economy has just experienced a

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sudden stop. Exactly how bad the numbers will get and how long the recovery will take is difficult to discern while the full impact of lockdowns remains unknown. Economists may think investors are missing something, but markets are simply reacting to a new reality. The rally in equity markets since March is not a reflection of confidence in the global economy, but rather the dramatic increase in money supply as a result of the colossal expansion of central bank balance sheets (see Graph 1). Because of that deluge of money, risk assets will

do well this year – albeit with heightened volatility. Monetary policy alone may not be able to solve the problems of this and the previous crises. Indeed, it may even exacerbate them. But if there is one lesson to be learned from the past decade, it is that central banks have the power to drive markets like nothing else, overriding economics, company fundamentals and seemingly even logic. And for markets, that means central banks are still the only game in town.

In response to the coronavirus crisis, central banks have rushed to prop up economies to such an extent it makes the support doled out in the GFC look like pocket money.

Investors addicted to central bank support get another dose As the global financial crisis (GFC) hit in 2007/08, central banks around the globe flooded the financial system with liquidity. They fended off a banking sector meltdown, but the collateral damage has proven to be greater than anyone foresaw. The spread of cheap money zombified the economies of developed countries, sustaining failing, inefficient companies that otherwise would have collapsed and given way to more vigorous entrants. This absence of ‘creative destruction’ entrenched low growth for over a decade. The indiscriminate search for yield caused investors to venture into ever riskier areas of the market. The expansion of central bank balance sheets subdued volatility, but markets

became hooked on this support. When the United States Federal Reserve announced plans to reduce its balance sheet in 2013, in what came to be known as the ‘Taper Tantrum’, US 10-year Treasury yields shot higher. Not only did the Fed ultimately back down from this proposal, two years later, it began yet another round of bond purchases. Then in 2018, the Fed again announced it would be reducing the size of its balance sheet, alongside raising

Graph 1: G4 central bank balance sheet as a % of GDP 50 45 40 35 30 25 20 15 10 2019

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interest rates. But once more markets were spooked by the threat of support being removed and financial conditions tightened dramatically, forcing the Fed to reverse its decision once again, culminating in the policy U-turn of January 2019. This is relevant for the Australian government bond market, which tends to be positively correlated with the US Treasury market (see Graph 2).

Zombie sequel as black swan hits Then along came a black swan. In response to the coronavirus crisis, central banks have rushed to prop up economies to such an extent it makes the support doled out in the GFC look like pocket money. On top of this has come increased dollar provision by the Fed, global interest rate cuts and a jump in fiscal spending. The supply of money has increased dramatically in a short space of time and this is percolating into asset prices and will continue to do so. This sudden, massive increase in debt will continue the trend of zombification, as real interest rates and growth head ever lower. The cleansing moments that normally rid the system of a build-up of unproductive debt may be painful at the time, but they ultimately lead to a more efficient allocation of resources. Policymakers have chosen again to avoid that path, storing up economic pain for the future. Central bank largesse after the GFC sustained the zombies, and in the COVID-19 sequel the same looks set to happen. Imbalances will not be remedied but aggravated. Public and private debt is set to continue growing at a spectacular rate. Much of that money will go to unproductive causes such as paying wages while no work is done. Given how reliant markets have become on support since the GFC, you can expect future crises, including, for example, a second or third wave of infections later in the year, to be met with the same reaction – more and more debt, with less and less Continued on next page

Source: Fidelity International, Bloomberg July 2020. 7 6 5 4

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QUARTER III 2020

INVESTING

Avoid being overly pessimistic, for now In the short term, therefore, it should be

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Central banks will be forced to keep nominal yields at their current low levels to ensure that ever-larger debt piles remain serviceable. Real yields will be driven even lower and more negative as asset price inflation bleeds into goods inflation. Inflation expectations will start to rise as a result of the money supply growth that is being unleashed in a way that did not happen after the GFC. This means, overall, nominal yields should remain fairly stable at current levels for a protracted period of time. It will take time for inflation to emerge, given the recent economic shock. But current inflation expectations are so low that now could be a good time to consider inflation-linked bonds on a longer-term basis. Gold too should perform strongly as the gold price is inversely proportional to real yields – when real yields are low, the opportunity cost of owning gold falls and investors are willing to pay more for the asset (see Graph 3). I expect the hunt for yield to reappear strongly as interest rates are intentionally suppressed by central bank liquidity. In this type of environment, risk assets like Australian equities will perform relatively well as there is no alternative for investors hoping to achieve their long-term investment goals. Asian and emerging market equities stand well placed to attract investors’ capital this year given their superior demographic profile, lower levels of debt and rising wealth profile.

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indication as to how it might be paid down. However, in future ‘whatever it takes’ might have to include more widespread purchases of corporate bonds and equity exchange-traded funds, as well as yield curve control throughout the yield curve, to elicit the necessary ‘hit’ for the addict.

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Continued from previous page

Graph 2 & 3 source: Fidelity International, Bloomberg July 2020.

a supportive environment for risk assets. This will confound some investors. It is true companies will take much longer than initially thought to return to 2019 profit margin and revenue levels, if they ever do. And share buybacks, one of the key drivers of markets in the past decade, will be prohibited in some cases. But the risk-free rate is being driven so low investors will have little choice but to turn to riskier assets, even as the economic damage becomes manifest.

And this can continue for as long as central banks can find ways to keep interest rates low without losing control of inflation. For now, while investors need to remain on their guard as markets absorb historically bad economic data, and growth for many companies turns negative, we would caution against being overly pessimistic – for as long as central banks keep the monetary taps firmly turned on.

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STRATEGY

CGT concession intricacies The small business capital gains tax concessions have been of great benefit to proprietors when they have sold their businesses. Maria Sui details how the concessions work and the implications of some potential changes to the rules.

MARIA SUI is superannuation special counsel with SuperCentral.

The Board of Taxation has conducted a comprehensive review of small business tax concessions with broad recommendations to revamp the small business capital gains tax (CGT) concessions. The Assistant Treasurer released the relevant report in December 2019. The board considers reform to small business tax concessions should be a government priority to make it simpler and more sustainable. If the recommendations were to be implemented in their current form, the reform would be farreaching and some existing measures, for example, the ability to contribute the entire capital proceeds of the asset disposal to a superannuation fund under the 15-year exemption concession, may potentially be removed.

Background The small business CGT concessions, including the 15-year exemption and the retirement exemption options, allow small business owners to disregard capital gains on the disposal of their eligible small business or underlying active assets and contribute the capital gains or entire capital proceeds (for the 15-year exemption) into a superannuation fund under a generous CGT cap. It is a recognition that small business owners typically invest cash surpluses back to their business growth phase and have little savings in super. Basically, it acknowledges the business is essentially their retirement nest egg.

The CGT cap â&#x20AC;&#x201C; the retirement exemption concession versus the 15-year exemption concession The CGT cap is a lifetime cap that applies to all excluded CGT contributions. An election regarding this cap has to be made by the member making the CGT contribution. The CGT cap is indexed to average weekly ordinary time earnings and is $1.565 million for the 2021 financial year.

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In addition, there is a limit to the capital gains a person can disregard under the CGT retirement exemption concession. The CGT retirement exemption limit is $500,000. It is a lifetime limit that is not indexed. Contributions under the retirement exemption concession count towards the CGT cap. As long as contributions from the relevant small business concessions are kept within the CGT cap, the active assets disposal can be staged to take place at different times. Under the 15-year exemption concession, the business has to have continually owned an active asset for 15 years and the CGT event has to happen in connection with the retirement of the business owner or significant individual, who has to be at least 55 years old or permanently incapacitated. The 15-year exemption concession allows the entire capital proceeds from the asset disposal to be contributed to a superannuation fund. Under the CGT retirement exemption concession, a contribution can only be made from the capital gains exempt amount. The contributing member does not have to retire or terminate employment. For those under 55, contribution of the retirement exemption amount to superannuation is compulsory.

Total superannuation balance The reduction in the annual concessional contribution and non-concessional contribution (NCC) cap amounts in recent years, and the introduction of the total super balance (TSB), which effectively reduces NCC to nil after the $1.6 million limit has been reached, means the CGT cap now provides a very valuable opportunity for small business owners to make a big boost to their retirement savings at the end of their business career. A contribution under the CGT cap is not affected by the TSB. However, the amount of the contribution will be added to the memberâ&#x20AC;&#x2122;s TSB at

the end of the financial year and may affect other super measures applicable in the ensuing years.

Board of Taxation recommendations The board’s recommendations were arrived at after industry consultation, with 41 submissions received. The core proposals are: • to preserve ‘small business entity (SBE)’ as the eligibility gateway and repeal the maximum net asset value test from the basic conditions, • to raise the turnover threshold for an SBE from $2 million to $10 million, and • to collapse the 15-year exemption, active asset reduction and retirement exemption concessions and replace them with one CGT exemption subject to a cap. The proposed cap amount is between $1 million and $2 million. The simplified approach would prevent the eligibility cliff, that is, the barrier to growth when businesses aim to stay below a $2 million threshold, and remove the complexity of grouping rules used in the calculation of maximum net value and other thresholds. It also aims to remove ‘excessive’ sheltering for some capital gains. In the report, only the replacement rollover concession has been retained out of the four concessions. The government has since requested the Board of Taxation conduct a review of the rollover provisions and asked it to report the findings by 30 November 2020. It is important to note the proposed reforms are only recommendations. There is no guarantee the government will implement some or any of the proposed measures and any changes will have to go through a lengthy legislative process. However, small business owners who have organised their retirement around the current concessions should be aware there may be impending tactical changes.

The effect of the proposed changes There are several identifiable ramifications should the recommendations be

implemented, including: • The widening of the SBE turnover threshold to $10 million would ensure more small businesses will benefit from the concession. • The new measures are simpler and easier to administer, with less compliance costs. • Those who have planned their retirement using the 15-year exemption may miss out on the opportunity to contribute the entire capital proceeds from the asset disposal to super following the collapse of the three concessions into one exemption capped amount. • The current 15-year concession exempts from tax all capital gains from the applicable CGT event once eligibility conditions have been met, whereas the proposed unified CGT retirement exemption amount is capped. • The board favours operation of the CGT small business concessions independent of the superannuation system as an incentive for entrepreneurial activities. It is unclear the extent a CGT exempt amount may be contributed to super outside the NCC cap under the new proposed rules. • It was further proposed to reconsider the practice allowing a CGT cap contribution to be made when an individual’s TSB is above $1.6 million. It is an important drawback if this flexibility is to be removed. • The board recommended no transitional arrangement and that the changes operate on a prospective basis for CGT events occurring on or after the date of announcement. If this proposal is to be implemented, the current concessions would end once the new measures, if adopted, have been announced. These issues mean legislative risk is now a factor to be taken into consideration in retirement planning.

Maximising small business CGT concessions At this juncture, it is worthwhile to have a look at the ways CGT small business concessions may be optimised under

current rules. If a small business is a sole trader, only one individual will potentially benefit from the CGT concessions. For SBEs that are companies or trusts, the exempt CGT distributions may be streamed to stakeholders of the entity. The CGT exempt amounts and contributions, including capital proceeds, may be optimised using each stakeholder’s CGT cap and limit. This option is especially desirable if large capital proceeds or capital gains from the CGT asset(s) disposal are to be anticipated. Listed below are important details regarding this type of arrangement and how it might work: • Both the CGT cap and retirement exemption limit apply on a per ‘individual’ basis. Each person and stakeholder is entitled to their own retirement exemption limit and CGT cap. • An SBE that is a company or trust can have up to a maximum of eight stakeholders (including significant individuals) who may benefit from the 15-year exemption or CGT retirement concession distributions upon meeting eligibility requirements. • Significant individual: An SBE company or trust is required to have at least one significant individual before the CGT event. A person is a significant individual if they have a small business participation percentage in the company or trust of at least 20 per cent made up of direct or indirect percentages that may be acquired through interposed entities. For the 15-year exemption, there must be a significant individual of the entity for a period totalling at least 15 years of ownership of the CGT asset, but it need not be the same individual. • CGT concession stakeholder: An individual is a CGT concession stakeholder if they are a significant individual or the spouse of a significant individual. The spouse can only qualify as a CGT stakeholder if they have a small Continued on next page

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business participation percentage in the company or trust that is greater than zero. The participation percentage can be held directly or indirectly through interposed entities. • Under the above tests, up to eight stakeholders may benefit from the concessions, for example, five significant individuals only, or four significant individuals and their spouses making up eight stakeholders. This arrangement in particular will suit a small family business with extended family members or joint venture arrangements. • Application CGT retirement exemption − Each CGT concession stakeholder has a lifetime CGT retirement exemption limit of $500,000. For a company or trust with eight stakeholders, the limit is effectively $4 million. − The company or trust may also choose the percentage of the capital gains exempt amount to be attributed to each stakeholder. Example: Daryl and Mary each own 50 per cent of the shares in a company and they are both significant individuals (stakeholders). The company meets the eligibility requirement for the CGT retirement exemption. The company makes a capital gain of $600,000 and distributed 30 per cent of the exempt amount to Daryl and 70 per cent to Mary to increase her retirement savings. It is within their respective retirement exemption limit. The 15-year retirement exemption − The company or trust must make a payment of the CGT exempt amount to a CGT concession stakeholder within two years after the relevant CGT event with exception for look-through earnout right arrangements. − The total payment of the exemption amount cannot exceed

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Table 1 Participation %

Capital proceeds distributed

Daryl

40%

$1.4 million

Mary

10%

$0.35 million

John

40%

$1.4 million

Leigh

10%

$0.35 million

the stakeholder’s participation percentage. − In addition, the entire capital proceeds, not just the CGT exempt amount, of the eligible asset disposal can be streamed to the stakeholders in accordance with their participation percentages and contributed to super under their respective CGT cap. Example: Daryl, John and their spouses Mary and Leigh (stakeholders) run a family motel business through a discretionary trust. They disposed of the business by selling the underlying active assets. The entire capital proceeds, including the CGT exempt amount, are $3.5 million. The trust meets the 15-year exemption requirements. The participation percentages and amount of the capital proceeds distributed to each stakeholder can be found in Table 1. Daryl, Mary, John and Leigh each make a CGT cap contribution of the tabled amounts to their SMSF. This enables the entire capital proceeds of $3.5 million to be contributed to the SMSF. − Only one significant individual has to meet the age 55 and retirement requirement. The other stakeholders may be under 55 and in employment. Note, the distribution of capital proceeds above the CGT exempt amount potentially has no tax consequences if the SBE is a discretionary trust. If the SBE is a

company, distribution of capital proceeds of assets that have no cost base, such as goodwill, will remain exempt. If the CGT asset has a cost base, a return of capital from the company may have tax consequences and tax advice should be sought. Where the SBE is a company or trust, the small business owner may also opt to sell the shares or trust interest to qualify for the CGT concessions, instead of selling the underlying assets. There are new rules that apply a modified look-through active asset test for this arrangement, as well as more stringent connected entity requirements. It is anticipated access to the small business tax concessions by multiple owners of the same business may be retained under the board’s proposed reform.

Conclusion The CGT small business concessions allow small business owners access to generous tax concessions and superr opportunities. The timing of the business disposal, the structure of the SBE and the super requirements of respective stakeholders are all integral to the decision as to the path and the concession to be chosen. The risk of legislative change should also be taken into consideration. There are eligibility requirements for each CGT concession set out in this article that have to be met. In addition, the contribution to superannuation must satisfy super law requirements.

COMPLIANCE

The ethics of SMSF advice

The newly imposed Financial Adviser Standards and Ethics Authority Code of Ethics has been the cause of much consternation in the advice industry. Bryan Ashenden highlights the standards to which SMSF advisers will need to pay close attention.

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

Itâ&#x20AC;&#x2122;s been over seven months now since the Financial Adviser Standards and Ethics Authority (FASEA) Code of Ethics came into effect for financial advisers to consider when providing personal advice to a retail client. And to a large extent, the transition has been smooth, which is a great reflection that in reality most advisers have always been acting ethically when providing advice. In reality, many of the issues with the code have really centred on the question of how to document the actions, thought processes and considerations that arise and not actually the way the adviser has acted. However, when it comes to advice regarding SMSFs, things can be a little more complicated.

The first complication is actually determining who it is that you are advising. We often remind our clients if they have (or are contemplating having) an SMSF, one of the important aspects to always remember is keeping the assets of the fund separate and distinct from their personal assets. The ATO has a significant focus on this as well. So what does it mean when it comes to the Code of Ethics? Difficulties are common in advising SMSF clients: Am I advising a person as an individual or as a trustee? Who do I address my advice to? Does it matter? Arenâ&#x20AC;&#x2122;t they the same, given all members Continued on next page

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need to be trustees anyway? This conundrum immediately brings us to a consideration of Standard 1 of the FASEA code for SMSF advice, requiring practitioners to “act in accordance with all applicable laws, including this code, and not try to avoid or circumvent their intent”. Identifying who the client is for SMSF advice can often be easily determined by asking the question of who needs to take the relevant action or, perhaps in even simpler terms, to whom would I be addressing the advice if the client was in a retail super fund. As an example, advice on drawing on a retirement income stream would likely be directed at the member as you wouldn’t provide advice on drawing on a retirement income stream to the trustee of a retail fund. However, if this advice also includes advice on the underlying investments of that income stream, which would naturally have an impact on the investment strategy of the SMSF, to whom would you direct that advice? If it was advice concerning a retail fund, again you would direct it to the member on the basis of the fund allowing for member investment choice. So is it any different for an SMSF? Where FASEA Standard 1 could cause some issues, however, is where questions arise regarding whether the SMSF could or, perhaps more correctly, should be regarded if a wholesale investor. With comfort given by the Australian Securities and Investments Commission (ASIC) a few years back that no action would be taken where an SMSF is classified as a wholesale investor if the accountants certificate test requirements have been met, has this led to more SMSFs being advised on this basis? While we don’t have any readily available data to show whether a change has occurred or not, perhaps the initial question is why should it change the advice approach? What is the reason for treating an SMSF, and its trustees, as a wholesale investor rather than a retail investor?

58 selfmanagedsuper

Many of the issues with the code have really centred on the question of how to document the actions, thought processes and considerations that arise and not actually the way the adviser has acted.

With retail investors receiving additional protections under the Corporations Act, could making a change to the status of the client, because it may make the advice process easier, be seen as avoiding the intent of the law? With virtually all other advice on super regarding a retail fund being required to be provided on a retail basis, how do you justify a different position for a SMSF? Unfortunately, as with many ethical

dilemmas, there is no simple and easy answer, and I am not saying treating an SMSF as a wholesale client cannot be an appropriate solution. But there is a need to ensure the adviser can justify why you have undertaken a particular position. Not surprisingly, one of the more common areas of ethical consideration for SMSF advice is where a multidisciplinary firm is in being used that offers both the advice and administration services to the client. Clearly, the question here is whether Standard 3 dealing with conflicts of interest has an impact on this situation. Now, let’s deal with a couple of headline issues upfront. Firstly, the FASEA code has not been designed to prevent firms operating multidisciplinary practices that can service many needs for clients under the one roof. Secondly, Standard 3 does not actually prevent you from proceeding where a conflict has been identified. The intent of Standard 3, when you read through all the supporting documentation and guidance notes FASEA has issued, fundamentally comes back to a question of acting in the best interests of the client. To this end, a simple test can be to ask the question: “If the conflict we are focusing on didn’t exist, would my advice have been any different?” If the answer is “no, it would have been the same advice”, then it is hard to see how

the conflict has impacted the advice in any manner, and Standard 3 should not give rise to any concerns. It is the nature of the business arrangement in place here that has caused the issue or concern to be raised for discussion in the first place. It should not automatically be assumed that because an adviser works within a practice that also offers SMSF administration services, that any advice to a client to establish an SMSF is done because of the ability of the firm to generate additional revenue from those administration services. Similarly, if those administration fees are slightly cheaper because of the nature of the in-house referral, that again doesn’t mean it’s not appropriate, as it could be cheaper to service the client all under the one roof through the appropriate sharing of information. However, it would also be reasonable to expect there would be a greater level of scrutiny and advisers in this position would likely need to have more proof points to demonstrate their compliance with the FASEA code requirements. The more hurdles that exist, the more hurdles there are that need to be overcome. It is the same dilemma that faces advisers who work in vertically integrated businesses. There is an assumption (I would suggest erroneous) that advisers who operate in these business models are naturally conflicted. The tests (or the standards) aren’t any different, it’s just the hurdles may be set a bit higher. And, of course, it’s where you need to identify the difference in requirements between corporations law and the FASEA code. Under corporations law, advice to invest in a product that may be produced or managed in-house could meet the best interests requirements if it can be shown to help put the client in a better position. While this best interest requirement still applies under the FASEA code, albeit without a seven safe-harbour steps approach, Standard 3 would pose the question whether a different product would have been recommended if the

advice was being given in a non-vertically integrated environment. One other FASEA standard that has particular application, or perhaps a greater emphasis, for SMSF advice is Standard 5, and in particular its emphasis on requiring an adviser to ensure a client understands not only the benefits of the advice and products being recommended, but also the risks and costs, and that the adviser has reasonable grounds for being satisfied the client has this understanding. It is always important any recommendation to establish an SMSF is being done for the right reasons and not a reaction to a client’s request to have one simply because their mates do or because they aren’t happy with their existing retail fund arrangements. The need for trustees to understand their obligations in running an SMSF is a fundamental requirement exceeding them simply signing an ATO trustee declaration that they understand their duties and obligations. Where a challenge could be faced for SMSF advice is where there appears to be a main decision-maker among the trustees. It is not uncommon one trustee plays a larger role than the other(s) and is often looked to as being the person who calls the shots. With many SMSFs being comprised of family members, this is perhaps not a surprising outcome. It is also doesn’t mean the SMSF is not appropriate as all the trustees may understand their duties and obligations, may understand the risks and be aware they are equally liable for the actions of any of the fund trustees. The difficulty for advisers under Standard 5 is to distinguish between simply deferring to another trustee and disinterest in their obligations. And while it can sometimes be hard to identify the indifference, for SMSF advice this is perhaps one of the key focuses for Standard 5. Remember, this particular standard is really there to help support and protect the adviser. If a client were to make a complaint, what would be the first statement in their complaint? “I didn’t understand the advice,

An increased focus on the standards and appropriately documenting considerations, thought processes and observations throughout the advice process can only be a good thing.

I didn’t know what I was getting into.” A proper consideration by an adviser of the requirements of Standard 5 should mean this complaint should never be successful. And remember, the testing of Standard 5 around understanding should never be set and forget. It needs to be tested, considered and assessed each and every time advice is given to any client as circumstances can change. While the use of an SMSF could have been appropriate at one point in time, this justification may not exist in the future. There is no doubt the FASEA Code of Ethics has created some challenges for the advice industry since its introduction, but fundamentally it hasn’t changed the actions of the vast majority of the industry who have always done the right thing. But an increased focus on the standards and appropriately documenting considerations, thought processes and observations throughout the advice process can only be a good thing to give a solid basis for showing how the delivery of advice, and in this case SMSF advice, is moving from an industry to truly being regarded in the eyes of the consumer as being the delivery of a professional service by professionals.

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COMPLIANCE

ATO guidance road test The ATO provides a vast array of guidance material aimed at assisting taxpayers. Daniel Butler lists and examines the effectiveness of each of these items.

DANIEL BUTLER is a director at DBA Lawyers.

The ATO is a large bureaucracy and produces a lot of guidance material. Generally the regulator feels bound by its published material from an administrative viewpoint. However, only certain publications bind the ATO. Thus, it is important advisers and taxpayers understand the range of material, or products, published by the ATO and the level of protection each provides. For example, a tax ruling is generally binding on the regulator. As discussed, the ATO’s general administrative practice is that it feels bound to follow its own written materials, but in the event it is wrong, the tax still remains payable but penalties may be remitted. In particular, only certain documents provide a ‘precedential ATO view’. This is the regulator’s documented view about the application of any of the law administered by it in relation to a particular interpretative issue. The ATO has precedential views to ensure its decisions on interpretative issues are accurate and consistent. Practice Statement Law Administration (PS LA) 2003/3 states that precedential ATO views are set out in the following documents: • public rulings (including draft public rulings), • ATO interpretative decisions (ID), • decision impact statements (DIS), and • documents listed in the schedule of documents containing precedential ATO views (attached to PS LA 2003/3). We discuss the main types of ATO publications below and also provide a handy summary at the end of this article.

Public rulings Public rulings contain binding advice expressing the ATO’s interpretation of the law. Different types of public rulings are published, including:

60 selfmanagedsuper

TR — Taxation ruling, TD — Taxation determination (short form ruling), GSTR — Goods and services tax ruling, MT — Miscellaneous taxation ruling, SGR — Superannuation guarantee ruling, CR — Class ruling, and PR — Product ruling. Where a taxpayer follows a public, private or oral ruling that applies to them, the ATO is bound to assess them as set out in the ruling. If the correct application of the law is less favourable to a taxpayer than the ruling provides, the ruling protects the taxpayer from the law being applied by the ATO in that less favourable way. A public ruling usually applies to both past and future years and protects a taxpayer from the date of its application, which is usually the date of effect of the relevant legislative provision. In addition, a public ruling that is withdrawn continues to apply to schemes that had begun to be carried out before the withdrawal. TR 2006/10 is an ATO public ruling that provides details on the protection offered by public rulings, et cetera. The ‘advice under development program’ tracks the development of rulings, determinations and significant addenda, including topics that have been added or withdrawn, and rulings and determinations that have been finalised.

Administratively binding advice The ATO provides administratively binding advice to assist taxpayers in certain limited circumstances. The regulator considers it is administratively bound by its advice and an early engagement (for advice) request can lodged with the ATO to discuss the matter before applying for such advice. Generally, the ATO stands by its advice and will not depart from it unless: • there have been legislative changes since the advice was given, • a tribunal or court decision has affected the ATO’s interpretation of the law since the advice was given, or

• the advice is no longer appropriate for other reasons. If a taxpayer follows the advice and the ATO later finds out it does not apply the law correctly to them (and none of the points above apply), they will be protected from having to repay amounts of tax that would otherwise be payable and any penalties and interest on those amounts. Applications for administratively binding advice are done via a private ruling application form.

Private binding rulings A private binding ruling (PBR) on a tax query is binding on the ATO. Note, this is the information provided at the start of most PBRs: • You cannot rely on the rulings in the register of private binding rulings in your tax affairs. You can only rely on a private ruling that we have given to you or to someone acting on your behalf. • The register of private binding rulings is a public record of edited private rulings issued by the ATO. The register is an historical record of rulings and the ATO does not update it to reflect changes in the law or ATO policies. • The rulings in the register have been edited and may not contain all the factual details relevant to each decision. Do not use the register to predict ATO policy or decisions. As you will note, a PBR only provides protection to the particular taxpayer to whom it is issued. Thus, those who seek to rely on information in the register of PBRs do so at their own risk. An example where this may prove risky for SMSFs is if they relied on a favourable PBR issued to another taxpayer on a nil interest related-party limited recourse borrowing arrangement (LRBA), since there would be no protection from that PBR as it only protects the taxpayer specifically covered by it. Note, following several PBRs issued by the ATO in the 2014 financial year, numerous other SMSFs entered into LRBAs without one.

The ATO issued Practical Compliance Guideline (PCG) 2016/5 in April 2016, which stated SMSFs with non-arm’slength LRBAs that did not bring them in compliance with arm’s-length terms prior to 31 January 2017 would be subject to the non-arm’s-length income rules. Fortunately, these SMSFs did not suffer additional tax or penalties for relying on a strategy covered in another taxpayer’s PBR. In contrast, there have been other situations where taxpayers have suffered extra tax and penalties for relying on another taxpayer’s PBR, which did not provide protection to them.

Tax determinations A TD provides similar protection to a public ruling. By way of example, the protection provided by a TD, as described in TD 2013/22, is as follows: • This publication (excluding appendixes) is a public ruling for the purposes of the Taxation Administration Act 1953. • A public ruling is an expression of the commissioner’s opinion about the way in which a relevant provision applies, or would apply, to entities generally or to a class of entities in relation to a particular scheme or a class of schemes. • If you rely on this ruling, the commissioner must apply the law to you in the way set out in the ruling (unless the commissioner is satisfied that the ruling is incorrect and disadvantages you, in which case the law may be applied to you in a way that is more favourable for you — provided the commissioner is not prevented from doing so by a time limit imposed by the law). You will be protected from having to pay any underpaid tax, penalty or interest in respect of the matters covered by this ruling if it turns out it does not correctly state how the relevant provision applies to you.

IDs are produced to assist ATO officers to apply the law consistently and accurately to particular factual situations. ATO IDs set out the precedential ATO view we must apply in resolving interpretative issues. They are not rulings. Below is an example of the level of protection provided by ATO ID 2012/16: • If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the tax office or from a professional adviser. For more information refer to PS LA 2001/8 (see immediately below) which is the Law Administration Practice Statement that explains the policy for ATO IDs.

Law administration practice statement A PS LA provides direction and assistance to ATO staff on the approaches to be taken in performing duties involving the application of the laws administered by the commissioner. For more information see PS LA 1998/1. Although PS LAs are published in the interests of open administration, their intended audience is ATO staff and they have a main purpose of providing instructions to ATO staff on the manner of performing law administration duties.

Interpretative decisions

Practical compliance guidelines

An ATO ID is a summary of a decision on an interpretative issue and is indicative of the regulator’s view on the interpretation of the law on that particular issue. ATO

From 2016, PS LAs will align more closely with their main purpose and PCGs will be Continued on next page

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the appropriate communication product providing broad law administration guidance to taxpayers. Provided a taxpayer follows a PCG, the ATO will administer the law in accordance with the approach reflected in that guideline. PCGs are not binding on the ATO and are used as safe harbours to provide an indication of how the regulator will apply its compliance resources. For example, PCG 2006/5 provides safe harbour terms for related-party LRBAs that, if satisfied, will not result in the ATO applying resources to review and audit LRBAs prior to the 2016 financial year.

Law companion rulings Law companion rulings (LCR), formerly known as law companion guidelines, provide the ATO view on how recently enacted law applies and is usually developed at the same time as the drafting of the relevant bill. An LCR will normally be published: • in draft form for comment when the bill is introduced into parliament and will be finalised soon after the bill receives royal assent. It provides early certainty in relation to the application of the new law, or • where taxpayers need to take additional action to comply with the law, to provide certainty about what needs to be done. An LCR will not usually be issued where the new law is straightforward, is limited in its application, or does not relate to an obligation to pay tax, penalties or interest. An LCR will usually be finalised as a public ruling at the time the bill receives royal assent and becomes law, unless issues arise during consultation or the bill is significantly amended in its passage through parliament. Because LCRs are prepared at such an early time, an LCR will not be informed by experience of the new law operating in practice. Therefore, while they offer the same protection in relation to underpaid tax, penalties or interest as a normal public ruling, this will only apply if a taxpayer relies on an LCR in good faith.

62 selfmanagedsuper

SMSF specific advice An SMSF specific advice instrument regarding a Superannuation Industry (Supervision) (SIS) Act or SIS Regulations SMSF question is not binding on the regulator. Typically ATO advice can be sought in relation to the following topics: • acquisition of assets from related parties, • borrowing and charges, • in-house assets, • business real property, • in specie contributions/payments, and • payment of benefits under a condition of release. In certain cases, if taxpayers request a PBR and SMSF specific advice, the ATO generally asks that these be separated into different requests. However, we have noticed a number of PBRs issued where the ATO has combined these two forms of guidance, but has been very express in its letter that this is where the PBR starts and finishes, and similarly this is where the SMSF specific advice starts and finishes so there is no confusion as to the parts that are binding on the ATO and those that are not.

Taxpayer alerts Taxpayer alerts (TA) are intended to be an early warning of the ATO’s concerns about significant and emerging potential aggressive tax planning issues or arrangements the regulator has under risk assessment. Moreover, the ATO usually develops its views more comprehensively following the issue of a TA on a topic and prior TAs can be superseded shortly after being issued. The comment at the beginning of a TA is: “TAs are intended to be an early warning of our concerns about significant or emerging higher risk planning issues or arrangements that the ATO has under risk assessment, or where there are recurrences of arrangements that have been previously risk assessed.”

of the case, including the implications of the decision and whether any ATO ruling needs to be amended. Invariably, the regulator seeks to distinguish a decision based on the facts and circumstances of the case where the ATO does not succeed.

Superannuation circulars Superannuation circulars explain the various legislative requirements that apply to the operation of SMSFs under the SIS Act and SIS Regulations. SMSF regulatory bulletins and SMSF regulator’s bulletins (SMSFRB) outline the ATO’s concerns about new and emerging arrangements that pose potential risks to SMSF trustees and their members from a superannuation regulatory and/or income tax perspective. These bulletins are specifically designed for SMSFs. The ATO’s aim is to share its concerns early to help trustees make informed decisions about their funds. To the extent the bulletin provides guidance to a trustee, and it is applied in good faith to their own circumstances, the commissioner will administer the law in accordance with the guidance outlined in the bulletin. For example, SMSFRB 2018/1 examines the ATO’s position on the use of reserves by SMSFs.

ATO web page and fact sheets The ATO’s web page and fact sheets can be useful but cannot be relied on. The general administrative practice is that the regulator feels bound to follow its own written materials, but in the event that the ATO is wrong, the tax is still generally payable but penalties may not be imposed. PS LA 2008/3 explains that, in the interests of sound administration, the ATO’s practice has been to provide administratively binding advice in a limited range of circumstances.

Decision impact statements DIS are succinct expressions of the ATO’s response to significant cases decided by the courts or tribunals. They provide the details

Media releases and speeches Media releases are brief announcements used to deliver ATO messages on

Table 1: ATO products Product

Binding on ATO

Comments

Public rulings

Yes

Issued by the ATO for all taxpayers to rely on.

Administratively binding advice

Designed to assist taxpayers.

PBR

Yes

Issued for a speciﬁc taxpayer and a register of PBRs is available. A taxpayer cannot rely on another’s PBR.

Yes

Similar to a public ruling.

ATO ID

ATO view on a technical issue.

PS LA

Practical guidance to taxpayers.

PCG

Practical guidance to taxpayers.

LCR

Yes

Practical guidance on new laws.

SMSF speciﬁc advice

ATO advice on SIS Act and Regulations queries.

DIS

Succinct statements of the ATO’s response to signiﬁcant cases decided by the courts or tribunals.

Superannuation circulars

Explains the legislative requirements that apply to SMSFs under SIS Act and Regulations

ATO fact sheets

Practical guidance on tax and super matters.

Media releases/speeches

Brief ATO announcements to the media on newsworthy topics and speeches to be transparent.

Oral rulings for individuals

Yes

Oral phone advice on personal income tax and Medicare levy queries for individuals.

Tailored technical assistance

To provide an ATO view of how the law applies to a particular technical issue.

newsworthy topics and to communicate the regulator’s intentions in relation to certain issues. A media release reflects the ATO’s position at the time of its publication, which may subsequently be updated. Speeches by senior ATO officers reflect the regulator’s thinking on particular issues and are published for transparency reasons.

Oral rulings – for individuals An oral ruling is a form of legally binding advice the ATO gives over the phone to individuals in relation to their specific circumstances; typically in relation to personal income tax or Medicare levy queries. If an individual relies on an oral ruling,

the ATO is bound to assess their liability in accordance with the oral ruling. If the oral ruling is incorrect and disadvantages an individual, it may apply the law in a way that is more favourable to that person provided there is no time limit in doing so.

• a taxpayer is not certain how the ATO view of the law applies to their circumstances, or • a taxpayer is seeking greater certainty (protection) than what ATO published products provide. Typically, this is best managed by a tax agent or a tax expert.

Tailored technical assistance The ATO provides tailored technical assistance in some circumstances, orally or in writing, depending on the nature and complexity of the query. The regulator suggests a taxpayer may seek this type of assistance if: • they are not able to find an ATO view of how the law applies to a particular technical issue,

Summary of ATO materials There is a vast array of information issued by the ATO. Advisers should be aware of each type of product and understand how it applies to taxpayers. In particular, different levels of protection apply to taxpayers relying on regulator materials. A summary of numerous ATO products is contained in Table 1.

QUARTER III 2020

LAST WORD

JULIE DOLAN EXPLAINS THE ADVANTAGES BROUGHT ABOUT BY DELAYING THE WORK TEST REQUIREMENT

JULIE DOLAN is enterprise director at KPMG.

64 selfmanagedsuper

From 1 July 2020, individuals aged 65 and 66 can make voluntary contributions to superannuation without having to comply with the work test. This test requires an individual to have worked a minimum of 40 hours in a consecutive 30-day period during the financial year prior to the making of the contribution. This amendment is an increase in age of two years from the previous requirements with the purpose of progressive alignment with the eligibility age for the age pension. This change to the work test was initially part of the federal government’s 2019 budget. As the change is an amendment to the Superannuation Industry Supervision (SIS) Regulations, registration by the government was required. This was successful and hence was codified by changes to sub-regulation 7.04 of the SIS Regulations. Allowing an individual an extension of time to make voluntary super contributions provides a layer of potential contribution strategies. Based on an individual’s total super balance (TSB), it allows a person another two years of nonconcessional contributions, up to $200,000, without having to meet the work test. Added to this is the proposal to increase the bring-forward age to allow individuals to make non-concessional contributions to super of up to $300,000 where all eligibility requirements are met. This measure was initially introduced into parliament through the Treasury Laws Amendment (More Flexible Superannuation) Bill 2020 in May. As it currently stands, the next parliamentary sitting is in August. If passed, it is assumed the change will be made effective from 1 July 2020. So what are these potential additional strategies? One such strategy (as mentioned above) is for an individual to make additional non-concessional contributions by using the bring-forward rule. This new opportunity may help individuals who have additional amounts to contribute to superannuation on top of any downsizer contributions or proceeds from the sale of businesses. As a recap, the downsizer contribution allows an individual 65 years or over to contribute the proceeds from the sale of a principal place of residence (PPR) where the contract of exchange occurred on or after 1 July 2018. The PPR has to have been owned by the individual or the individual’s spouse for 10 years or more prior to the sale. It has to be a home located in Australia

and cannot be a caravan, houseboat or other mobile home. Election is made via the approved form either before or at the time the downsizer contribution is made. The contribution is required to be made within 90 days of receiving the proceeds of sale. The amount of the contribution is up to a maximum of $300,000 each and cannot exceed the total proceeds from the sale. As an example, for a person with a super balance of $1 million, the change could enable an additional $450,000, through a combination of concessional and non-concessional contributions over a period of two years, to be contributed that would otherwise not have been permitted under current rules. If a person’s super balance is already above $1.6 million, additional contributions would be limited to annual concessional contributions of only $25,000. Factoring in the downsizer contributions adds an additional $300,000 per individual. A further strategy is around the re-contribution strategy and reducing the taxable component of an individual member’s account balance. Extending the ability to contribute nonconcessional contributions for a further two years without satisfying the work test allows an individual who has reached 65 to withdraw funds from super and then re-contribute them as non-concessional contributions. This is obviously subject to the TSB of the member at 30 June in the prior financial year. This has a significant effect in relation to estate planning. Should the individual’s superannuation balance be ultimately paid to a non-tax dependant either directly or via the estate, a tax liability of at least 15 per cent is levied on the taxable component of the member account. By using the re-contribution strategy, a lump sum is withdrawn from the individual’s superannuation account in proportion to the taxfree/taxable components. An amount can then be re-contributed under the new rules up to the age of 67 without having to satisfy the work test. The re-contributed amount would be classified as a non-concessional contribution. Therefore, what was a taxable component has been converted to a non-taxable one. Obviously this strategy has maximum effect when the individual’s member account has a substantial taxable component supporting their member account. Depending on the size and level of the taxable component, this strategy can save a substantial amount of tax when ultimately paid to non-tax dependants.

SMSF TRUSTEE EMPOWERMENT DAY

2020

DIGITAL EVENT 15 SEPTEMBER

SMSF Trustee Empowerment Day Digital 2020 will provide a wealth of information designed to boost compliance, strategy and investment knowledge, helping SMSF owners to navigate these challenging times.

The event will feature a number of leading industry technical experts covering the areas of greatest importance to SMSF trustees and is a mustattend event for people who own and run their own superannuation fund. While in-person meetings and events are on hold, weâ&#x20AC;&#x2122;re offering this event completely online with free admission.

GET YOUR FREE TICKET ď&#x201E;&#x2026;

More information at www.smstrusteenews.com.au/events

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self managed super: Issue 31

Articles inside

Guarding SMSF wealth – part two

ATO guidance road test

Bring-forward contributions state of play

Compliance problem solving

Regulation Round - Up

The ethics of SMSF advice

Don’t whinge. DO!

THE WAY FORWARD

The SMSF cost conundrum

DEEP DIVE: EXPLORING THE STATUS OF SMSFS