2023 SMSF Roundtable: issues too big to ignore

Superannuation in 2023 has been too big to ignore with the government putting a proposed objective and new targeted tax on the table, setting the scene for the selfmanagedsuper annual SMSF roundtable, which considered how these changes will progress and what happens next in regards to non-arm’s-length arrangements.

Participants

Belinda Aisbett (BA) - Super Sphere director.

Peter Burgess (PB) - SMSF Association chief executive.

Craig Day (CD) - Colonial First State head of technical services.

Jemma Sanderson (JSa) - Cooper Partners director and head of SMSF and succession.

Moderators

Darin Tyson-Chan (DTC) - selfmanagedsuper editor.

Jason Spits (JSp) - selfmanagedsuper senior journalist.

The objective of superannuation

In February, the government announced it would put in place an objective for the superannuation system, but its terms are open to interpretation with the panel questioning whose definitions will be implemented and how they will be applied to calls to use super for infrastructure and aged-care investing.

DTC: The draft bill for the objective of super was recently released. What did we think of the proposed legislation at this point in time?

PB: We are supportive of the objective of super and think it’s a good idea that everyone has an understanding as to the purpose of the superannuation system. It can only enhance consumer confidence in the system, which is a big thing when it comes to people making voluntary super contributions. The draft bill is unchanged from what we saw earlier in the year in the consultation paper and it will be a separate act that won’t override any of the Superannuation Industry (Supervision) (SIS) Act or Regulations provisions. This means it won’t impact things like preservation rules and cashing requirements.

CD: There’s been a number of reviews over the years and they have all pointed out we’re dealing with quite a complex system. We need to be clear about the purpose of superannuation because that drives policy settings, so we are supportive of the idea of an objective for the simple fact that it provides stability for those policy settings and we don’t get people moving the goalposts because of budgetary requirements. We are also supportive of the government continuing to consult as the objective is implemented because it does have potential to make a big difference.

BA: From a personal observation on how it would impact my work, if it doesn’t change the SIS requirements, then the overall auditing requirements and obligations aren’t going to change. I like the idea there is an approach to super so that if there are any proposed changes, it has to be married up to what has been set down as the objective and that gives us confidence that things aren’t going to be just changed for the sake of change; they have to align with the purpose and that is a good thing.

JSa: I agree with what everyone has said, but there will need to be consideration for the many different types of super in Australia. The objective is great in terms of sustainability and being equitable, but it is very difficult to get sector neutrality. If the government does legislate this objective of super, how can we achieve that neutrality across the board between the historical legacy accounts and defined benefits in comparison to a self-managed superannuation fund? It will be interesting to see if the draft bill gets legislated, then how it is applied when people are looking to make these changes from that perspective.

DTC: There are concerns about the definition for an equitable and sustainable system as being fairly broad terms. Have they been sufficiently clarified so that we can say they are going to be interpreted in a way that is not counter to the objective?

CD: The concept of the policy is to set the objective so we all know what we’re trying to achieve and then if the policy setting is done through that lens, I’m not worried about the wording. If we’ve got a clear objective that sets the framework through which future policy is set, the outcome that we’re getting is stability. In terms of the particular words used, I don’t have much of an issue with them and it’s not something that we’re concerned with.

PB: There’s some wriggle room there, but it is still an extra step the government and future governments are going to have to go through if they’re looking to make changes to the superannuation laws. There is a statement of compatibility that’s referred to in the explanatory materials, which means the government has to explain that if they do want to make a change to a superannuation law, how that is consistent with the objective. There are some funds which will be carved out of this which are constitutionally protected funds and they are not subject to this objective. Whether that statement is going to change anything is the question, but it gives more certainty and an extra step that any particular government has to go through to justify whatever changes they’re making to the superannuation rules. In regards to some of the specific terms such as sustainability, we’ve argued changes like the $3 million cap add complexity to the system and the more complexity we have, the less sustainable the system is.

DTC: Can you briefly describe the constitutionally protected funds that you referred to?

PB: Most of the state government funds and federal or commonwealth government schemes are not covered by this objective, which has got to do with the structural base of the funds being defined benefit interests.

CD: Some are state based because under the constitution, the federal government can’t raise taxes on the state, so as soon as you’ve got a superannuation fund set up under some sort of state act, the federal government can’t tax it.

JSp: We’ve been talking about the definitions of equitable and sustainable, but the other one is a dignified retirement. Is that a definition we’re comfortable with or is it too broad?

JSa: It is broad because a dignified retirement for me might be different to anyone else and it’s a bit like the phrase ‘the lifestyle to which you are accustomed’. For a high-flyer, a dignified retirement might be substantially more from an income-generation perspective than someone who hasn’t had that lifestyle. Then you’ve got to overlay different healthcare requirements and everyone will have a different concept. It’s really hard to put a benchmark on what that looks like, which is an area that the age pension is trying to do in supporting people towards that dignified retirement. It’s one of those terms where everyone will have a different definition of what that looks like for them.

DTC: Within the draft bill there are references to how superannuation could support national economic priorities if they were in the members’ best financial interests. Is this a way to allow the government to use our retirement savings for their purposes, such as affordable housing or infrastructure?

PB: It’s a carefully worded statement which they are linking to the financial best interest of the member and we wouldn’t support the mandating of superannuation to be used for nationbuilding projects because you’ve got to be able to show that it actually is in the financial best interest of the member. You need to make sure that whatever investments are being made are in the best interests of the members and it’s consistent with the sole purpose test and we wouldn’t like to see that watered down in any way, shape or form.

DTC: Does anybody know what the parameters of financial best interest actually means because that opens the floodgates to further discussions as to how you can make this sort of thing work for your own purpose?

JSa: You could probably justify anything and that’s where the challenge lies if I’m taking on all this risk, but the returns are going to be substantial. Where we don’t want to get to is having mandated requirements for how you invest money and this was brought to the fore a couple of years ago when the ATO sent notices to people who had limited recourse borrowing arrangements (LRBA) and said they should consider if it’s a breach of the investment provisions. It’s not their role to determine how people invest their money, so it’s a similar sort of thing if you force an investment and there are certain people that don’t want to take on any more risk than a term deposit. If they had to invest their money in superannuation in a prescribed way in an infrastructure project or something like that, a behavioural change would kick in and they would just rip it all out.

BA: Spot on. We don’t want to be dictating where people invest their money. It’s a self-managed superannuation fund for a reason, they want control. If something like that was introduced, there would be so many funds impacted because their money is already tied up in investment choices that they’ve made quite legitimately. To be told you must invest a certain percentage, even if it’s a low percentage, in a particular area is not going to be well received. What does the audit look like for those types of funds? What are the consequences for trustees that decide to vote with their feet arguing they have been investing their way all this time and they can’t be told where to put their money?

JSa: If there was a requirement it would likely just give rise to some investment arbitrage system where people say you can satisfy the requirement by doing certain things, which then allows scam type arrangements to come through. People are opportunistic when those sorts of measures are put in place and so I would be cautious in prescribing those sorts of requirements. Is it also in the best financial interests of the member if you’ve got a prescription because it might not be a good return-generating asset?

CD: It could potentially just begin to apply to large superannuation funds because for SMSFs it might be like herding cats to try and get them to do that. In which case you might see some different behaviour as well because if people don’t want their money invested in some sort of government-prescribed investment, will we see a movement to SMSFs because of that, which would be counterintuitive to what you’re trying to do.

DTC: If you’re looking at adhering to the legislation, in the context of that objective, does that rule out something like using super to fund aged care as was proposed in a recent issues paper?

PB: If the objective of super is in play, there will be an obligation for the government to show that whatever changes they are making are consistent with that objective and whether those terms are sufficiently broad to accommodate that type of thing. We wouldn’t support that. It’s up to the members to decide where they invest their money and how they spend that money in retirement. We are very prochoice, being in the SMSF sector, so we wouldn’t support measures which look to restrict how people in retirement or the pension phase are required to draw down that money.

CD: We’re all supportive of the objective of super because it brings certainty and stability to the policy settings, but then if governments go on to say, “well we can contort our reason for this into anything”, then it just completely undoes the whole purpose of the objective.

JSa: The proof will be in the pudding in terms of whether there is something like that. It’s a fantastic example to see how that might get tested. If it’s going through the gauntlet of the objective of super and someone justifying the introduction of a law that might prescribe that, it would be interesting to see the debate that goes on.

BA: These types of calls imply there’s a one-size-fits-all to this approach and we’ve got to have a portion of our funds dedicated to that end goal. This is a relevant issue for any number of members of SMSFs, especially with the age demographic that have got an SMSF. Also, now we can have up to six members, we’ve got some old and some younger members and that alone makes it challenging to say to younger members they have got to have a certain per cent of their investments earmarked for aged care as it’s not going to be on their agenda for some time.

JSa: This ties into the issue of what is equitable. Let’s say you have a requirement to fund something like aged care, but you’ve got all those defined benefit interests. How does that fit into a requirement that you fund your own aged care? They really can’t do that due to how that super is invested because it’s been invested by the federal government. So again, sector neutrality may be an issue and how is that equitable? Is it equitable that a 21 year old who has their superannuation guarantee go into their fund having part of that now going to fund aged care that they might not need for 60 to 70 years?

CD: How does all this interact with the sole purpose test? We’ve got things such as the First Home Super Saver Scheme, and life insurance and income protection insurance within superannuation and that all works from a sole purpose perspective. Do we have to start to think about changing sole purpose because we’ve got so many things that superannuation is now being used for that’s not about retirement? Is aged care about retirement or post-retirement? We seem to be opening up superannuation to more and more things that takes away from its ability to achieve that one goal that we really want it to achieve and makes it harder to actually achieve that by trying to make it do more and more things.

The $3 million soft cap

Put forward within days of the proposed objective of superannuation, the $3 million soft cap has the potential to seriously impact SMSFs ahead of any other form of super, a point not lost on the panel, which noted if the tax must be applied, there were better ways to do it than those put forward by the government.

JSp: In regards to the $3 million soft cap, we’ve seen issues arise, such as the lack of indexation and the taxation of unrealised capital gains, but has there been any change in the government’s attitude from what they stated on day one in regards to this proposal?

PB: The short answer is no. We’re still waiting for draft legislation to be released. At the moment it’s just the consultation paper that we’re all working from. We’ve had no indication from government that they’re looking to change the broad concept of what they’ve already announced. We will see some adjustments made to things which will be included in the $3 million threshold. There were plenty of submissions that went in on the back of that consultation paper, pointing out some of the inequities that will arise if you don’t exclude certain things from that threshold, and also from the definition of earnings. I expect we’ll see some tinkering around that, but for the broad concept of the $3 million threshold we’re not aware of any movement from government in terms of the way they’re going to calculate earnings by using the movement in a member’s total super balance. We’ve had quite a bit to say about the inequities of that approach, including unrealised capital gains is grossly unfair, and we’ve been doing what we can to convince the government to take a different approach when it comes to calculating earnings. We understand that it’s highly unlikely at this point the government is not going to proceed with the $3 million threshold, but we remain optimistic that they will use a different approach to calculating earnings to what we saw in the consultation paper. I have nothing to really base that on, but hope they see sense in the fact that it’s not equitable to include unrealised capital gains in their calculation and they should base the calculation on actual taxable earnings, which is not a difficult thing for the SMSF sector to report. The objective of this tax is to claw back some of the tax concessions that people with very large balances get from the superannuation system, but there’s plenty of scenarios where that won’t be achieved. That’s something we need to look into more because if you look at some situations people will end up paying a lot more tax if they keep their money in the superannuation environment than they would if they took it out and invested it outside of super. If the intent is to claw back some of those concessions, I understand that, but we have a situation with what they’re proposing where someone could pay a lot more because they’ll be subject to additional tax. Unrealised capital gains is a new concept of earnings. We’ve got the tried and tested, accepted definition of taxable earnings and what they’re doing is bringing in another definition of earnings with unintended consequences.

DTC: Lack of an indexation component was one of the early criticisms of the measure, with suggestions this aspect will affect more than the estimated 80,000 superannuants because by the time 1 July 2025 comes around, the buying power of $3 million will not be at that level. Has anything changed on this front?

PB: No indication of change on that picture. Some of the figures we’ve seen show there is a significant number of individuals in that $2 million to $3 million range, so they’re going to tip over that $3 million threshold pretty soon. We’re going to see more and more of that over time if this threshold is not indexed, but nothing that we’ve heard from government indicates they’re looking to change their position on not indexing that threshold.

DTC: We have mentioned changes in behaviour in the context of the objective of super, but in this context have you noticed any sort of change in attitudes towards investing and saving and investing outside of super among clients concerned about breaching this threshold?

JSa: We are seeing people look far more critically at the best entity to invest in and during my conversations with people who are retired, they are considering their succession and looking if they should use superannuation money to buy an asset like property. Some of these are farming families and looking if they should buy farming land in the superannuation fund or pull the money out of super and put it in a different entity for ease of what’s going to happen later from a succession perspective, and not having to think about it within the context of the $3 million threshold. I’ve had some clients say they want to benchmark down to $3 million and don’t want the hassle at all so they’re talking about pulling substantial amounts of money out of super. I’ve told them not to panic but wait a little bit, but it’s definitely front of mind for a lot of people just wanting to know how it works. The other thing is there are people that have taken the risks and have got some substantial amounts in super, but they’re young – in their 40s and early 50s – and they’re going to be hit with this and can’t do anything about it. They’re very annoyed and frustrated with this proposal because there’s no way for them to try and manage their position as they are not eligible to take lump sum withdrawals and those sorts of things. It’s having unintended consequences and I absolutely see people changing their behaviours.

DTC: Have we got any information on when we might get some further draft legislation?

PB: We haven’t heard anything further. We did hear a couple of months ago now that it was expected out in a few months, but there’s been nothing, so you would expect it’s imminent, but we haven’t been advised and are still waiting like everyone else. We expect we will see something soon because there will be another consultation phase and expect the standard phase this time of about five weeks. What we had earlier in the year was something ridiculous, but they did make it clear to us at the time there will be another consultation phase once the exposure draft legislation is out. That will take us up to the end of Christmas and we won’t see a bill introduced into parliament until early next year is how we expect it’s going to play out. Working back, if they do want to get that bill into parliament early next year, it means we need to see some draft legislation pretty soon to give the industry sufficient time to go through that consultation phase before we break for Christmas.

JSp: There’s been a lot of scrutiny regarding asset valuations in the past 12 months from the ATO. Is the introduction of the soft cap going to intensify the focus on asset valuations, possibly as a means of getting under the $3 million threshold?

BA: Every auditor that I speak to can see the pain on the horizon. We have enough challenges now with getting sufficient audit evidence on asset valuations and if you’ve got trustees that are motivated to stay under a particular cap, that risk escalates. It is going to be problematic, we’re going to have clients who do their damnedest to keep it down, which makes the audit process more complicated and challenging. The end result is we’re going to see more qualified audit reports and more ATO reporting, but where does that leave us as an industry or the ATO as a regulator? How are they going to manage and how are they going to catch up with those funds that are understating their asset values to keep under that cap and how are they going to be dealt with? It is going to be problematic and auditors are bracing for that. If you’ve got clients that are relatively young, and they’ve got lucky in the SMSF and now have some big gains in there, they don’t have the option to restructure their funds by taking money out. They’re going to be problem funds as well for auditors for the simple fact that they’re going to get taxed on these unrealised gains and have no means of paying the tax. I have got a couple of clients in that exact boat who invested in property that has kicked goals for them, but have no real money in the bank. They didn’t need money in the bank because they had their assets in property, but how are they going to pay these tax bills?

JSp: Is this going to lead to more administration costs just to run a fund because you’ve got to know about the fund holdings under $3 million and then the separate calculations and valuations for everything over that figure as well?

BA: From the auditors’ perspective, you might find they are going to say if you’ve got property or other assets that might be challenging to value and you’re close to those caps, or may be pushed over them, they will want more quality audit evidence. There might be an expectation from some auditors for a sworn valuation every year, which is a huge cost to SMSF trustees that have property. Having to get it done annually to make sure they’re complying with the caps and paying the tax that might be levied on the fund with any increases in those property values is likely to make those administration costs go up. Who knows whether trustees will try and manage that by finding an auditor that won’t require more detailed information is hard to say.

JSa: There’s many unlisted shares and unlisted unit trusts that might be an active business and have property underpinning them. If it’s an active business in which a super fund is a passive investor and not heavily involved in the business, there will be pushback if they say they need a valuation done for the fund audit. To value a business costs tens of thousands of dollars every year in the absence of a capital raising, so the audit evidence to justify those sorts of things is going to increase. Auditors’ fees are quite low for what their requirements and obligations are and it’s becoming more rigorous for auditors who are left holding the baby in a lot of situations. So it’s justified when we’re doing the financials for a super fund to say to clients upfront we need a valuation of this, so you have to go off and do that because for audit we’re going to need that valuation. There’s no point in us even doing the financials until we have that valuation because we don’t want the back and forth as it just ends up costing everyone more time and money.

BA: We have a number of clients that have unlisted investments and it’s not been possible to get sufficient audit evidence for those so it becomes a qualification scenario. If you’ve got a cap that has a tax consequence, will everyone want that audit report qualified to stay under the $3 million threshold? That’s not practical or sustainable or going to achieve the objective that they want to achieve?

Everyone’s just going to take an audit qualification instead of going over the $3 million cap and be reported to the ATO, and how will it test the valuation. If we say we can’t verify the investments at market value and the trustee says they can’t do it either and that’s convenient because they stay under the $3 million cap, how are the ATO going to determine the valuations if none of us can?

PB: This is part of the reason we opposed this tax from day one because it’s complex, costly and everyone’s going to pay for it, not just those that are over $3 million. I saw some statistics the other day that a significant portion of members who have got more than $3 million are over the age of 75. So this is very much a legacy issue and these large amounts will be removed from the system over time, but all we’re doing here is making what is already a complex system even more complex.

BA: If older accounts are the problem, the solution is just handing the next generation an inflexible limit that doesn’t seem to be overly fair or equitable.

PB: It has the hallmarks of the super surcharge regime, which cost more than it raised in revenue for the government.

DTC: The issue with regard to illiquid assets has been identified and highlighted through situations such as including or excluding a farm from an SMSF and the farmers’ plight has been argued quite well around the potential and unintended consequences of this bill. The SMSF Association has been in discussions with other industry bodies like the National Farmers’ Federation and the Pharmacy Guild to further draw the government’s attention to this issue. Has this made any difference?

PB: We were very surprised with the proportion of farms that are owned by self-managed super funds in our discussions with the Farmers’ Federation. There’s no question some of those funds will have liquidity issues if this tax comes in. If they’re required to sell that property, it’s going to be disruptive to the broader community. We held discussions with small business associations to make sure they were aware of the potential impact that this new tax could have on their members. We know that there are a lot of small business owners who hold their business premises in their self-managed super fund, and you would expect many of those to probably be over that $3 million threshold. This tax is coming their way, so we wanted to make sure they were aware of that. We have provided them with fact sheets which explain what we know about how this tax is going to work, which they have used to educate their members as well.

DTC: Were they surprised or shocked?

PB: No, they were familiar with the $3 million proposal, but some weren’t aware of the technicalities of it. I have spoken to some small business owners myself who think this is a new tax that’s only going to affect people after a certain age and after a certain time. So it’s that type of education out there that we’ve got to be concerned about as well because that’s not the way this tax is intended to work and it will apply to everyone that has a business premises in their SMSF.

JSa: The other thing with farmers and small businesses is they are the backbone of the Australian economy and the biggest employer of people. It’s feast and famine for a lot of those businesses there. I was at a conference a couple of years ago and a chap who was part of the small business council said small business owners are exhausted, they can’t find staff, are working seven days a week, and then you throw in this as a consideration for them. No doubt they’re probably dismissing it or thinking I’ll deal with that later, but it will start to impact them where they’re over the $3 million threshold. Like the farms, the value of the land has gone through the roof but the rentals aren’t there to fund the tax. Will it be a debt account, like the super surcharge? Will you only be eligible if you have illiquid assets in the fund or if it’s a defined benefit? There’s so many quirky little bits and pieces that need to be ironed out before anything like that can come through.

BA: The fact that gains are incorporated but unrealised losses are not factored in, how is that fair and reasonable? It’s just a one-way street and you’ve got people who have unlisted investments that one year they’re up and the next year they’re down. It seems so unreasonable that they’re trapped in that situation through no fault of their own.

PB: The knock-on effect to the small business sector has not been properly considered in all of this and it’s not just the SMSF community, but the tax has a knock-on effect to the broader community when a lot of small business owners will have to pay more tax as a result of this measure. I don’t think it’s going to achieve its purpose either. We saw another example of this during the week with a very large fund of $20 million, which is clearly in the sights of the government in terms of where this tax is directed. If the tax had been introduced in the last financial year, they wouldn’t have paid any tax because while the fund earned quite a lot of income from bank interest in dividends and distributions, the asset value actually dropped. So the calculation of earnings would have meant no earnings under this new definition of earnings, even though under the traditional taxable earnings approach, they did have taxable earnings. I don’t think that’s an intended outcome where a fund of that size will pay no tax under this new threshold approach. So there will be plenty of scenarios where it’s just not going to achieve its intended outcome.

BA: It’s really quite a simple solution. If you’ve got a fund in that asset value, you could just tax its income at a slightly higher rate and there’s the equalisation and redistribution of benefits to those that can perhaps afford it more without having all of these unintended consequences. It’s quite a simple answer, the tax rate for those funds goes from 15 to 20, or even to 30 per cent.

DTC: It begs the question as to what the real purpose of this is and not the stated purpose, but that’s a discussion for another day.

JSp: Darin mentioned the intent versus the state of intent and one of the things we saw with this was a very limited consultation period. Should we be concerned this is an indication industry consultation is becoming less valuable or meaningless?

CD: From my perspective, if I look at the $3 million consultation, it was my understanding that the government was looking to announce that in the federal budget or to reconfirm it in the federal budget. With the budget being in early May, there was limited time to get that consultation in and it had to be squeezed into a short period of time. I don’t see that they’re not interested in listening to consultation. I participated in some of the consultation with Treasury and they were not open to some things. There was absolutely no point, they made it clear, in discussing the indexation issue. In terms of other issues around the meaning of contributions and earnings we had a quite detailed discussion about insurance policies, and what happens if an insurance policy triggers and pushes someone over $3 million. Would that look like earnings that’s going to be subject to tax for a 45-year-old person that’s been involved in a car accident and is disabled for the rest of their life? Treasury absolutely took that on. There were a couple of things put through by industry that Treasury hadn’t thought through or had not thought through to the extent that maybe industry had with the experience that we have dealing with clients and real-life situations. They were certainly taking all those factors into account and when we saw subsequent clarification, a lot of those issues had been picked up, so clearly they are listening.

PB: I agree with Craig. In terms of that short consultation phase we had around the $3 million cap, it was explained to us they wanted to get it in the budget papers so we had a very short consultation phase. It can be frustrating in the consultation phase as we don’t always get what we want, and we saw that through the nonarm’s-length expenditure consultation. It was a long extended process of working with government. We would have liked a different outcome and we didn’t get everything that we asked for. We are hoping when we see the draft legislation coming out for the $3 million cap that we will get a decent period of consultation because we are going to need it. This is not a simple tax and it’s going to need quite a lot of consultation. We haven’t seen anything and the way this tax is going to work for defined benefit interests, you would expect that to be addressed in the draft legislation. It will be the first time the broader community will get an understanding as to how it’s going to apply to those type of funds, and we’ll be disappointed if we don’t see at least that traditional six-week period we normally expect for a consultation.

NALE

Unlike the recent proposals of the objective of super and the $3 million earnings tax, non-arm’s-length expenditure (NALE) for general expenses has been a lingering issue which appears to have been solved and while the solution is workable, the panel noted it would not be evenly applied across all funds.

DTC: What does everyone think of the proposed NALE legislation with regard to general expenses?

PB: Well, it’s certainly a lot better than what was first proposed. We started with all the income of the fund potentially being taxed as NALE if general expenses were not on arm’slength terms. Then Treasury took the position the discounted amount would be multiplied by five times as part of the calculation of the nonarm’s-length income (NALI) penalty. That has been reduced to a two-times multiple now and it certainly is a big improvement. The piece that remains a concern for us is the way the rules are applied to specific investments so we still face the prospect there of all the income that the fund derives from a particular asset being taxed as NALI and we think it needs to be addressed. We’re trying to get Treasury back to the table to have those conversations because the job is not done.

JSa: How the NALE rules will be applied retrospectively is also a worry because there hasn’t been enough clarity on this issue. There has been an incorrect assumption any expenditure incurred or not incurred prior to 1 July 2018 will be disregarded, but the ATO said it was not allocating enforcement resources to NALE regarding general expenses, not those relating to specific assets. As a result, a lot of people have kicked that can, NALE relating to specific investments, down the road. So it’s a real concern how retrospective the enforcement of NALE might be and I think the draft bill is quite vague from that perspective. The law might say one thing, but the interpretation of the law might be totally different.

JSp: So does the situation place more onus on auditors to detect situations that might trigger the NALE and NALI rules?

BA: It certainly feels that way. Sometimes it’s very challenging for auditors to be able to spot whether there should be an expense, but there isn’t one. It’s just not something we’ve turned our attention to in the past. So it takes a little bit of retraining the brain to be looking for those types of things. And then obviously, as auditors, we run the risk of being sued if we don’t spot situations where an expense should have been incurred but wasn’t, when it triggers the NALE rules with an associated penalty. It also means the annual audit will require some extra work to mitigate our risk and that will drive fees up. Accordingly we are currently reminding our clients for the 2022/23 audit season appropriate expenses need to be charged to the fund so when the audit for the 2023/24 year comes around there should be no NALE issues involving general expenses, so even if there will be a two-times multiple applied to the shortfall, it won’t matter. But of course there will still be some problem ones.

JSp: So what impact will it have on the cost of the annual fund audit?

BA: That’s a hard one to answer because it really does depend on the nature of the fund and what sort of scenario we’re talking about. Things we’ll need to consider is whether the underpayment of an expense is easy to spot as well as the ease by which we can determine what is an arm’slength amount for that expense. So it will be a little like knowing how long a piece of string is, but there is clearly going to be more audit time needed to evaluate these situations.

DTC: How realistic is it to expect auditors to pick up NALE when a trustee performs work on an asset in their SMSF? Does it mean you have to know about every single thing your client does with regard to their super fund?

BA: It’s not something we’ve remotely been interested in in the past and I’ve never asked whether the trustee has made improvements to their property they might have done themselves. Even when I see a Bunnings receipt come through the file as a repairs and maintenance expense, I don’t sit there and ask whether the trustee performed the associated work themselves and what their day job is in that context. However, now we probably do need to start thinking about whether that’s an issue. It could just be a point to be raised in the management letter telling clients it is something they may need to evaluate and consider. I certainly updated my representation letters for the 2023 audit specifying if the fund members or trustees are providing services to the fund, they need to have an arm’s-length expense arrangement in place for them. So I’ve got a little of the issue covered, but as auditors we know our representation letter isn’t the solution to a lot of our problems, but if the matter is mentioned, hopefully trustees will read it and get a sense this is an area that is changing. I think an even bigger risk for my clients is the number of SMSFs neglecting to pay the annual ASIC (Australian Securities and Investments Commission) fee. There is a more obvious nexus between the ASIC fee and the entire income of the fund compared to the situation where an accountant is performing the bookkeeping services for their SMSF. There’s only a small portion of SMSFs where the trustees are qualified accountants doing the bookkeeping for the fund for free in their trustee capacity compared to the number of funds with a corporate trustee structure that doesn’t pay the ASIC fee.

DTC: When looking at the NALE rules dealing with general expenses and taking the concept of materiality into account, can the draft proposal actually be seen as a good result?

PB: In terms of the general expenses, where we’ve landed at two times a shortfall, I would imagine in most cases the amount is going to be immaterial. So again, it will land in the auditor’s lap to determine what action if anything is going to happen. The real concern we have is around the specific investment issue and the situation in example nine of Law Companion Ruling 2021/2 regarding Trang the plumber, where some modifications were made to an SMSF property by the trustee without charging an arm’s-length expense to the fund. The result is for all the income from that property to be forever tainted as NALI, including the capital gain when the property is sold and there is currently nothing the trustees can do about it. We don’t think that’s right and we think it’s very harsh. We’re asking for amendments to be made to at least give the trustees the ability to make good that situation. So there are some loose ends with these NALI and NALE rules that still need to be tightened up. But with regard to the two-times multiple on the expense shortfall, it’s where we’ve landed, we’re going to accept it, but it’s not what we asked for. We still don’t understand why we had to have the 2019 amendments to NALE in the first place. Clearly the mischief these amendments were trying to address were addressed by previous ATO rulings and the like. So it remains a mystery to us and no one at Treasury or the ATO has been able to explain to us why we actually need the 2019 amendments. Our preferred position is for a complete repeal of these provisions, not just for APRA (Australian Prudential Regulation Authority) funds, but also for SMSFs.

BA: I think the two-times multiple is really easy to resolve. All you’ve got to do is accrue the expense at the market value at 30 June. You might need to update the accounts, but it’s a nice, easy solution. I think it is dreadfully unfair, as you mentioned Peter, if you’ve got a fund that has a specific nexus issue regarding NALE, that it taints the asset for good. I had a client just recently that had a non-arm’s-length LRBA for a whole two months and the ATO has said that taints the asset forever. So the fund has just acquired the asset, for two months the trustees didn’t meet the LRBA safe-harbour provisions, and the ATO has ruled the asset is tainted for the entire time it is held by the fund, including when they sell the property. That means because they didn’t pay interest and capital repayments to the related-party lender for two months, the NALI penalty tax will apply, including to the capital gain and all the income the fund receives from the property on the way through. I just think it’s not workable and it’s not reasonable.

PB: The most disappointing aspect of all this is we’re going to have a different set of tax rules for SMSFs versus APRA funds. We’ve never seen this before, but I think that seems to be the track we’re going down. We don’t think that’s the right approach to have SMSFs subject to different types of tax rules than what other funds are. In some cases SMSF members end up paying higher rates of tax. We don’t think that’s sending the right message to the community to those who want to be more engaged with their savings and who are more aspirational.

BA: Absolutely. It’s not fair and it’s not logical either. When you’ve got a situation where a client like mine did mess up for a two-month period, they should be able to make good and they should be able to get that asset off the NALI train to have it just taxed as ordinary income because there was no mischief involved. It’s not like they were trying to avoid caps or avoid anything else. They just simply messed up for two months because they didn’t get their paperwork done in time. Yet they’ve got this lifetime tax consequence with this asset that just seems unreasonably absurd.

JSa: It’s in a similar sort of vein to Superannuation Industry Supervision (SIS) Regulation 13.22D provisions where if you fail them and your investment in a unit trust is no longer valid.

BA: At least in those situations you can go to the ATO and say I’ve had a slight hiccup in my SIS Regulation 13.22 structure so will you allow me to still be exempt from the in-house asset rules and the regulator in a lot of instances is agreeable to that. But this NALI situation is a tax position, it’s not a SIS compliance issue. So it seems grossly unfair clients like I’ve got, who make a mistake for a short period of time, have an asset that otherwise has no mischief attached to it whatsoever is forever tainted. If it was tainted for just the two months, I wouldn’t have a problem with it and I even suggested to allow my client to pay NALI for the rent for the two months.

JSa: It comes back to the interpretation side of things as well. You might have been talking to one ATO representative that would allow you to make good for the two months, while a different officer may not sanction this course of action. So this type of consistency is a real challenge.

CD: If you ask me, this whole saga has its genesis with the old LRBAs where people were putting in place basically what was a contribution and dressing it up as a loan with 50-year repayment terms and zero interest rates through that whole period. Basically people took undue advantage of the situation and as a result the ATO has reacted and this is what we’ve ended up with. So unfortunately, Belinda, your poor client is being treated in the same manner as those same people who put in place 50-year loan arrangements with zero interest rates. One of the learnings we get out of this is don’t push the rules too far because then we get people coming down with law and regulations and we end up in this mess.

BA: It’s particularly unfair now because those people who implemented related-party loans with 50-year repayment terms and a zero interest rate are now sorted because they fall under Practical Compliance Guideline 2016/5 and the income on the particular asset is being taxed at ordinary rates. But then you’ve got clients who inadvertently mess up for a couple of months and their asset is tainted with penalty tax rates applying forever. It’s obvious the wrong people are being penalised here.

JSp: So should the sector let the NALE general expenses issue go now and concentrate on some of the other elements of these penalty provisions?

PB: That’s a fair comment. Our focus is now very much on that specific expense issue. I think we’ve pushed it as far as we can on the general expense issue and we’ve got as good as what we’re going to get. So we’re laying down our weapons on that, if you like, and then focusing our attention on the specific expense issue.

BA: I think that makes sense. Like we mentioned, the situation of the nexus for general expenses is easily resolved – just accrue the expense amount it should have been, which means the fund will have the commercial costs that should be reported and there’s no consequence from a tax perspective. It’s the NALE nexus regarding particular assets that changes the tax treatment of the asset forever. That is really problematic.

JSa: Like you said, Peter, NALE with regard to general expenses is now pretty much immaterial. So I feel like we’ve landed where we started to a certain extent. There is still going to be the compliance issue to determine the commercial value of a service and that’s going to be inconvenient, mainly for auditors. I feel like we’ve gone through this whole rollercoaster ride to be back to a situation where NALE on general expenses doesn’t matter, like it’s nothing. I just find it frustrating after all of us around the table have spent hours and hours lobbying Canberra, lodging submissions and reviewing legislation, to get to the two-times multiple that might not even matter in the end.

Health of the sector

While the overall number of SMSFs and members within them continues to increase, that growth is not being matched by upward movements in the number of SMSF practitioners, placing pressure on those currently working to do more to grow and promote the sector.

JSp: How strong is the sector currently? Is it a concern growth looks like it is beginning to slow a little?

PB: As far as we’re concerned the growth is still quite strong. We would be more concerned if it was spiralling out of control, so we’d much prefer to see the growth as it is currently. We continue to see a lot of younger members setting up SMSFs. The ATO stats show over 40 per cent of SMSFs are being established nowadays by people under the age of 45 and I think that shows the real health of the sector that we’ve got younger individuals now turning to selfmanaged super funds. The sector is not without its challenges, though. We are seeing a significant increase in the number of trustees who are being disqualified. Looking at some of the figures, there were some 764 trustees disqualified in the last financial year compared to only 251 in the previous financial year, so that is a significant increase. The major cause of the jump was illegal early access and the nonlodgement of returns. So obviously the sector still has work to do in educating those members who do decide to set up a self-managed super fund to ensure they do understand their obligations. And I think it’s incumbent on all of us to do what we can to make sure SMSF members are aware of the preservation rules and the like. One of the things we do at the SMSF Association is to make sure our members have the materials they need to educate their trustee members on the rules and so forth.

JSa: I agree 100 per cent with what Peter said, that the education piece is huge. You’ve got the general super rules and then the SMSF overlay on top of them means the sector is becoming more and more specialised. In addition to the number of people wanting to engage with their retirement savings and set up a self-managed super fund, there is an equal number who are establishing an SMSF under the wrong pretence. That in itself is a challenge because they think “oh great I can invest in crypto or other exotic investments” and they go off and do that, but then it costs a small fortune to make sure the fund is complying. So part of the education piece is to bridge the gap in making people understand what it means to be a trustee and the responsibilities associated with it. There is a real danger people are not aware of the scams they’re susceptible to or of the costs involved in running their own fund or of the obligations present, such as having the annual accounts prepared. Also the potential loss of insurance if you switch to an SMSF is an issue. So I feel like there might be a gap there in terms of the education covering that side of things. Further, there is a challenge in the financial advisory space and even the accounting sector with fewer people entering the industry. It makes trying to keep up with the demand for SMSF advice difficult as well. Trying to get kids through the door and then having them do their professional year in the accounting, financial advisory and legal fraternities in general is not easy and then to encourage them to specialise in self-managed super funds is even harder.

CD: We’ve talked about younger people coming into the sector, but I think there’s another serious issue going on in the industry at the moment in relation to SMSFs and that’s just simply the proportion of members over age 75 is growing rapidly. If you look at the period from March 2019 to March 2023, there was a 6.4 per cent increase in the members who are over 75. And so you then have to start thinking about the relevant issues there, such as where advice is going to come from for these people who start to have capacity issues. There are going to be questions about winding up and rolling over back to a large fund potentially, or all of the advice around death benefits and we’ve seen all of the legal cases in this area. There seems to be another one every six months or so where people are fighting over payouts on the death of a member. This is a really growing issue and there is a real advice need to enable people to address it. I’m just wondering where this required special advice and support is likely to come from.

DTC: There has also been a drop in SMSF auditor numbers. How much of a worry is this development and will we end up seeing capacity constraints hamper the annual audit?

BA: It sounds like it should be a problem and a concern, but from my understanding the auditors who have handed in their ASIC ticket allowing them to conduct SMSF audits did not do very many of them. In reality the auditors exiting the sector service around 5 or 10 per cent of the SMSF market so I don’t think in practice it’s overly concerning. I think the bigger challenge is not dissimilar to what Jemma mentioned and that is getting the new entrants into the sector. We’re all going to want to retire at some point so we’re going to need those new entrants. But we must figure out how to entice them into an area that many see as being overly challenging and not overly rewarding. You know the SMSF auditor does cop a lot of flack and does have some challenges on a day-to-day basis. We need to find a solution to overcoming those realities and so when new entrants emerge they’re enthusiastic to take over the job. Even the independence issues for new entrants as to how they attract their initial clients with regard to the fee referral percentages is problematic. These practical issues are more concerning than the number of practitioners who have removed themselves or have been removed by ASIC from this space.