A radical SMSF approach – part one

GRANT ABBOTT is a director of I Love SMSF.

The scrutiny and accountability applied to SMSF trustees may make the requirement for all members to fulfil this role impracticable. In part one of this two-part series, Grant Abbott examines the case for a single-trustee structure for SMSFs.

It is commonly accepted every member of an SMSF also must be a trustee of the fund, but given the ever-increasing scrutiny and accountability being levelled at trustees, this structure may no longer be practicable. practicable.

In this article, over two parts, my goal is to In this article, over two parts, my goal is to completely change your thinking on the way an completely change your thinking on the way an SMSF should be run and managed. I know people SMSF should be run and managed. I know people generally hate change, but if there is a better way, generally hate change, but if there is a better way, one that advantages your client, simplifies SMSF one that advantages your client, simplifies SMSF administration and improves compliance, wouldn’t administration and improves compliance, wouldn’t you want to know about it? you want to know about it? And as SMSF advisers we need And as SMSF advisers we need to be able to change and to be able to change and change quickly. COVID-19 change quickly. COVID-19 has certainly taught has certainly taught me that me that change change can can quickly wash over us, so it is better to be adaptable when change hits.

Now I want to ask you one simple question. If being a trustee of an SMSF was optional for fund members, what percentage of your SMSF fund members, what percentage of your SMSF clients, understanding the high expectations and clients, understanding the high expectations and responsibilities of acting as an SMSF trustee, would responsibilities of acting as an SMSF trustee, would stick to membership only and abandon trusteeship? stick to membership only and abandon trusteeship?

The dangers of SMSF trusteeship

There are more than 3000 pages of laws, regulations and commissioner’s guidelines when it comes and commissioner’s guidelines when it comes to SMSFs, so there are very real dangers for any to SMSFs, so there are very real dangers for any member to act as an SMSF trustee in 2020. We are member to act as an SMSF trustee in 2020. We are no longer in the early cowboy days of SMSFs of no longer in the early cowboy days of SMSFs of the 1990s or the Simpler Super days of the 2000s. the 1990s or the Simpler Super days of the 2000s. It is 2020 and things have changed. I talk with It is 2020 and things have changed. I talk with accountants and planners all day long about SMSFs accountants and planners all day long about SMSFs and one thing they all tell me is over the past five and one thing they all tell me is over the past five years things have gotten tougher and tougher for years things have gotten tougher and tougher for advisers, licensees and trustees in the SMSF space. advisers, licensees and trustees in the SMSF space.

Take for example the current investment strategy Take for example the current investment strategy requirements for SMSF trustees contained in section requirements for SMSF trustees contained in section 52B(2)(f) of the Superannuation Industry (Supervision) 52B(2)(f) of the Superannuation Industry (Supervision) (SIS) Act 1993. Since 1994, creating one-page (SIS) Act 1993. Since 1994, creating one-page investment strategies with 1 to 100 per cent asset investment strategies with 1 to 100 per cent asset allocations has been the norm. Having worked in the allocations has been the norm. Having worked in the funds management industry and been part of writing funds management industry and been part of writing prospectuses for balanced retail super funds, having prospectuses for balanced retail super funds, having real benchmarks for each asset class was my norm, real benchmarks for each asset class was my norm, but it is hard to change an industry and my detailed but it is hard to change an industry and my detailed SMSF investment strategy musings oft en fell on deaf SMSF investment strategy musings oft en fell on deaf ears. But I always remind myself of a quote from ears. But I always remind myself of a quote from Frank Abagnale: “The law sometimes sleeps; it Frank Abagnale: “The law sometimes sleeps; it never dies.” never dies.”

So it was no surprise to me when the So it was no surprise to me when the commissioner of taxation began writing directly to trustees and their fund auditors in September 2019 telling them if their SMSF’s investment strategy was not adequately diversified, each trustee of the fund may be liable for a $4900 fine. Now that letter shook things up because it bypassed advisers and went straight to fund trustees.

And what a furore it caused, but it did not stop there. In February 2020, the commissioner released on the ATO website a brand new set of investment strategy guidelines stating, in part, the following:

i. An investment strategy must be in writing and cover each member’s age, employment status, super benefit details and their specific retirement objectives, as well as any fund insurances on their behalf.

ii. Ensure the investment strategy is a forward-looking document which is to be prepared at the beginning of an income year, not post year end.

iii. That benchmark asset allocation, for example, domestic equities 20 to 40 per cent, is to be used across all asset classes and must include the time frame for holding that asset class plus the asset class characteristics.

iv. The commissioner notes a 0 to 100 per cent asset allocation is not an investment strategy leaving the SMSF’s adviser and auditor exposed to legal action from members for any investment losses on fund investments.

v. The requirement for a new investment strategy where a pension is commenced, the market for the asset class falls or a new member comes into the fund.

This suddenly rendered a lot of 2019 investment strategies in breach of the rules and we can expect to see some heavy audit contravention reports for the 2020 income year as SMSF auditors realise their exposure.

Importantly, it shows the taxation commissioner has turned from the education of trustees to compliance. There is no hiding behind advisers and accountants anymore. And despite our protestations, it was bound to happen with the SMSF industry hitting $750 billion in assets, complaints from industry super funds, the royal commission and the Australian Securities and Investments Commission (ASIC) toeing a heavy compliance line and virtually warning prospective SMSF members away from these funds. Things are getting tougher for trustees.

The commissioner’s expectations of SMSF trustees – would you want to be one?

First off, acting as trustee of an SMSF or a director of a corporate trustee is no walk in the park and the commissioner of taxation is forthright about that. To this end he has stated the following on the ATO website:

What it means to be an SMSF trustee or director

Whether you’re a trustee or director of a corporate trustee, you’re responsible for running the fund and making decisions that affect the retirement interests of each fund member, including yourself. As a trustee or director, you must:

• act honestly in all matters concerning the fund,

• act in the best interests of all fund members when you make decisions,

• manage the fund separately from your own superannuation affairs,

• know, understand and meet your responsibilities and obligations, and

• ensure that the SMSF complies with the laws that apply to it.

All trustees and directors are equally responsible for managing the fund and making decisions – you’re responsible for decisions made by other trustees even if you’re not actively involved in making the decision.

You can appoint other people to help you or provide services to your fund (for example, an accountant, administrator, tax agent or financial planner). However, the ultimate responsibility and accountability for the SMSF’s actions lie with you, as trustee or director.

COVID-19 has certainly taught me that change can quickly wash over us, so it is better to be adaptable when change hits.

As an individual trustee or director of a corporate trustee, you may be personally liable to pay an administrative penalty if certain laws relating to SMSFs are not followed.

Other members of the fund can take action against you if you don’t follow the terms of the trust deed. Any fund member who suffers loss or damage because of a breach of any trustee duties may sue any person involved in the breach.

Let’s unpack some of the commissioner’s points.

Firstly, being a compliant trustee are pretty big shoes to fill. Consider these three points:

1. the trustee of an SMSF must know, understand and meet their responsibilities and obligations, and

2. the trustee must ensure the SMSF complies with all the applicable laws, and

3. as an individual trustee you are personally liable for any administrative penalty.

Now the above three statements are daunting even for the most qualified SMSF specialist adviser or lawyer, let alone an untrained SMSF trustee. Hence the commissioner’s recommendation that the trustee may need to seek help to run the fund.

The new hard-line administrative penalty regime – section 166 of the SIS Act

At our Accountants Strategy Summit in July 2020, I had the opportunity of sitting down with ATO SMSF segment acting assistant commissioner Steve Keating to discuss all things SMSF.

One of the more important questions I asked Keating was about how the ATO penalty regime works and how often had it been applied.

In reply, he noted that in the past the ATO had remitted far too many administrative penalties and that was about to change. During the interview he also forecast a guideline on the regulator’s approach to SMSF administrative penalties. So it was no surprise when the ATO released a practice statement (PS) for auditors, advisers, trustees and ATO staff on 15 October 2020, PS Law Administration 2020/3 – Self-managed superannuation funds – administrative penalties imposed under subsection 166(1) of the Superannuation Industry (Supervision) Act 1993.

Here is an example of a breach of the SIS Act and how the penalty regime applies:

Example – personal liability, individual trustees

Larry and Adam are members and trustees of the Redrock SMSF. In the 2020 financial year, an auditor contravention report found the trustees of the SMSF had contravened subsection 84(1) by providing a loan to a related party, who is not a member, in excess of the in-house asset limits.

Each trustee of the Redrock SMSF is individually liable for the full administrative penalty. The administrative penalty for this contravention is 60 penalty units. Larry and Adam are each issued a separate penalty notice for 60 penalty units.

• 60 penalty units for the 2021 income year is equal to $13,320.

There are nine examples in the PS, with the final one three pages long and important reading for any adviser with SMSF clients and definitely auditors.

Some of my key takeaways from the PS are:

a. For any administrative penalty, individual trustees are personally liable.

b. For any administrative penalty where there is a corporate trustee, directors of a corporate trustee are jointly and severally liable.

c. Monies from the SMSF cannot be used to pay the penalty as they are personal fines.

d. The penalties are prima facie payable, but the commissioner may remit these penalties taking into account:

i. the decision to remit must be fair and reasonable,

ii. the reasonable person trustee test is to be applied, not whether the trustee was doing the right thing,

iii. a transaction may involve multiple breaches – such as breaches of section 62, section 66, section 84 and section 52B(2)(f) in relation to a transfer of an asset from a related party to the trustee of an SMSF.

The taxation commissioner has turned from the education of trustees to compliance. There is no hiding behind advisers and accountants anymore.

Given the ATO will be more forceful in administering the penalty provisions on trustees and directors of corporate trustees, plus the extensive responsibilities and legal knowledge required by a trustee of an SMSF, it ought to be considered whether every member of the fund should be a trustee.

Should all members be trustees?

You may not have known it, but I was there at the very, very start of the SIS Act \ and in fact made submissions on the SIS Bill in 1992. One of the key features of the SIS Act was section 18A, which provided for a small excluded super fund, the forerunner to today’s SMSF. In essence, it was a four-member small super fund that was excluded from the prospectus provisions for a public offer super fund. It also had various enabling provisions not available to public offer super funds, such as acquiring business real property from a member or related party provided it did not exceed 40 per cent of the fund’s assets.

To be an excluded super fund, the following conditions had to be met:

1. The fund was a regulated super fund pursuant to section 19 of the SIS Act. This meant it had to have a trustee and if individual trustees, it could only pay pensions and not lump sums.

2. The superannuation fund had less than five members.

3. Each member was a trustee of the fund or director of the corporate trustee unless the member was a relative of the trustee or an associate of the trustee as that term was defined under the Corporations Act.

In practice, this meant an excluded superannuation fund that had four members – John Smith (father), Sally Smith (mother) and two adult children, Max and Mary – could have John Smith as the sole trustee or director of the fund’s corporate trustee because he was a relative of the members.

Having one person acting as trustee, one person dealing with advisers, one person interacting with the auditor and the commissioner of taxation certainly simplifies the operation of the fund.

In the next part of this article, I will look at the five reasons to have a single trustee or director of the corporate trustee of the fund as well as the commissioner’s guidelines on how an SMSF can be run by an external party to fund members and still not be in breach of the SMSF rules. This is way beyond the original excluded super fund requirements above.