self managed super: Issue 33

QUARTER I 2021 | ISSUE 033 | THE PREMIER SELF-MANAGED SUPER MAGAZINE

INDEPENDENCE DAY AUDITORS DISRUPTED

FEATURE

STRATEGY

ANALYSIS

COMPLIANCE

APES 110 Amended standard’s impact

Excess contributions When to retain them

New cost data Sector viability reinforced

LRBA COVID relief Action now needed

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COLUMNS Investing | 20 Long/short strategies and SMSFs.

Investing | 24 Opportunities in emerging markets.

Strategy | 28 The case for retaining excess contributions.

Compliance | 31 Revisiting off-market transfers.

Strategy | 34 The salary sacrifice/transition-to-retirement combination.

Analysis | 38 Cost-effectiveness of SMSFs.

Strategy | 41 Single trustee SMSFs part two.

Audit | 44 A possible independence solution.

Strategy | 48 The new ECPI rules.

Compliance | 52 Managing LRBAs after the coronavirus relief.

Strategy | 55 The appeal of six-member funds.

Compliance | 58 Transferring super from overseas.

Strategy | 61 Super splitting after relationship breakdowns.

INDEPENDENCE DAY AUDITORS DISRUPTED Cover story | 12

FEATURE Refilling the COVID crater | 16 Steps to repair the early release hit.

REGULARS What’s on | 3 News | 4 News in brief | 5 SMSFA | 6 CPA | 7 SISFA | 8 IPA | 9 CAANZ | 10 Regulation round-up | 11 Last word | 64

QUARTER I 2021 1

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

Can someone please stop this ride Does anyone else get the feeling the financial planning industry is on a never-ending merrygo-round ride with the government? And does anyone else wonder when this seemingly endless circular process will end?

If you’re wondering what I’m talking about, let me refer you to two recent developments that highlight this continuing set of circumstances.

First is the Retirement Income Review report.

What exactly did this really achieve? I know we were told it was basically just a fact-finding exercise regarding the operation of the current retirement incomes system, but at the end of the day what did the process uncover that we didn’t already know?

This is best illustrated by the report’s conclusion that “the system would benefit from a clear objective in order to guide future policy and provide a framework for assessing its performance”. Does this statement alone not make a farce of the review?

A call to have the objective of our superannuation system properly and officially defined was already included in the Financial System Inquiry and that was concluded in December 2014. Six years on and another review comes up with exactly the same finding.

Further, doesn’t his statement alone prove the whole process and its other findings are completely laughable? On the whole it was determined the system is in the main working well. How do you know a system is working well when you don’t even know what it is supposed to be achieving? It’s like parking a brand new car in your backyard and saying it works really well as a cubby house for your

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children. Granted it might satisfy that purpose, but that’s not what a motor vehicle is designed to do.

The second situation is worse still and is evidence this Groundhog Day situation has been going on for over a decade.

Submissions have recently been made to the Australian Securities and Investments Commission’s (ASIC) Consultation Paper 332, which is examining access to affordable advice.

And you probably don’t even have to read on to know what I’m about to reference next.

Perhaps the Association of Financial Advisers summed it up best in its paper when calling for a reduction in the compliance obligations placed upon financial planners and a greater focus on the value and purpose of advice.

You’d be forgiven if you thought you’d heard this argument before because you’d be correct.

This is a call that has been made over and over again for at least the past decade, but continues to fall on deaf ears. In fact I believe I could pull budget submissions and those made to other inquiries over this period and I swear you’d think you were reading the same document over and over again.

Unfortunately we hear the same excuses as to why nothing positive is ever done about these situations. They often revolve around the government having more pressing priorities.

But something needs to change here and I welcome the day it does. Unfortunately I’m not expecting this to happen anytime soon or anytime at all for that matter. So I suppose we all need to get used to the horse we chose and enjoy the carnival music of the ride for a little while longer.

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

SMSF Association National Conference 2021 16 February 2021 Virtual platform 8.30am-4.40pm AEDT 18 February 2021 Virtual platform 8.45am-4.50pm AEDT

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

Investment strategies destroy the red tape reduction strategy 23 February 2021 Webinar 12.30pm-1.30pm AEDT

Creating a contribution strategy playbook VIC 16 March 2021 Grand Hyatt 123 Collins Street, Melbourne SA 18 March 2021 Mayfair Hotel 145 King William Street, Adelaide

What asset segregation means to an SMSF 23 March 2021 Webinar 12.30pm-1.30pm AEDT

Cash, coins, crypto and collectables 20 April 2021 Webinar 12.30pm-1.30pm AEST

Cooper Grace Ward Inquiries: events@cgw.com.au

2021 Annual Adviser Conference QLD 25-26 March 2021 Sofitel Brisbane 249 Turbot Street, Brisbane

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

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

Changing Face of SMSF 17 March 2021 Webinar 12.00pm-1.00pm AEDT

SMSF Virtual Day 2021 30 March 2021 11.00am-4.00pm AEDT 31 March 2021 10.30am-3.30pm AEDT

Face to Face SMSF Specialist Course 1-3 June 2021 9.00am-5.00pm AEST SuperConcepts Level 17, Chifley Tower 2 Chifley Square, Sydney

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

Super Unpacked

Working on your practice – pricing your services

30 April 2021 Webinar 12.00pm-1.00pm AEST

4 March 2021 GoTo webinar 2.00pm-3.00pm AEDT

DBA Lawyers

Tech talk live Q&A

Inquiries: dba@dbanetwork.com.au

11 March 2021 GoTo webinar 2.00pm-3.00pm AEDT

SMSF Online Updates 5 March 2021 Webinar 12.00pm-1.30pm AEDT 16 April 2021 Webinar 12.00pm-1.30pm AEST 7 May 2021 Webinar 12.00pm-1.30pm AEST

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

SMSF Regulatory Update and Fundamentals Recording 31 March 2021 Cahoot learning webinar

Victoria Congress 2021 VIC 29 –30 March 2021 RACV Torquay Resort 1 Great Ocean Road, Torquay

SuperConcepts Virtual SMSF Specialist Course 16-18 March 2021 10.00am-2.00pm AEDT

The implications of TBC indexation 25 March 2021 GoTo webinar 2.00pm-3.00pm AEDT

Heffron Quarterly Technical Webinar 25 February 2021 Webinar Accountants-focused session 11.00am-12.30pm AEDT Adviser-focused session 1.30pm-3.00pm AEDT

SMSF Clinic 9 March 2021 Webinar 1.30pm-2.30pm AEDT 13 April 2021 Webinar 1.30pm-2.30pm AEST

SMSFPD Digital 2021 Inquiries: Jenny Azores-David (02) 8973 3315 or email events@bmarkmedia.com.au

25-26 May 2021 12.00pm-5.00pm AEST

QUARTER I 2021 3

NEWS

Hume rules out extra top-up measures

By Jason Spits

The federal government has ruled out introducing new measures to rebuild superannuation balances that have been reduced due to COVID-19-related early release provisions, claiming the current concessions are sufficient to do the task.

Following a recent address to the industry, Superannuation, Financial Services and the Digital Economy Minister Jane Hume said in response to a question from selfmanagedsuper there was no plan to change the way fund members could contribute to their superannuation even if they had made use of the early release provisions.

This was despite a move by Pauline Hanson’s One Nation party to include an amendment

to the Treasury Laws Amendment (More Flexible Superannuation) Bill 2020 that would allow superannuation fund members to recontribute these amounts, in part or full, in any year until 2030.

According to Hume, the early release provisions were not a new measure and already existed for those facing financial hardship, but during 2020 the government had temporarily changed what that meant and adapted the release mechanism to ensure withdrawal applications were legitimate.

“One change we made that may have flown under the radar was that we made the withdrawal tax free, which normally, in the case of financial hardship withdrawals, aren’t tax free, so there was a tax benefit on the way out,” she said.

“One of the things One Nation is talking about is a tax-

Jane Hume free or tax concession on the way back in and that is already in place because the concessional cap is $25,000 per year, so if you are putting in your 9.5 per cent [superannuation guarantee contribution] and it’s less than $25,000 a year, there is already a tax concession up to that cap.

“We also have a catch-up contribution and if you have not put in the full $25,000 in previous years, you can roll those years’ concessional caps over, so there are already opportunities to put more money back into

superannuation to make up the difference, taxed concessionally, and you can do it at a time that suits you.”

According to statistics released by the Australian Prudential Regulation Authority in January, $36.4 billion of payments have been made under the early release measures announced in mid-2020.

These payments came from 3.5 million applications in the first period of release from March to June last year, and 1.4 million applications in the second period of release from July to September, with an average payment of $7638 being received by superannuation fund members.

Within those numbers, ATO figures for the SMSF sector as at 1 November 2020 show that $377 million has been released as a result of 39,000 applications from 20,000 SMSFs.

Technology to assist wind-ups

By Darin Tyson-Chan

A strategic specialist has predicted technology currently available in the market could end up having a significant impact on SMSF administration processes, particularly when funds are being wound up.

Speaking during a recent BT SMSF Roundtable event facilitated by selfmanagedsuper, BT Financial Group SMSF strategy national manager Neil Sparks identified blockchain technology as an innovation that will add value to the process of fund wind-ups, especially in situations where assets are transferred to another retirement savings structure instead of being cashed out to facilitate this type of transaction.

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“Distributed ledger technology I think could have benefits for self-managed super funds, particularly when it comes to moving assets,” Sparks said.

“It [will allow us to move] away from [traditional forms] of paperwork, such as using an Australian standard transfer form [to acknowledge an asset was] sold by the SMSF and bought by BT, for example, because the transaction on the blockchain would simply recognise that [the asset] has gone from [person A’s] SMSF to BT, [with BT recognised] as the legal owner with [person A] as the beneficial owner. I think that kind of blockchain technology could have significant future benefits for financial services administration most definitely.”

He said the adoption of this technology is already underway and will likely gain

in momentum. “A lot of managed funds are moving to blockchain technology for settlements. The ASX (Australian Securities Exchange) [similarly] had a program of work to replace CHESS (Clearing House Electronic Subregister System) with a blockchain system,” he said.

Similarly, he identified SuperStream rollovers as another technology-driven process that will make a substantial change to SMSF wind-ups where a trustee sells the assets of the fund and transfers the cash generated by those transactions to another retirement savings vehicle in the form of a lump sum. “SuperStream rollovers for SMSFs will make a big difference. [It means trustees will not have to hold] an amount via a cheque and then send the cheque to the next super fund, which sometimes sits in an accountant’s trust account,” he said.

NEWS IN BRIEF

TBC indexation set for July The ATO has announced indexation of the general transfer balance cap (TBC) will occur on 1 July due to the latest consumer price index (CPI) exceeding the 116.9 figure required to trigger such a move.

In an update on its website, the regulator confirmed the CPI figure for the December 2020 quarter had reached 117.2, triggering indexation so that, from July, no single TBC would apply to all individuals.

“Individuals will have a personal TBC somewhere between $1.6 and $1.7 million. If an individual already has a TBC, the only place they can view their personal TBC is in ATO online services through myGov,” it said.

“We will calculate each individual’s personal TBC based on the information reported to and processed by us. If you report pre-1 July 2021 events after 1 July 2021, we will go back and recalculate the member’s personal TBC and apply that new cap to their affairs.”

NALE guidance considered The impending legislation regarding non-arm’s-length expenses (NALE) could contain guidance providing methods that will allow SMSF trustees to avoid breaching the final provisions. “[An] area being considered here is how guidance can be provided on how the trustees can avoid breaches of the trustee remuneration provisions within section 17A [of the Superannuation Industry (Supervision) Act],” Smarter SMSF chief executive Aaron Dunn revealed.

“So this is important because we’ve

got both [sections] 17A and 17B, and [section] 17B naturally looks at the fact that a trustee can charge [the fund] for particular services, but they do need to be suitably qualified, they need to be operating a business in that respect, they would be [holding] insurances, et cetera,” he added.

“Therefore, if we are relying on that section 17B, then we would be expecting to see some sort of commercial fee [being recommended to be] charged [in situations where NALE could be triggered].”

and the National Consumer Credit Protection Act.

New adviser body looming A new industry association, currently in its development stages, is set to be launched in March with the purpose of serving SMSF practitioners involved in the delivery of three specific financial advice areas.

AFCA rules amended The Australian Financial Complaints Authority (AFCA) has changed the rules under which it operates with regard to receiving consumer complaints about the conduct of authorised representatives of its member organisations.

An Australian Securities and Investments Commission (ASIC) legislative instrument issued on 5 January necessitated the amendment and arose after a New South Wales Supreme Court decision handed down in November last year.

In the case of DH Flinders Pty Limited v Australian Financial Complaints Authority, the court determined AFCA has no jurisdiction to handle a complaint against the authorised representative of an Australian financial services licence (AFSL) holder where they have allegedly acted outside their authority.

According to AFCA, the judgment meant its rules needed to be clearer to guarantee they stipulate AFSL holders and their authorised representatives have the same obligations and liabilities as determined by the Corporations Act. As such, rule changes have been made binding licensees and their authorised representatives to the requirements of the Corporations Act

Grant Abbott The new body will be called the Succession, Asset Protection and Estate Planning Advisers Association (SAPEPAA) and is being established jointly by LightYear Docs founder Grant Abbott and LightYear Docs group director Michael Jeffriess.

The initiative has come about from Abbott’s and Jeffriess’ identification that advice regarding the aforementioned three areas has until now been delivered in a silo-like manner leading to their recognition for a more coordinated approach to be achieved by an overarching industry body.

“To date when we have a look at those three key areas, succession, asset protection, and estate planning, which has many, many niches underneath it, there’s never been anyone comprehensively doing any of that,” Abbott noted.

QUARTER I 2021 5

SMSFA

It’s just too complex

JOHN MARONEY is chief executive of the SMSF Association.

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“The system should not be unnecessarily complex for consumers. The retirement income system should be as simple as possible, although the range of issues covered are such that it will inevitably involve a degree of complexity. The aim, nevertheless, should be to keep the complexity to a minimum. Where complexity cannot be avoided, mechanisms are needed to help people understand and navigate the system, including giving them access to advice and guidance to do so.”

These are the words of the Retirement Income Review. It’s a clarion call to simplify the system for the excellent reason it is complex and hard to navigate.

Additionally, this complexity and uncertainty, combined with a lack of assistance, guidance or advice, and low financial literacy, makes it hard for people to make well-informed decisions about their retirement income. That is why the SMSF Association has used its 2021/22 pre-budget submission to focus on complexity and the critical need to improve the affordability of advice.

Since 1 July 2016, the complexities in the legislation and administering superannuation accounts, particularly for SMSFs, have significantly increased.

There are now numerous thresholds, caps, indexation methods and limits that require constant monitoring and reporting. The different total superannuation balance (TSB) thresholds, looming proportional indexation and lack of SMSF adviser access to ATO portals are all issues that compound the problem.

With proportional indexation due to start on 1 July 2021, time is of the essence. According to the December 2020 consumer price index figures, the current general transfer balance cap (TBC) will be indexed to $1.7 million, up from the current $1.6 million. Over time, a client’s personal cap may differ from the general TBC due to proportional indexation.

Under proportional indexation, the unused part of the client’s TBC will be used to determine their personal TBC. This is an overly complex situation that over time will result in most members in the retirement income phase having their own personal TBC which is different to the general TBC. The ATO will calculate an individual’s entitlement to indexation, and their personal TBC after indexation, based on the information reported to and processed by it when indexation occurs. If information that affects an individual’s highest-ever balance in their transfer balance account is reported to the ATO after indexation of the TBC has occurred, the regulator will

be required to recalculate the individual’s entitlement to indexation and will adjust their TBC accordingly.

This complexity is unnecessary. That is why we have proposed abolishing proportional indexation by ‘locking-in an individual’s TBC at the time they begin a retirement-phase income stream or, alternatively, reducing the number of possible TBC bands an individual may have to five.

On the issue of reducing the number of caps and thresholds, it is time to clean up the number of TSB thresholds. What we propose is simple: Going from this: • $300,000 TSB for work-test exemption contributions, • $500,000 TSB for catch-up contributions, • $1 million TSB threshold for quarterly TBC reporting, • $1.4 million, $1.5 million and $1.6 million bringforward non-concessional contribution caps, • these thresholds are likely to be indexed resulting in less intuitive figures, such as $1.48 million, • $1.6 million TSB threshold for non-concessional, spousal and co-contributions, and • $1.6 million TSB threshold for segregated pension assets, To this: • $500,000 TSB threshold for work-test exemption contributions and catch-up contributions, and • $1.6 million (indexed to $1.7 million) TSB threshold for non-concessional contributions, spousal contributions, co-contributions, bring-forward contributions and segregated pension assets.

On the issue of advice, in our view there are two key issues that need to be addressed: affordability and the inability of SMSF advisers to access a client’s super data. Currently, only registered tax agents can access the ATO portal to obtain TSB and TBC information for their clients in a timely and efficient manner. Ironically, these individuals are often unable to provide SMSF advice as they are not licensed to provide personal financial advice. Incongruously, those licensed advisers who can provide SMSF advice have no reasonable way of sourcing ATO portal information directly from the regulator as they are not, generally, the member’s personal tax agent. In essence, there is a fundamental lack of information for SMSF advisers who need to provide timely advice based on myriad complex caps, thresholds and balances. This jeopardises the quality and efficiency of advice that is being provided to members.

The level of complexity, makes a compelling case for change. Let’s hope for the sake of 1.1 million SMSF members and their advisers, the government acts on it.

CPA CPA

Underperformance an SMSF issue too

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

Consultation on the proposed underperformance test for Australian Prudential Regulation Authority (APRA)regulated superannuation products has now closed. If the reforms proceed according to schedule, the test will apply to MySuper products from 1 July 2021, followed by choice products 12 months later. The test won’t apply to SMSFs, but that doesn’t mean SMSF trustees shouldn’t pay attention.

The test is intended to ensure new members, or those switching investment options, don’t inadvertently select underperforming products. Under the proposal, products that fail the test once will be required to notify members. Two consecutive failures will result in the product being banned from accepting new members. When it comes to SMSF members, research shows performance and cost considerations do not feature as prominently as control or choice.

This suggests at least some SMSF members intentionally trade-off performance in order to have more say over how their assets are invested. As the Cooper review noted, there is link between increased choice and individual responsibility.

However, there is no evidence to quantify how much of a trade-off is acceptable for members of an SMSF. Arguably, performance and cost considerations are still highly relevant to SMSF members, which means there is considerable value in examining an SMSF’s performance.

So, how can SMSF trustees establish whether they are delivering good performance for their members?

And, if two years of underperformance is appropriate for an APRA-regulated fund, what period might be considered the tipping point for an underperforming SMSF by its members? Trustees have access to resources from APRA fund websites, APRA’s own statistics and heatmaps and rating agencies. For funds that are mostly invested in conventional asset classes, benchmarking performance is relatively straightforward. For these funds, trustees should ask: “If we compare our fund to an equivalent APRAregulated fund, how have we performed?”

However, a large number of SMSFs are set up for special purposes or to house assets that are somewhat difficult to assess against APRA-regulated funds. For funds holding assets such as artworks, wine or direct property, benchmarking performance

can be problematic.

Whether the fund holds specialised assets or more conventional ones, the trustee should understand and review the fund’s investment strategy annually.

Typically, funds have a targeted return adjusted for inflation, such as the consumer price index plus 2.5 per cent. This will usually be included in the investment strategy. Trustees should also know their fund’s asset allocation. Finally, they should know what their returns are, after fees and tax. Comparing this information in the market is necessary to establish performance. For example, if a fund is targeting a lower return than its asset allocation suggests is appropriate, the trustee needs to consider whether the targeted return is appropriate or if the fund is taking on investment risk unnecessarily.

Trustees need to also consider the fund’s targeted return against that of other funds in the market. Provision of a product’s targeted return is only required for APRA-regulated funds in respect of their MySuper product dashboards. If a fund’s asset allocation more closely resembles a choice investment option offered by APRA-regulated funds, finding comparable information may prove difficult.

Comparing asset allocations is generally easier although not without problems. Many APRAregulated funds hold international assets that can be difficult markets for SMSF trustees to access. In such circumstances, it may be easier for trustees to split their assets into different buckets and compare them to single-sector choice products. Comparisons between funds with an SMSF investment style can also be tricky. Descriptions of funds’ options in promotional literature are often riddled with jargon. It can sometimes be hard to tell a passively managed fund from an actively managed one. Again, when trying to compare like for like, the closer the comparison is, the more reasonable it will be.

Finally, armed with this information, trustees should be asking themselves what the appropriate period of underperformance might be. Even if a fund is performing well currently, it is a good idea for trustees to draw a hypothetical limit for future underperformance. Whether it’s an APRA-regulated fund or SMSF, the need for the trustee to ascertain whether retaining the fund is in members’ best interests is constant. Trustees who fail to do this are penalising themselves and wasting their time and money.

QUARTER I 2021 7

SISFA

Life should be easier

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

In our last column for 2020, the Selfmanaged Independent Superannaution Funds Association (SISFA) set out some changes we believe could reduce red tape for SMSFs and help stimulate economic activity.

We outlined a number of bigger picture issues in the superannuation system we believe should be reviewed.

As part of the annual budget-setting process, Treasury invites pre-budget submissions on a variety of areas and SISFA has made a submission for the 2021/22 budget. These are some of the areas of superannuation we feel warrant a review to help make the administration of super easier and fairer.

Fixes to the BDBN system SISFA believes the death benefit settings of the superannuation system should be revised. While this process could possibly take considerable time in consulting with the interested parties, in the meantime, SISFA believes some simple changes should be made to the binding death benefit nomination (BDBN) system and these include: • BDBNs should not lapse after three years – like a will, they should apply until they are revoked or replaced, and • ‘informal’ BDBNs should be allowed – just like a will, if a BDBN does not meet the strict requirements, it should nonetheless be binding if it shows a clear intention to deal with the benefits of a superannuation fund.

Amend the Australian super fund rules Under the current legislative settings, if an SMSF breaches section 17A of the Superannuation Industry (Supervision) (SIS) Act 1993 or otherwise fails to satisfy the definition of an Australian superannuation fund, the SMSF is automatically made non-compliant and is issued with a tax penalty equal to almost half the value of its assets. This approach is not consistent with other breaches of the SIS Act where the ATO has discretion in determining whether to make the SMSF non-compliant. SISFA believes the automatic non-compliance for breaching section 17A, and failing to be an Australian super fund, should be replaced with the tax office’s discretion that applies to other SIS Act breaches for consistency.

Streamline the personal deduction process The current administrative process required to claim a tax deduction for personal superannuation

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contributions is unnecessarily complex. In particular, the requirement to first notify the fund via an approved form of an intent to claim a deduction is administratively burdensome. SISFA believes this process should be streamlined to make it easier for superannuation fund members to claim a deduction for personal super contributions. For example, members could make an election as part of their individual tax return and the ATO notify the relevant superannuation fund on behalf of the member. This would avoid unnecessary paperwork and reduce the number of errors in claiming deductions for personal contributions.

Other super system areas needing examination There are a number of other superannuation system aspects that should be reviewed to aid in streamlining them and cutting red tape. They include: • tax settings – the taxation of superannuation is a complicated mess that has been amended in a piecemeal fashion over many years. Like the Income Tax Assessment Act, governments of the day have tinkered with the system to achieve specific outcomes at the time without taking into view the long-term impact on existing rules.

Constant manipulation of the system destroys consumer confidence in superannuation as a viable system of saving for retirement, • death benefits – the death benefit system, including to whom benefits can be paid and the tax outcomes, has hardly changed in decades.

Our view is it no longer meets the needs of modern society, and • onshoring and offshoring issues – the interaction of the Australian superannuation system with foreign pension systems and the tax residency of Australian citizens is overly complex and no longer meets the needs of a modern international society.

The superannuation guarantee system is also overly complex and uncertain, in particular in its operation in relation to contractors. The current penalty system is harsh and is disproportionately affecting employers who do not fully understand their obligations due to the overly complex rules and administrative requirements.

While the superannuation system has become overly complex, some simple changes such as these would have a meaningful impact for many SMSFs.

IPA

A potential small businesses saviour

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

COVID-19 has forced the federal government to address many outstanding reform issues, including our insolvency laws. During 2020, there was a relaxation of the insolvent trading laws in the hope it would help businesses survive the pandemic. Some though, like ANZ chief executive Shayne Elliott, were bracing for the worst, telling a parliamentary committee the bank was building up teams to deal with the pain expected in 2021.

In preparation for the withdrawal of economic and financial stimulus, and to give small businesses a fighting chance of survival, the government has made more changes, with the introduction of legislation relating to reconstruction and turnaround, that is, pre-insolvency, as well as introducing a simplified liquidation process. It is estimated to cover 76 per cent of businesses subject to insolvency, of which 98 per cent are small businesses. The new regime commenced on 1 January 2021.

Restructuring A major part of the reforms is to establish an efficient and effective restructuring process that will allow eligible companies to retain control of the business, property and affairs of the company while it develops a plan to restructure with the assistance of a restructuring practitioner. However, before appointing a restructuring practitioner, the directors need to ensure they have substantially complied with the requirement to have paid the entitlements of employees that are due and payable, and be up to date with the company’s tax lodgments.

Given the ATO is the main creditor in small business insolvencies, it will be interesting to see how many of them are able to access the new regime and survive into the future. Despite this criticism, the government is keen to ensure integrity is built into the new system. Other eligibility criteria include the requirement that businesses must be incorporated and total liabilities must not exceed $1 million, as well as safeguards to avoid phoenixing activity.

Small business restructuring practitioner Under the Insolvency Practice Rules, a new category known as a restructuring practitioner has been established, who will only be able to deal with the debt-restructuring process. Despite the confusion and ambiguity, this new practitioner does not have to be, but could be, an existing registered liquidator.

The requirements to become a restructuring

practitioner are still not totally clear, especially in terms of what qualifications are needed. Applications for registration are made to the Australian Securities and Investments Commission, though how long the whole process will take is another question.

Applicants must be a ‘recognised accountant’.

This means they must be a member of one of the three professional accounting bodies, such as the Institute of Public Accountants, hold a professional practice certificate and comply with the relevant continuing professional development requirements.

In addition, they have to have demonstrated the capacity to perform satisfactorily the functions and duties of a restructuring practitioner for a company and for a restructuring plan. The objective is to deal with the anticipated wave, or some say trickle, of small businesses facing solvency problems when the pandemic recovery protections are removed by broadening the category of professionals that could readily qualify as a restructuring practitioner. How the existing accountancy market responds will also depend on whether this new restructuring process can be undertaken profitably and it appears there is a divergence of views on this question.

Unintended consequences A major feature of the reforms strongly leans on the voluntary administration process and Part X debt agreements. Some commentators believe only registered liquidators and/or registered trustees have the necessary familiarisation and working knowledge of these elements to ensure the correct administration of the new simplified process. Further, the interactions of these new insolvency laws with the existing laws concerning the Personal Property Securities Act 2009, and secured creditor appointments via a receivership, also need to be considered. These could be sources of unintended consequences and need to be carefully monitored and addressed.

Commitment to review Given the importance of the reforms, the potential for unintended consequences and the fact they have been rushed into legislation, we strongly believe the government should commit to a full review of the operation of the reforms shortly after 12 months from commencement. In the meantime, it is to the credit of Treasury that it is keeping a close eye on the implementation of the reforms and with our joint effort they will operate as intended and ensure the survival of many small businesses.

QUARTER I 2021 9

CAANZ

Large and comprehensive

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

10 selfmanagedsuper

The federal government’s Retirement Income Review (RIR) is a large comprehensive document and overall the view of Chartered Accountants Australia and New Zealand (CAANZ) is that there is much to like about it and we believe it will serve a useful purpose.

On page 25 of the RIR is a significant sledge: “Many comments and statements (particularly in the media) about the way the [retirement income] system operates and the impact of possible changes can be mere assertions than evidence based on considered assessments. Yet, they are often presented as if they were indisputable facts.”

It is highly unlikely this RIR comment will change anyone’s behaviour because, as the saying goes, never let the truth get in the way of a good story.

The idea for the RIR came from the Productivity Commission’s report assessing the efficiency and competitiveness of the superannuation system. On page 619-620, it said: “This review should examine the net impact of compulsory super on private and public savings, as well as its distributional impacts across the population and over time.

It should also holistically examine the role of superannuation in funding retirement (alongside the age pension, private savings, housing and aged care), and its impact on public finances (including tax concessions and age pension outlays). These public policy issues have not been subject to review since they were (partially) considered by the FitzGerald report on national savings in 1993…”

The FitzGerald report sought to address four main issues: the factors affecting household saving over the medium term, the ability of retirement incomes policy to further contribute to national saving, the factors affecting the ability of the business sector to generate additional internal funds to help meet its investment needs, and the scope for the commonwealth and state governments’ fiscal strategies to provide an improved level of national saving.

One of the key points made in that report was: “For households, which provide the bulk of private saving, the centrepiece of government policy to lift saving directly is the superannuation guarantee. The ultimate aims of that policy should be clarified. (Is one goal to make most Australians independent of the age pension, ultimately requiring total contributions of around 18 per cent of earnings?) Recognising the tension between achieving the best system and avoiding further change, a number of outstanding

issues should be resolved as soon as possible, both to settle the superannuation guarantee system and ensure optimal interaction with the age pension over the long transition ahead.”

The report also said if retirement income policy, and superannuation in particular, was to add to national savings, then five specific policy options would need to be adopted. Interestingly only one of these suggestions has ever been fully implemented, while the rest have been mostly ignored.

When the Treasurer established the RIR, he asked that the panel identify: • how the retirement income system supports Australians in retirement, • the role of each pillar in supporting Australians through retirement, • distributional impacts across the population and over time, and • the impact of current policy settings on public finances Perhaps the first dot point above deals with FitzGerald’s plea to have the purpose of the superannuation guarantee clarified. But a review of the report was not part of the picture.

FitzGerald in 1993 took the view that national savings would be increased by compulsory super and concluded this was a worthwhile outcome. In 2007, in a report prepared for the then Investment & Financial Services Association, FitzGerald referred to a 2004 paper, prepared by two Reserve Bank of Australia researchers, that found compulsory super had added to household savings.

The RIR elected not to examine this issue. Instead it referred to a 2011 Treasury report that estimated national savings had increased and that growth would become larger because of the expected 12 per cent superannuation guarantee. Overall this assumption about increased national saving presumes compulsory super reduces other private savings by 30 per cent.

However, the Mercer CFA Global Pension Index released in October 2019 and 2020 found a strong correlation between increases in overall household debt and increases in retirement savings. The October 2019 publication said: “There are likely to be several causes of this strong relationship but the well-known wealth effect is probably a major factor in many economies. That is, consumers feel more financially secure and confident as the wealth of their homes, investment portfolios or accrued pension benefits rise.

In short, if your wealth increases, you are more willing to spend and/or enter into debt.”

REGULATION ROUND-UP

Member numbers Treasury Laws Amendment (Self Managed Superannuation Funds) Bill 2020

Louise Biti Director, Aged Care Steps Aged Care Steps (AFSL 486723) specialises in the development of advice strategies to support financial planners, accountants and other service providers in relation to aged care and estate planning. For further information refer to www.agedcaresteps.com.au

This bill includes the proposal to increase an SMSF’s member limit from four to six and is still before the Senate. While this legislation increases the number of members allowable in an SMSF, for individual trustees it will still be important to check whether the relevant state/ territory laws limit trustee numbers.

The legislation is proposed to take effect at the start of the quarter following royal assent. If this is granted in March, it would make 1 April the start date.

While this legislation increases the number of members allowable in an SMSF, for individual trustees it will still be important to check whether the relevant state/territory laws limit trustee numbers.

Indexation of TBC thresholds After four years, the general transfer balance cap (TBC) is finally set to be indexed on 1 July to $1.7 million. This means individuals who have already triggered a TBC will have a personal cap between $1.6 million and $1.7 million.

Individuals can check their personal details using ATO online services through myGov.

Administration of penalties Practice Statement Law Administration 2020/3

This document provides guidelines to ATO staff in relation to the administration of penalties for Superannuation Industry (Supervision) Act and Regulations breaches. This includes guidelines for staff on the factors to consider in relation to the remission of fees.

When making a decision, staff are instructed to take into account the background, experience and intentions of trustees/ directors, the seriousness of the breach and whether remission (or not) is likely to lead to a behavioural change to prevent further breaches.

ATO digital improvement program Monthly and quarterly activity statements are available online. As part of the streamlining and efficiency measures, notification emails are no longer sent to registered agents. Agents will be able to use on-demand reports to check due dates, with access through the practitioner lodgement service or online services for agents.

45-day rule dropped Exposure draft for the Treasury Laws Amendment (Miscellaneous and Technical Amendments) Regulations 2020

Proposals to require an SMSF to finalise financial statements at least 45 days before lodging the annual return have been dropped from these regulations. The superannuation industry has welcomed this change.

ATO’s new online services for business The business portal and electronic superannuation audit tool are being phased out over 2021 and will be replaced with the new online services for business tool to manage tax and super obligations. The new service is accessed through myGovID.

SuperStream for rollovers All rollovers to or from an SMSF now need to use SuperStream. This will require an electronic service address.

COVID rental income deferrals SPR 2020/2 Self-Managed Superannuation Funds (COVID-19 Rental income deferrals – Inhouse Asset Exclusion) Determination

This determination was published on 27 November 2020 and is now effective. It ensures that an in-house asset is not created where COVID-19 rental concessions were provided to a related party or the SMSF held an interest in a company or unit trust that provided rent concessions.

QUARTER I 2021 11

FEATURE

INDEPENDENCE

DAY AUDITORS DISRUPTED

The amendment to the auditor independence standards under APES 110 will have a significant impact on who is able perform an audit. Tharshini Ashokan assesses what the implications are for the SMSF sector.

12 selfmanagedsuper

FEATURE INDEPENDENCE DAY

The introduction of amended audit independence standards enforcing restrictions on financial statements and audits being prepared by the same party is set to impact the SMSF sector in a big way, with as many as between 200,000 to 300,000 funds estimated to be required to find a new auditing firm this year.

The restructured APES 110 Code of Ethics for Professional Accountants and accompanying Independence Guide, which was developed by the Accounting Professional & Ethical Standards Board in conjunction with Chartered Accountants Australia and New Zealand (CAANZ), CPA Australia and the Institute of Public Accountants, will be mandatory for audits in Australia from 1 July.

The guide clearly states an auditor cannot audit an SMSF where the auditor, their staff or their firm has prepared the financial statements for that fund, unless it is a routine and mechanical service, and the requirements placed on auditors to ensure they are not in breach of the new standards have left many in the industry scrambling to find possible solutions for the funds cast adrift by the change.

An outcome professionals across the sector tend to agree on is that the amended standards will signal a surge in demand for specialist audit firms due to the number of larger firms having to find alternative audit arrangements for many of their clients.

“It’s a turning point for firms that specialise in SMSF auditing. If they haven’t been getting lots of inquiries over the past few months, I’d be very surprised,” Super Sphere director Belinda Aisbett says.

“There are so many firms the new standards impact. It would have to have a positive impact on specialist firms.”

Peak Super Audits managing director Naomi Kewley agrees the implementation of the new standards is likely to mean a boom time for SMSF specialist auditors, but anticipates some

hurdles as a result of the increased workflow.

“It’s going to be a challenge for the industry and firms like mine in terms of how we can adapt our staffing and skills and resources to have the range to absorb that increased workflow,” Kewley points out.

While she believes the influx of work is a good opportunity for people considering moving into the SMSF audit space, she also recommends they look before they leap, noting the SMSF audit is “a world within itself”.

“You really need to know what you’re about in this industry. And like we’ve seen in recent years with regard to litigation, it doesn’t deal lightly with the SMSF auditor, so people will need a lot more than a degree and 300 hours in audits to do this job well,” she says.

“What I would say to people looking to come in is don’t enter it lightly. But if you think this is your thing, then go for it because there’s going to be a lot of work moving through this industry.”

A recent spate of ultra-cheap audits being offered across the SMSF space from companies targeting accounting and auditing firms has also highlighted the possibility of the new standards giving rise to audit services that may lack the required skills.

Aisbett agrees there may be potential for some firms taking advantage of the situation by offering low-quality services, but believes the new standards will ultimately lift the quality of audits in the SMSF space.

“There’s the good, the bad and the ugly in every industry and SMSF auditors are no different unfortunately. I’ve no doubt there will be some auditors that you do have to question how they have such low fixed fees and whether the quality of those audits are reflective of that,” she says.

“There may be an increase in questionable audit services, but I’m also

“It’s a turning point for firms that specialise in SMSF auditing. If they haven’t been getting lots of inquiries over the past few months, I’d be very surprised.”

Belinda Aisbett, Super Sphere

hoping that there’ll be an increase in the quality at the other end of the spectrum.

There are some really decent, quality SMSF specialist auditors out there and if their practices grow and allow them to increase their staffing and their ongoing Continued on next page

QUARTER I 2021

13

FEATURE INDEPENDENCE DAY

“I think there is a risk that the new independence guidelines are going to set an increased number of audits adrift out there and we could see some cowboys entering the industry as a result.”

Naomi Kewley, Peak Super Audits

Continued from previous page

training, we’ll have both ends of the spectrum improved.”

Kewley notes a reduction in fees from SMSF audit providers cannot necessarily be taken on face value as a resultant

14 selfmanagedsuper

drop in the quality of the audits being performed.

“The industry at the moment is certainly experiencing a lot of pressure to reduce fees and, to a point, this has been really healthy because there are real efficiencies that can be gained through the intelligent use of audit software that doesn’t compromise the quality of the audit at all,” she says.

However, she like Aisbett is cautious about the presence of fund audits being offered at extremely low prices.

“I’m very concerned to see some of the advertising that is going around like for flat fees of $400 or $300 irrespective of a fund’s investment mix,” she admits.

“I think there is a risk that the new independence guidelines are going to set an increased number of audits adrift out there and we could see some cowboys entering the industry as a result.”

In addition, she points out when it comes to audit services trustees do get what they pay for.

“The decision to have an SMSF should never be about saving on administrative costs. As a former administrator myself, my experience is it’s worth every cent to engage an auditor who is going to help you navigate the compliance terrain and who will take the time to answer your questions,” she suggests.

“It comes down to a challenge for all the good SMSF auditors out there, we need to be providing real value in the service we offer as compliance experts, and then we need to communicate that to accountants and the trustees as well.”

While many firms continue to look for a suitable way to adapt to the changes, larger accounting firms may have the advantage of having anticipated independence issues long before the new standards were imposed on them.

“For us, it’s going to be business as usual because we actually made the decision over 18 months ago that we were going to use an outsourced

provider for our audits,” Deloitte Australia partner Liz Westover reveals.

“Even though Deloitte has an SMSF compliance business and an SMSF audit business, we made the decision some time ago that independence is not just about actual but perceptions, and that it was in our best interest to move away to make sure there was no question around independence for us.

“Part of that process was to literally analyse who we were using, what we were doing, how we were operating, and we looked at that piece and we made the decision as a firm that we would use an outsourced provider.”

Firms that have been used to doing SMSF audits in-house and are only now thinking about adapting to the new standards need to be mindful of time constraints, Aisbett warns, especially those that want to find auditors with values that align with their own.

“Timing is really crucial now. We’re all going to be heading into the May deadline and those firms that are doing those audits in-house are going to be busy right up through until possibly the end of the year,” she says.

“It means that 30 June is going to sneak up on all of us pretty quickly.

Trying to find yourself an auditor that has capacity and that suits your firm, ethics, objectives, and has a good fit with your client base is going to be perhaps a little rushed and a little more challenging.

We really don’t have long to have these decisions considered and decided.”

CAANZ superannuation leader Tony Negline acknowledges the impact of the COVID-19 pandemic on businesses has also made the timing of the introduction of the new standards less welcome among practitioners.

“Everyone’s been extremely busy with additional workload because of the pandemic,” Negline acknowledges.

“Change is never particularly popular in business and the impact of the

FEATURE

“Change is never particularly popular in business and the impact of the pandemic has probably made APES 110 implementation even less welcome.”

Tony Negline, CAANZ

pandemic has probably made APES 110 implementation even less welcome.”

Despite this, he believes the initial largely negative reaction to the new standards is gradually giving way to more firms accepting the inevitability of the changes and being willing to work out the best way to implement them.

He also looks forward to the implementation of the new standards helping to improve the perception trustees have of audits, particularly those who tend to view audit services as a “grudge purchase”.

“Our hope is that the benefits of seeing audits and other fund work performed independently of each other will help improve the outcomes of the audit process,” he adds.

“We’ll be able to point to that and say to the government that the current SMSF settings are appropriate and do not need to be tightened along the lines of some of the things that have been said to them in the past.”

Aisbett believes the new standards will help change how SMSF audits are viewed by the industry as a whole, as well as the trustee.

“I think the end goal of what the ATO is trying to achieve is that independence is treated a whole lot more seriously than what it has been in the past. Just with that as the primary motive, the quality of the

audits has to improve when they’re taken out of an internal environment,” she says.

“Clients will get better service because when you go to a truly independent auditor, you’ve got a clean slate. We as auditors start with the fund and we know nothing about the client, and have no preconceived idea about whether they’re a good client or a bad client or somewhere in between, which means our audit procedures won’t be clouded or predetermined.

“I think there will be an improvement in quality, just from that aspect alone.

The client is then paying for a really complete and top-notch audit versus them paying an audit fee and not having things looked at as thoroughly as would otherwise be by a specialist firm.”

Westover concurs, noting the enforced standards will take away any doubts firms may have previously had as to whether or not audits being conducted were truly independent.

“I think it will focus people’s thinking on making sure that the audit is actually undertaken in an independent way,” she says.

“I’ve spoken with firms over the years who wanted to talk through independence with me. And my response often was ‘if you’re having to ask the question, then you’re probably not independent’.

“So this takes that doubt away.

People have to genuinely operate in an independent way, in a more prescribed fashion and that has to be good for the industry.”

For firms wanting to ensure a smooth transition, Negline recommends reading the APES 110 standard, as well as the Independence Guide, as a necessary place to start.

“You’ve actually got to read the document and think about how it may apply in your business because I think otherwise you’ll start from behind. You run the risk of implementing it not quite the right way or maybe not the best way for your practice,” he explains.

“It would be good to get it right from the get go – it’s one fix and one fix only and away you go.”

He also encourages firms to contact their relevant professional accounting body and highlights the importance of contacting the ATO with any doubts about ensuring their compliance with the new standards.

“At the end of the day, the ATO does knock on people’s doors with a checklist and the implementation of this standard roughly from July onwards will be one of the things that will be on the checklist,” he adds.

“Making sure that you’ve satisfied them is going to be an important element.”

QUARTER I 2021 15

FEATURE

REFILLING THE

COVID CRATER

The impact of COVID-19 has rippled throughout Australian society and did not spare the superannuation system, with balances taking a hit from reduced returns and members taking advantage of the early access provisions. Jason Spits examines what measures are in place to repair that impact and how the superannuation agenda has shifted.

16 selfmanagedsuper

FEATURE COVID IMPACT

The rapid arrival of the coronavirus into Australia and its ongoing impact on society has become a source of constant background noise for many, and particularly for the federal government, which has had to wrestle with the sudden economic impact on the nation and millions of individuals within it.

Given the $2.9 trillion currently stored in superannuation, it was only natural some of that would be tapped to dig the government and populace out of the financial hardship that developed quickly in the middle of 2020.

Early release of superannuation (ERS) provisions were repurposed to fit the COVID-19 downturn and up to $20,000 of people’s own money was available to them following an application to the ATO. The most recent figures released by the Australian Prudential Regulation Authority (APRA) at the end of January 2021 indicate $36.4 billion of payments have been made from 3.5 million initial applications and 1.4 million second applications, with an average payment of $7638. Within those figures, $377 million has been released as a result of 39,000 applications from 20,000 SMSFs, as at 1 November 2020, according to data supplied by the ATO to selfmanagedsuper.

This latter figure is consistent with the experience of Verante director Liam Shorte and SuperConcepts SMSF technical support executive manager Nick Ali, who both report SMSF trustees and members were aware of the ERS provisions, but had their focus on other issues related to superannuation and retirement.

Ali says the typical higher net worth demographic of SMSF members meant they were less likely to have to rely on superannuation and Shorte points out low interest rates, poor market returns and reduced rental income were probably of greater concern to some SMSFs than easy access to the $10,000 tranches allowed by the ATO. SMSF Association deputy chief executive and director of policy and education Peter Burgess says feedback from members indicated SMSFs were generally better placed to handle COVID-19 than retail and industry superannuation funds.

“Based on discussions with members, it appears SMSFs have recovered from the

initial impact and for those in the drawdown phase, which is about 40 per cent of funds, the government played its part with the 50 per cent reduction of the minimum pension drawdown, which means balances will be able to recover,” Burgess says.

However, SMSF Association technical manager Mary Simmons says for some SMSFs it does not matter how their balances were depleted if they are staring down the barrel of a reduced balance or pension income now or in the near future.

“Some are asking whether they have enough time to ride out the impacts of COVID-19 before the recovery comes or will they have to make a decision sooner about what to do with their fund and their retirement income plans,” Simmons says.

A political solution The impact on superannuation balances from low interest rates and poor market returns is hard to sheet home to any one party, but critics of the early release scheme were quick to point out the damage it would do to lowbalance and low-income fund members.

While supporters of the ERS have been pointing out its utility in helping people meet their financial obligations, and as critics continue to point out the impact on current balances and future retirement balances, there has been minimal discussion about letting people backfill those withdrawals in the short term.

Only a handful of pre-budget submissions have broached the topic, with the Australian Institute of Superannuation Trustees suggesting the government provide a $5000 one-off contribution for low-income earners who accessed their super, as well as increasing the cocontribution rate from 50 cents to $1.50 for every dollar voluntarily contributed.

In its submission, CPA Australia also proposed using the co-contribution scheme, higher contribution limits and an increased total super balance (TSB) threshold for those who accessed superannuation and wanted to use carry-forward provisions to make up the difference. At the same time, The Tax Institute proposed a new cap over and above existing limits to allow for a maximum total contribution of $50,000 to be made within five years.

This latter proposal is similar to an amendment put forward by Pauline Hanson’s One Nation to the Treasury Laws Amendment (More Flexible Superannuation) Bill 2020, which would allow superannuation fund members to recontribute their ERS amount, in part or full, in any year until 2030.

At present, however, there is limited interest in this approach from the government, according to Superannuation, Financial Services and the Digital Economy Minister Jane Hume.

Following an address to the industry in late January, Hume says current contribution measures should be sufficient when selfmanagedsuper questioned her on the issue.

“Understand that early release of superannuation was in fact an existing measure. You could always take out superannuation on the basis of hardship. All we did was build some integrity measures around it and changed the definition of hardship temporarily to acknowledge COVID-19,” she says.

“One change we made that may have flown under the radar was that we made the withdrawal tax free, which normally in the case of financial hardship withdrawals aren’t tax free, so there was a tax benefit on the way out.

“One of the things One Nation is talking about is a tax-free or tax concession on the way back in and that is already in place because the concessional cap is $25,000 per year, so if you are putting in your 9.5 per cent [superannuation guarantee contribution] and it’s less than $25,000 a year, there is already a tax concession up to that cap.

“We also have a catch-up contribution and if you have not put in the full $25,000 in previous years, you can roll those years’ concessional caps over, so there are already opportunities to put more money back into superannuation to make up the difference, tax concessionally, and you can do it at a time that suits you.”

Practical considerations With this in mind, Simmons says the best way to approach the issue of back-filling balances is to consider whether an SMSF, and its Continued on next page

QUARTER I 2021 17

FEATURE COVID IMPACT

“Some are asking whether they have enough time to ride out the impacts of COVID-19 before the recovery comes or will they have to make a decision sooner about what to do with their fund and their retirement income plans.”

Mary Simmons, SMSF Association

Continued from previous page

members, are in accumulation or pension phase or a combination of both, and use the options currently available.

“Those in accumulation phase have got time to wait for the market to recover, but in the meantime if they’ve got access to capital, the focus should be on maximising their contributions, especially nonconcessional contributions, because there are no more work or age tests for anyone under 65,” she says.

Reduced individual balances will also create a reduced TSB, providing an opportunity to access the maximum $300,000 non-concessional contribution allowed under bring-forward rules, she notes.

“It is a good time for individuals to have a look at what the reduced member balance does for their TSB and apply that before 30 June and see if they qualify for the bringforward provisions.”

The concessional cap of $25,000 also remains in play for all super fund members and Simmons says that for younger members who are more likely to have accessed funds under the ERS model, they can also access catch-up contributions.

“The concessional contribution offers a tax deduction and the bonus on top is that if a member has a TSB less than $500,000, they can access the catch-up concessional contributions that have been in place since the 1st of July 2018,” she says.

Adding to these, Shorte says there are a number of other options for people with lower balances or reduced ability to make large contributions.

“The spouse contribution allows $540 to

18 selfmanagedsuper

be added to a fund and the co-contribution still attracts $500 for every $1000 contributed, while salary sacrifice can save 24 cents on the dollar,”he explains.

“For those with some extra cash, there are still some choices about where they can make contributions for the best earnings.”

Heffron managing director Meg Heffron observes salary splitting, via salary sacrifice, has waned in popularity, but it is a suitable long-term strategy to equalise balances between two people.

“If there are two members in an SMSF with large incomes, salary sacrifice makes sense and it can be used to boost the balance of one or both members,” Heffron says.

“If there is an age difference between them, splitting between the older and younger members also gives the ability to access those funds earlier.”

For those straddling the accumulation and pension phases, Simmons acknowledges being aware of the various tax components of the TSB is useful because investment returns can be allocated to the tax-free component.

“With a TSB there is a tax-free and taxable component and when you take a super benefit, either as a lump sum or pension, it has to be split based on a proportion rule,” she says.

“The tax-free component is based on this formula while you are in accumulation phase and whatever is left over, which includes all your investment returns, makes up your taxable component.

“Negative returns reduce that taxable component until it is exhausted and they start eating into the tax-free component – but only notionally – and there is a temporary reduction in the dollar value of a member’s

tax-free component.

“This means there are some opportunities to restore that tax-free component through investment returns, which would ordinarily be a taxable component, but because the level of the tax-free component has yet to be restored to the notionally reduced level, they automatically become tax free.”

Extending this thinking to those in pension mode, she says SMSF members who are already receiving a pension with a high taxfree component should leave it and allow the earnings to recover and remain tax free.

“If they do need additional capital, then they should be taking that out as a partial commutation so that they don’t impact on those tax proportions but still retain them in the fund, but if they have a pension with a high taxable component, this might be an opportunity to commute the pension and pull everything back into the fund and start a new pension with a better tax-free component.”

A rocky recovery While the strategies outlined above can apply to all superannuants, there are elements of the superannuation landscape unique to SMSFs, including limited recourse borrowing arrangements (LRBA).

Rent and loan payment relief measures introduced in mid-2020 for commercial property arrangements have also applied to LRBAs, but Burgess and Ali see the road ahead remaining bumpy for LRBAs for the foreseeable future.

Burgess says investment guidance from the ATO to SMSFs requires investments to be able to deliver sufficient cash flow, provide retirement income funds and be diversified where the fund is in retirement phase.

FEATURE

“SMSFs must have a cash flow for pension payments and if the balance falls, that will need to be factored into an investment review and ensure the investments, including the LRBA, are fit for purpose,” he says.

For Ali though, the sudden decline in rental income and pressure on LRBAs echoes recent warnings and predictions related to the arrangements.

“Rental income is down, but those funds will have to repay those loans, even without rent and the ATO was right – they needed to diversity if that was their only or major asset,” he says.

“COVID-19 has also made people nervous about using an LRBA and the virus may have achieved what regulators could not, and that is the end of LRBAs within the SMSF sector.”

Despite this possible dark spot, Shorte and Heffron believe SMSFs are uniquely placed to recover faster and better serve the need of their members than their retail and industry fund counterparts.

“The fact is SMSF trustees and members are more engaged and use the superannuation and tax systems to find the best place for their money,” Shorte points out.

“The transparency of their investments also provides more confidence to stick with a strategy compared with some of the more fixed and illiquid positions taken during the market scare of 2020.”

Building on that, Heffron says the individual nature of SMSFs is their strength during times when investments, returns and income are under pressure.

“The real benefit of SMSFs is they focus on the needs of two people, typically. This does not mean they are necessarily better than retail or industry funds in creating returns, but they have the freedom to focus just on those members and so can be ideally positioned to recover from anything,” she says.

Ali notes the impact of COVID-19 became the backdrop for the release of the Retirement Income Review (RIR) in November 2020 and a rolling discussion about the future level of the superannuation guarantee contribution, and has reconnected people to super and SMSFs. “People are looking at SMSFs again for their flexibility and COVID-19, like the global financial crisis, has shown how nimble they

“People are looking at SMSFs again for their flexibility and COVID-19, like the global financial crisis, has shown how nimble they can be.”

Nick Ali, SuperConcepts

can be,” he says.

“They are more critical of the role and performance of their superannuation and they want to be sure their superannuation meets their circumstances.”

Resetting retirement With the focus on back-filling the negative impact on super balances caused or exacerbated by the virus, is it time to also encourage fund members to see their balances as retirement income and not as a boon for the next generation?

The final report of the RIR suggested retirees should be spending more of their savings instead of holding on to them and smoothing their spending and consumption between their working and retired lives, but Shorte says this does not factor in an

unknown future.

“People are more worried about their own longevity than leaving something for their kids. They are seeing their own parents live longer and considering they may have 35 years in which to fund themselves,” he notes.

“In some cases they are taking care of themselves, their parents and their kids and are doing that outside of superannuation, but their fund is for their old age so they can stay at home and not be totally dependent on the pension system.”

Ali, however, sees this focus on an unknown future and the calls by the RIR to reexamine super as an essential discussion that involves the next generations of retirees, who are unlikely to be able to build large balances and maintain them over time.

“There will be a shift from the idea that superannuation is a nest egg that you slowly run down to seeing it as an annuity vehicle and that change in the narrative has been backed by the findings of the RIR,” he says.

“Concerns about outliving your money and about capital preservation are part of a discussion about the future, but they will be legacy issues because superannuation for the next generation will be amortised over their life expectancy instead of being set up as an estate planning tool.”

How and when that discussion will take place depends on the government’s actions towards super, but it is clear COVID-19 and the early release of superannuation have started the ball rolling, a fact even Hume admits.

“COVID-19 provided a rare opening. The economic ramifications of the pandemic, alongside measures such as the early release of super, prompted many Australians to reassess their finances, engage with their superannuation and incorporate their retirement savings into their personal balance sheets,” she says during her address.

“The RIR final report observed ‘many superannuation funds have reported spikes in member engagement, including members switching to more conservative investment strategies’.

“While the full effects of COVID-19 remain to be seen, 2021 presents an opportunity to build on increased levels of engagement while continuing to maximise the retirement savings of all Australians.”

QUARTER I 2021 19

INVESTING

2021: a long/short investment odyssey

While SMSF investors understand how to make money from rising stock prices, many are unaware it is also possible to make money from falling stock prices. Jun Bei Liu explains this approach can be a good strategy for SMSFs looking to smooth out returns in volatile markets.

JUN BEI LIU is a lead portfolio manager with Tribeca Investment Partners.

20 selfmanagedsuper

A long position, essentially a buy-and-hold approach to investing, is how most investors tackle share market investing. But by adopting an approach that shorts stocks in tandem with a buy-and-hold approach, called a long/short strategy, investors can invest in a larger universe and better ride out market volatility.

A long/short equities investment strategy, also sometimes called an active extension strategy, aims to provide investors with returns that beat the benchmark, whatever the market conditions.

With this strategy SMSF investors can benefit from rising stocks prices by taking a long investment position in selected companies and from falling stock prices by taking a short position in other companies.

Done properly, the end result is a portfolio that profits from both positive and negative share price movements, with less volatility.

A long/short approach and the economy The expectation is 2021 will be a positive year for Australian equities. Markets are supported by low interest rates, as well as ongoing government support, including JobKeeper and JobSeeker, in the wake of COVID-19. Global economies too will continue on a path towards normality as the various COVID-19 vaccines are rolled out and the lagged impacts of social restrictions unwind.

A solid global backdrop, led by China but including the United States, will also provide a strong

tailwind for specific areas of the market, such as commodities, as well as both domestic and internationally exposed cyclicals.

While risks will remain ever present, and extended valuations for some areas of the market are an ongoing threat, both the government and the Reserve Bank of Australia have laid the foundations for a solid economic recovery, which will be increasingly supported by an accelerated rollout of a COVID-19 vaccine.

We have already seen how last year’s COVID-19 vaccine announcements drove a sharp reversal in the performance of many laggard areas of the domestic equity market, such as financials, travel and tourism, consumer discretionary and industrials.

It also saw a sharp repricing in the fixed income market with a dramatic increase in long bond yields and profit-taking in many ‘work from home’ winners.

This repricing reflected increased confidence in the economic outlook and it is likely these trends will continue through this year as growth normalises. This should provide ongoing support for cyclicals, value stocks, small caps and domestic stocks that are globally exposed.

The Australian share market is expected to rise in excess of 10 per cent this year, supported by modest valuation expansion in cyclicals, broad earnings upgrades, continued low interest rates and strong equity inflows as investors hunt higher yields and capital returns.

It is in this type of environment that long/ short equity investment approaches often come into their own.

Long/short investing simplified Traditional Australian equity strategies often just look at the good news stories. In contrast, a long/short equity strategy can take advantage of negative views of stocks and sectors as well as weaker fundamentals.

Typically designed to take advantage of the upside of markets, while minimising the potential downside risk, adopting a long/ short strategy is a two-pronged process.

The long strategy simply involves buying and holding undervalued stocks that are

expected to increase in value over time.

The short strategy is a little more involved.

Essentially an investor pays to ‘borrow’ a share that is expected to decrease in value from other holders in the market. They immediately sell it, and then buy it back again later once the price has dropped. The investor then pockets the difference before returning the share to the lender.

One of the biggest constraints for investors in the Australian share market is its limited size – it represents only 2 per cent of global share markets, and is also very concentrated in nature, being dominated by financial and mining stocks.

Diversification is the cornerstone of every investment portfolio, but all too often share market diversification for SMSFs comes by investing only in a selection of stocks drawn from the top 50 or top 100 Australian Securities Exchange (ASX) listed companies, either directly or through a managed fund.

Being limited to only investing in stocks that are expected to increase in value, a typically long-only approach, further constrains the investment scope.

But by investing in stocks expected to rise in value as well as making money from stocks expected to fall in value, an investor is effectively doubling the investment universe available as well as smoothing out returns and mitigating a traditional long-only equity portfolio risk.

Many long/short investors have a focus on short selling a range of stocks with weak investment characteristics and reinvesting the proceeds in long positions in preferred stocks that are expected to increase in value.

This combination of long and short positions provides a large degree of flexibility and enables more active decision-making.

The strategy provides the opportunity to unlock returns that simply aren’t available to long-only investors.

Self-direction or expert funds management SMSF investors, by their very nature, like to take a hands-on approach when it comes to managing and controlling their superannuation investments. For these

investors a solid and successful investment strategy relies on building a portfolio that mirrors their financial needs and their short and long-term goals. It also takes into account changing circumstances and market conditions.

A long/short equities strategy is best suited to SMSF investors with a longerterm view in mind. Inevitably this type of strategy will incur short-term periods of underperformance on the way to longerterm outperformance.

Importantly however, the ability to short shares in a portfolio means investors are able to profit during a market downturn, and so adopt a different risk/return profile to that of a typical long-only Australian equity portfolio.

Investors willing to adopt this approach are potentially able to achieve higher levels of divergence in the performance of the portfolio, relative to the performance of the share market benchmark, than can be achieved by those who only take long positions.

Long/short investing is a complicated strategy, however, and investors should be aware of the risks. In particular, this approach requires a high degree of investment research taking in a wide variety of stocks as well as up-to-date market research. While some SMSF investors will make the decision to adopt a long/short strategy based on their own investment research, others will choose to invest in long/short strategies through a managed fund or similar vehicle.

From a stock-specific point of view, and as an example of the types of investments that can be made with a long/short approach, the Tribeca Investment Partners Alpha Plus Fund stocks that contributed to the fund’s performance in the fourth quarter of 2020 are provided below.

The top-performing stocks that contributed on the long side were: • Nuix (NXL) – the exciting cybersecurity technology provider that listed in December, Continued on next page

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INVESTING

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• Fortescue Metals (FMG) – as the iron ore price rallied strongly on supply curtailment in Brazil and growing demand from China, • Afterpay (APT) – the leading technology stock on the ASX that was also supported by index inclusion in December, • Seek (SEK) – leveraged to reopening and broader improvement in the domestic and Asian labour markets, and • Oil Search (OSH) – as the energy sector rallied on cyclical rotation and reopening.

On the short side, it was underweight positions in the following stocks during the period: • AGL Energy (AGL), • ASX Limited (ASX), and • Newcrest Mining (NCM).

Risk and return The main risk associated with long/short investing for those who are investing through a managed fund, or similar, is that it increases the SMSF’s exposure to a fund manager’s investment skill. If the manager selects stocks poorly, the outcome could be worse than it might be if the SMSF was invested with a long-only manager.

There is also some additional risk in short selling, and this occurs if the borrowed stock is recalled. In this case, it can also force a repurchase of the share at the same time as the recall. Although this is not a common occurrence, it can happen, and it may mean the share has to be repurchased at a less than favourable price.

In the case of the Tribeca Investment Partners Alpha Plus Fund, this risk is managed by ensuring the short positions held are mainly in liquid shares rather than in the smaller, lower liquidity assets whose price moves further in the event of a short squeeze.

Investor types Long/short investment strategies are often used in a core/satellite investment strategy to complement an SMSF’s core holding of index investments by providing the opportunity for outperformance at the

22 selfmanagedsuper

edges of the investment portfolio.

It is often a strategy adopted by those who are still in the accumulation phase of their superannuation savings as these investors have a longer investment time horizon and can afford to take on the additional risk that comes with investing in growth assets.

However, it should not be discounted as a strategy for older accumulators or even those who have entered the retirement phase of their life. Longevity risk

is a real concern for these investors and the fear that they will start to run out of money in retirement is real – particularly in the current low interest rate ‘lower-for-longer’ economic environment. These investors realise a risk-free conservative investment strategy will provide almost a zero return and a tilt to towards growth assets is required. They recognise there should be some allocation towards growth assets and a long/short Australian equity fund may meet that criteria.

EXTENDING MARKET REACH Active extension strategies allow stock pickers, like Tribeca, to better express their highest conviction stock ideas by increasing underweight and overweight positions relative to the index.

They can short poor companies with weak financial fundamentals and use those proceeds to increase their long positions in the highest-quality companies.

This is especially useful in concentrated markets such as the S&P ASX/200, where the largest 20 companies make up more than half the value of the entire market.

The graph below illustrates how the long/short strategy enables investors to mitigate market concentration and extend the available investment universe.

% 120

30%

100 80 60 100%

100%

100%

40 20 0 -30%

-20 -40 Long-only

Gross exposure

Net exposure

Active exposure

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2021

INVESTING

EM set to stir SMSF interest

With investment returns from traditional equities and bonds challenged in the current environment, and with many emerging market economies reopening faster than their developed world peers post COVID-19 shutdown, the case for investing in these jurisdictions has never been stronger. But finding the opportunities at a country, sector and individual stock level requires selectivity and time in the market, Alex Duffy writes.

ALEX DUFFY is a portfolio manager of the Fidelity Global Emerging Markets Fund.

Emerging markets (EM) have been growing rapidly in recent years. In fact, they now contribute over 50 per cent of global growth and are expected to contribute more than 60 per cent by next year. Clearly it is a sector that investors should be considering.

With the changing landscape and growth of EMs, their economies are beginning to account for a much higher percentage of global gross domestic product (GDP). The International Monetary Fund (IMF) World Economic Outlook Database shows that in 1980 these nations had a combined GDP of less than half that of advanced economies. By 2010, the two were close to level.

Emerging markets are a significant contributor to global GDP However, by 2022, it’s estimated emerging

24 selfmanagedsuper

economies will have an output that is larger than the developed world. In just four decades, EMs will have gone from a peripheral position in the world economy to a central one (see graph 1).

Despite this, they still account for just a fraction of most Australian investment portfolios, and are an option that has been overlooked by many SMSF investors. However, that could be set to change.

Defining EM Once dominated by agriculture, mining and lowcost manufacturing, EM countries are now home to some of the world’s fastest-growing economies and most innovative companies, including those in the technology sector. Needless to say, global investors have taken note and have been eager to capture this growth trajectory.

Graph 1:Contribution to GDP (%)

36%

36%

43%

54%

62%

64%

64%

57%

46%

38%

1980

1990

2000

2010

2022e

Source: IMF, World Economic Outlook Database October 2017. Fidelity International and MSCI ACWI and MSCI EM Index as at 30 September 2020.

An EM is characterised by the transitioning from low-to-middle to high income per capita. These economies share some characteristics of developed markets, including a functioning stock exchange, access to debt and, in most cases, predictability of government regulation.

Global indices will classify EMs differently, however, it’s universally accepted the likes of China, India, Indonesia, Brazil, Taiwan and South Korea are core EM economies, and places such as Argentina, Hong Kong and Singapore waver between emerging and developed.

Another defining characteristic of EMs is the degree of demographic and social change, with a large proportion of these populations having younger generations about to become middle-class workers and consumers. Between 2009 and 2030, China alone is expected to add 850 million people to its middle class, taking it from 12 per cent to 73 per cent of its population.

With this increased affluence comes more consumption – not just of consumer goods such as cars, technology and

electrical goods, but of more sophisticated products and services. China’s healthcare industry, for example, grew fourfold between 2006 and 2016.

COVID-19-driven changes Within the context of EMs, SMSF investors need to be aware they’re operating in a more fluid environment than is the case in other asset classes.

In the 12 months prior to the global outbreak of COVID-19, there were a lot of concerns around currency devaluation, whereby the US dollar had been very strong and the Federal Reserve was raising rates which, in turn, was putting pressure on the cost of capital for EMs. However, by the end of 2019, much of this concern had dissipated and there were tentative signs the trade wars were starting to abate and support the EM asset class.

But then COVID-19 hit. In the first quarter of 2020, EM equities recorded their worst quarter since the global financial crisis.

Interestingly, however, for many EM

economies, while the human side of the event was catastrophic, infrastructure spending from stimulus measures presented a number of opportunities in less favourable sectors at the time such as industrials. This sector was attractive from a valuation perspective and, coupled with commodity prices, demand started to pick up.

The pandemic has also led to a genuine ‘at home’ culture, whether it be in the form of working, schooling, shopping or even the burgeoning area of telehealth. EMs that can capitalise on this trend, especially those with established technology sectors, are likely to see strong growth for the foreseeable future.

In China, for example, working from home has boosted the need for cloudbased service, which is in its infancy and ripe for expansion; mobile phone time surged to over five hours per day and time spent gaming on Tencent titles – Honour of Kings and Game for Peace – surged to two to three times the prior monthly run rate.

The rise of the internet and persistent technological advancement have been increasingly important drivers of EMs. China, which was traditionally the powerhouse of global manufacturing for decades, today rides the wave of digital innovation with the success of the BAT tech giants – Baidu, Ali Baba and Tencent.

Some of the largest e-commerce, gaming, social media and hardware manufacturers reside in EMs and the changing nature of the index shows just how much this changed over a decade.

Other changes in society and consumer habits will emerge from the pandemic, some semi-permanent and some permanent, such as a greater focus on health, lifestyle choices and financial planning.

COVID-19 has also emphasised the rising purchasing power of EM consumers across a range of segments. Structurally sound companies operating across an array of sub-sectors, going beyond purely Continued on next page

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Continued from previous page

internet-related names to include autos, sportswear and cookware, are ones to watch, along with those that can perform well despite lower levels of international trade. These include leading domestic hardware manufacturers.

Where to from here?

The equity markets of China, Taiwan and South Korea in particular, however, pose an interesting proposition for SMSF investors.

While these economies reopened relatively quickly post shutdown, the risk of further outbreaks, even with promising vaccine developments, adds heightened uncertainty.

As sentiment towards hardly hit Latin America and EMEA (Europe, Middle East and Africa) regions improves, supported by a pick-up in activity as well as pricing support for commodities driven by inflation, investors should anticipate a sharp re-rating, emphasised by the historically low valuations.

As these markets attract flows, this could also translate into a risk as there could likely be significant downward pressure on more extended parts of the universe, such as China and broader north Asia.

Heightened levels of industry consolidation throughout EMs are also likely to materialise, with larger brands, such as those within the aforementioned consumer and technology sectors, set to benefit.

Importantly, while the pandemic has served as a further catalyst for digitalisation, with internet/tech-related names likely to benefit from this, structural growth drivers such as urbanisation, financialisation and lifestyle changes persist and will continue, indicating opportunities also across a range of more traditional domestic businesses.

Inflationary and interest rate considerations could have potential implications for resources and financialbased stocks respectively.

Given the inflationary backdrop and economic recovery exposure to commodities, including copper, steel and

26 selfmanagedsuper

By 2022, it’s estimated emerging economies will have an output that is larger than the developed world. In just four decades, EMs will have gone from a peripheral position in the world economy to a central one.

platinum group metals, should be done on a selective basis. Financial stocks are another area of relative caution, particularly in an ultra-low interest rate environment likely to remain that way for some time.

But the potential for growth is great.

With disruption of supply chains during the COVID-19 pandemic, EM economies with large domestic consumption are expected to benefit in the short to medium term. The rise of regional economic centres, where growing demand from a large economy like China or India, will fuel growth in other developing countries nearby. Coupled with strong domestic consumption driven by a rising middle class and the evolution towards growth industries, it makes for a compelling case for SMSF exposure to EM economies.

EM and sustainability Environmental, social and corporate governance (ESG) considerations will continue to drive investment decisions and EMs are no exception. There is now a strong correlation between companies that score highly in terms of their approach

to ESG and higher-than-average returns for investors.

Key to this will be maintaining a focus on identifying businesses with best-inclass practices that are reflected in clear ESG policies. Company management and boards also need to be able to stand by these policies, and demonstrate the company’s commitment to ESG through its strategy and operations.

COVID-19 has highlighted the importance of investing in high-quality names, characterised by sound balance sheet structures, that enable them to weather more challenging environments and come out stronger from the volatility than peers. A focus on governance and capital structures therefore has to remain paramount in avoiding permanent loss of capital, an important consideration for SMSF investors, particularly those approaching, or in, retirement.

There are many reasons for SMSF investors to remain optimistic towards EM equities, which are set to benefit from longterm structural growth drivers and more recent global developments, namely those relating to technology and the new stay-athome phenomenon.

Greater diversification across countries, sectors and companies affords investors the ability to take into account the varying impacts of COVID-19 on EM economies, the sectors and the companies themselves.

However, as volatility levels remain elevated, selectivity remains paramount.

Against this backdrop, a focus on identifying companies characterised by robust corporate governance and balance sheet structures is key.

Because of the risks associated with EM economies, they often generate higherthan-average returns for investors. Not all are good investments, but for those investors willing to research and focus on identifying high-quality names, EMs will remain an attractive proposition for some time yet. And for SMSF members, who are investing for the long term, they have the long-term time frame needed to ride through the EM peaks and troughs.

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STRATEGY

Retaining the excess

In the event an SMSF member breaches their contributions caps, it can be instinctive to refund the amount in excess. However, in some situations retaining the excess in the fund can be beneficial, Meg Heffron writes.

MEG HEFFRON is managing director of Heffron.

28 selfmanagedsuper

After several false starts since 2007, the rules for excess contributions today are relatively straightforward and logical.

If an individual goes over the relevant cap, they can choose to take a refund out of superannuation.

The benefits being: • For excess concessional contributions – members can refund 85 per cent of the excess concessional contributions. Choosing the refund option makes no difference to the tax paid in relation to the excess. However, it does mean the excess will not count towards the member’s non-concessional contributions cap.

For many people this makes sense – why use up the non-concessional contributions cap with a contribution that will not create a tax-free

component and will be taxed at 15 per cent in the fund? A far better approach would normally be to refund as much as possible and contribute whatever is leftover (after paying additional tax) as a normal non-concessional contribution.

• For excess non-concessional contributions – members can refund the excess nonconcessional contribution plus 85 per cent of the ‘associated earnings’ amount (notional interest on the excess contribution). Choosing the refund option means extra taxes will be calculated in a different way. Rather than being subject to excess non-concessional contributions tax (47 per cent on the amount of the excess contribution itself that is paid from the superannuation fund), the member will be subject to extra personal

income tax at normal rates (less a 15 per cent offset) on the associated earnings amount. For most people this means much less tax is paid.

But when does it work the other way where members might choose to leave the excess in superannuation?

Excess non-concessional contributions It is rare members would not choose the refund option where the non-concessional contributions cap has been exceeded.

The imposition of tax at 47 per cent (and the fact this tax must be paid from superannuation) makes retaining the excess in super counterproductive in virtually every practical scenario. The rare case where it might be beneficial to leave the excess in the fund is where the associated earnings have accumulated over many years and the associated earnings amount is so high that: • the personal tax cost of paying income tax on the associated earnings amount is higher than • 47 per cent of the excess nonconcessional contributions.

It is always worth a quick sanity check before releasing in these situations.

Beware though – since 1 July 2018 the default position has been that excess nonconcessional contributions be refunded automatically. Someone wanting to avoid that outcome would need to respond promptly to the excess non-concessional contributions determination issued by the ATO and tell them not to instruct the superannuation fund to refund the money.

fund), there can be valid reasons for leaving excess concessional contributions in super.

No longer able to make nonconcessional contributions Firstly, members who are no longer able to make non-concessional contributions due to age and work status may deliberately leave excess concessional contributions in superannuation. The logic here is they can’t adopt the normal approach of refunding and then putting whatever is leftover back into superannuation because they are no longer eligible to make non-concessional contributions.

For example, in 2019/20, Marcus was 68 and met the work test to make superannuation contributions. At 30 June 2020, his total superannuation balance was $1 million and in 2020/21 he will no longer meet the work test, nor will he be eligible for work test exempt contributions.

This means he cannot make any voluntary contributions in 2020/21.

In 2019/20, Marcus made concessional contributions that exceeded his cap and triggered an excess of $10,000. He did not make any non-concessional contributions in that year.

Marcus might choose to leave his excess concessional contributions in the fund. While the full amount of $10,000 would count towards his non-concessional contributions cap for 2019/20 and would not create a tax-free component, he can at least leave the contributions in the fund.

In contrast, if he withdrew $8500 (being 85 per cent of the excess), he would be unable to recontribute it as a normal nonconcessional contribution in 2020/21.

Excess concessional contributions Excess concessional contributions are another matter entirely.

Remember, whether or not the member chooses the refund option has no real impact on the amount of tax paid. Hence, providing cash flow is not a problem (that is, the member has enough cash to pay the extra liability personally and doesn’t need a refund from the superannuation

Current year’s non-concessional contributions cap is $nil Secondly, members whose superannuation balances have grown and now have a nonconcessional contributions cap of $nil (but didn’t in the year the excess concessional contribution was made) are in the same boat.

Take Tristan for example, who is 55, had a total superannuation balance of $1.55

million at 30 June 2019 and made no nonconcessional contributions in 2019/20.

He did, however, exceed his concessional contributions cap by $10,000. At 30 June 2020, his total superannuation balance was $1.65 million. Hence his non-concessional contributions cap is $nil in 2020/21 but was $100,000 in 2019/20.

Tristan might also choose to leave his excess concessional contributions in the fund. While the full amount of $10,000 would count towards his non-concessional contributions cap for 2019/20 and would not create a tax-free component, he can at least leave the contributions in the fund without creating an excess nonconcessional contribution.

This would not be the case if Tristan’s total superannuation balance was $1.6 million or more at 30 June 2019. His nonconcessional contributions cap would then be $nil in both years. Choosing not to release his excess concessional contributions would simply flow through to a $10,000 excess on his non-concessional contributions as well. This would make no sense as it would mean further taxes on the same excess. As such, Tristan would do better to refund the excess concessional contribution in the first place.

Have other plans for this year’s nonconcessional contributions cap The above examples highlight a key point – when the excess concessional contribution is left in superannuation, it counts towards the non-concessional cap in the year in which the contribution was made. In contrast, if the amount is withdrawn and recontributed, it will count towards the non-concessional cap in the year it is recontributed.

This timing difference can be vital in ensuring non-concessional contribution plans are not disrupted.

For example, Mark is currently 66 but turning 67 in October 2021. He is pretty confident the new rules allowing bringContinued on next page

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forward non-concessional contributions up until the year in which the member turns 67 will be passed into law very soon. Since he reaches 67 in 2021/22, his plan is to make non-concessional contributions of $100,000 in 2020/21 and then $300,000, or even more now the contribution caps are indexed from 1 July 2021, in 2021/22. His total superannuation balance won’t be a problem, it’s only $1 million, and he didn’t make any non-concessional contributions in 2019/20.

Unbeknown to Mark, he actually had an excess concessional contribution of $10,000 in 2019/20. By the time he receives the ATO determination, he’s already contributed his $100,000 of nonconcessional contributions for 2020/21.

If Mark refunds the excess concessional contribution, he won’t be able to recontribute it as a non-concessional contribution in 2020/21 without disrupting his plans. Going even $1 over the $100,000 cap this year will mean he triggers his three-year bring-forward a year early. He can’t opt out of doing that; it will happen automatically.

Since he didn’t make any nonconcessional contributions in 2019/20, Mark decides to leave his excess concessional contributions in the fund. He will use up $10,000 of his non-concessional contributions cap in that year, but since he didn’t use that year’s cap anyway, there’s no real downside.

As an aside, remember that it’s all in the timing. Mark’s position would be completely different if the excess concessional contribution occurred in 2020/21. Leaving his excess in super would mean it was counted as a nonconcessional contribution in 2020/21 – the year when he absolutely did not want to exceed $100,000. He would definitely need to make sure he took the refund option so the excess did not disrupt his plans. The refund would probably be received in 2021/22 and if he had already

30 selfmanagedsuper

The imposition of tax at 47 per cent (and the fact this tax must be paid from superannuation) makes retaining the excess in super counterproductive in virtually every practical scenario.

made his large ($300,000 or more) nonconcessional contribution for that year, he would simply keep the cash rather than putting any further non-concessional contributions into super.

Funds with reserves Not many SMSFs have reserves, but those holding them are frequently faced with the problem of how to distribute them to members quickly and tax effectively.

This issue is becoming more acute as the members of funds with reserves get older. If all members were to die while reserves remain in place, these days there is no practical means of adding them to a deceased member’s death benefit and extracting them from the SMSF tax effectively.

Allocations from reserves are not contributions, but they are counted for the purposes of the concessional contributions cap unless the allocation meets both of the following requirements: • the amount is allocated in a fair and reasonable manner to all members (or at least to the members in a particular group who contributed to the existence of the reserve), and • the amount over a financial year is less than 5 per cent of the value of the member’s interest in the fund at the time

of the allocation.

If the allocation does not meet these conditions, the full amount counts towards the concessional contributions cap.

However, it is worth bearing in mind that if the members are older, say beyond the age at which contributions can be made: • they may not be using their concessional contributions cap in any case. For 2020/21, this means the first $25,000 of an allocation from a reserve will count towards their cap but this will have no impact, • their concessional contributions cap may be even higher than the standard annual cap if they are eligible for the rules allowing certain members to carry forward any unused concessional contributions cap amounts to a later year (that is, their total superannuation balance is less than $500,000 at the previous 30 June), and • while they will pay income tax on any excess over their concessional contributions cap: − if their other taxable income is modest, this could have very little impact, and − remember the 15 per cent tax offset is available on this additional ‘income’ even though the tax it was designed to account for, that is, the 15 per cent contributions tax, was not actually paid on the amount allocated to the member from the reserves.

Hence this may be one group that would deliberately create an excess concessional contribution. They may also choose to leave the excess in superannuation because they have the normal non-concessional contribution caps even though they are unable to make these contributions.

Conclusion Most people try to avoid excess contributions and most will also opt to refund them from super much of the time.

But it pays to understand when this may not be desirable as some valuable planning opportunities can emerge.

COMPLIANCE

The trouble with off-market transfers

Off-market transfers are not new to SMSFs, but are not what could be considered straightforward transactions. Tim Miller presents some of the more finicky aspects involved with using this method of asset acquisition.

TIM MILLER is education manager at SuperGuardian.

When the ATO forms and shares an opinion, the SMSF industry has choices to make. We can embrace it, challenge it or we can go about things in our own manner and ignore it. The third option is fraught with danger, but many of us have been around the industry long enough to know that in some instances all three approaches are taken, especially when the opinion clashes with preexisting practices. Off-market transfers (OMT) are a classic example of this, and we are now at a point where ignorance is not an excuse and going about them the wrong way could have significant tax ramifications.

Let’s be clear, OMTs were so much simpler

before May 2005, or more to the point the timing of transfers and indeed the value was considered far less relevant as we did not have nonconcessional contribution caps. When I say the value was far less relevant, we still had to operate on the basis of market value. The Super System Review, otherwise known as the Cooper review, came within a whisker of having OMTs removed altogether. In the end, we got a picture of where the ATO stood with reference to OMTs and by association in-specie contributions. All of a sudden they are back in the spotlight.

Continued on next page

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Continued from previous page

Why are we talking about OMTs in 2021?

In recent times, the release of Law Companion Ruling (LCR) 2019/D3 shone the light on the non-arm’s-length expense measures introduced from 1 July 2018.

Finalisation of the ruling is due any time now. Most notable in the ruling was the reference to general fund expenses potentially impacting all of a fund’s income, however, what was striking in the ruling was the link between OMTs and non-arm’slength income. This is not the first time the ATO has addressed OMTs. Two instruments, Tax Ruling (TR) 2010/1 and Self-Managed Superannuation Funds Ruling (SMSFR) 2010/1, deal with OMTs resulting in in-specie contributions and much of this stems from the capacity to acquire certain assets, such as listed securities, from related parties.

Interestingly, LCR 2019/D3 discusses ‘the terms of the contract’ when referencing purchasing assets, which has very little practical application in everyday SMSF transactions. It might be the case for a property transaction, but is unlikely to occur for the purposes of listed securities.

Given the opportunity to speculate we could consider ‘the terms of the contract’ to simply mean the OMT form.

The ATO’s position is rather curious as it states that if an asset is being purchased by a fund, any difference between the consideration paid and the market value cannot represent the value of an in-specie contribution. The ruling further states that an in-specie contribution can only be made in conjunction with a purchase if the purchase is only for part of the asset. Such a transaction should be recognised in the contract for purchase. This appears out of touch with industry practices and if further clarity is not provided, it could fundamentally change how shares are transferred. The ruling also says non-arm’s-length income will arise even in the event that the fund represents the difference in value as an in-specie transfer.

Let’s look at the history.

32 selfmanagedsuper

There is clearly a lot to play out in this space and a great deal of clarity required.

SMSFR 2010/1 – acquiring assets from related parties SMSFR 2010/1 contemplates what assets can be acquired from a related party.

The first interesting bit of commentary is provided at paragraph 13 of the ruling: “The phrase ‘acquire an asset’ in subsection 66(1) encompasses not only the purchase of an asset by a trustee or investment manager but also the acquisition of an asset if the SMSF does not provide any consideration.

For example, accepting a contribution of an asset, assets gained through improvements made to SMSF property, receiving an in-specie trust distribution or receiving an in-specie payment of income, profit or gain.”

In the ruling, this paragraph includes a linked reference to TR 2010/1, so there is clarity that these documents were created in contemplation of each other.

A key to section 66 of the Superannuation Industry (Supervision)

(SIS) Act is the exception to acquire either listed securities or business real property and the reference to acquiring at market value. Commentary on this is provided in paragraphs 38 and 39: “If the asset is purchased by the SMSF and the consideration paid for the asset is equal to the asset’s market value, the market value requirement is satisfied.

“However, if either no consideration is given for the asset, or the consideration given is less than the asset’s market value, the commissioner accepts that the market value requirement can nonetheless be satisfied. If the asset is wholly or partly a contribution and is treated by the SMSF as a contribution equal to the asset’s market value to the extent that consideration was not given for it, the market value requirement is satisfied.”

The ruling identifies that market value is at the time of acquisition. This is addressed below.

What SMSFR 2010/1 does is provide the basis for the trustee to make a determination as to whether an acquisition is covered by the amount paid in the transaction or whether the trustee needs to contemplate a contribution to make up the difference to market value. Either way, if we go back to the essence of non-arm’slength income (NALI), there is no attempt to unduly divert income into the SMSF and the capital gains tax (CGT) market substitution rules take care of ensuring the

gain represents the difference between market value on acquisition and sale price, where there is some minor chance market value wasn’t paid upfront.

Therefore, a key to these transactions is how the timing of them could impact the market value consideration to the point where the amount on a contract differs to the market value at the point the SMSF takes ownership. In the instances where this occurs, is it appropriate to then consider that the trustees have entered into a scheme to not deal with the other party at arm’s length?

TR 2010/1 provides some practical considerations that are potentially the problem.

TR 2010/1 – contributions Given that a contribution is anything of value that increases the capital of a superannuation fund, with obvious exclusions, this ruling identifies the following way the capital of a fund can be directly increased: • transferring an existing asset to the superannuation provider (an in-specie contribution).

Specifically, at paragraph 18 the ruling states: “The fund’s capital will be increased when a person transfers an asset to the superannuation provider but the provider pays no consideration or pays consideration less than the market value of the asset.”

What is critical to this transaction is what the commissioner considers the point in time that the contribution is made, which will ultimately determine what market value is used.

The following extracts from the ruling are the greatest indication as to how OMTs must occur: Paragraph 20 states: “A contribution by way of a transfer of an asset will be made when the superannuation provider obtains ownership of the asset from the contributor. The commissioner accepts the superannuation provider obtains

ownership of an asset when beneficial ownership of the asset is acquired and that beneficial ownership can be acquired earlier than legal ownership.”

So the first consideration for completing an OMT and potentially making an in-specie contribution is beneficial ownership.

Paragraph 24 states: “A superannuation provider acquires the beneficial ownership of shares or units in an Australian Stock Exchange listed company or unit trust when the provider obtains a properly executed off-market share transfer in registrable form.“ By way of detailed explanation, the commissioner provides the following at paragraph 203, thus forming the basis for any ‘in practice’ process: “Whether a contribution is made when beneficial ownership of property passes will need to be determined on a case-by-case basis. A contributor or superannuation provider who seeks to argue that a contribution of property is made when beneficial, not legal, ownership of the property passes must retain sufficient evidence of the relevant transactions and events to precisely identify when the change of beneficial ownership occurs. The evidence should show when everything that is required to be done to enable the superannuation provider to obtain registration of the change of ownership occurs. Such evidence would include relevant minutes of any trustee meeting held to consider the acceptance of the in-specie contribution, the relevant transfer forms, and any other record of when the relevant transfer took place.

In the absence of such evidence, the commissioner will treat the contribution as made when the superannuation provider obtains legal ownership of the relevant property.”

The ruling provides an example of a client who completes part of the form on 29 June and posts it to their broker who completes the rest of the form on 2 July. In this case 2 July is considered the

contribution date despite the form being completed by the client on 29 June and processed via CHESS on 5 July.

OMTs in practice Herein lies the problem with OMTs. In the example above, the trustee completes the first part of the form and the broker then completes any missing information and then lodges the form.

It is not unusual for the broker and the trustee to discuss a transfer, often linked to a contribution value, and for the broker to complete the share information, including consideration, at the time of the discussion. The form is then sent to the trustee who inevitably signs it on a date other than the date of the consideration and then returns the form to the broker who lodges it with the registry.

In almost all instances where these forms are sent between two parties the consideration date and the signing date will differ, meaning the contract value and the market value will often be different. In a volatile market the price difference can be significant.

Where does this leave SMSF trustees in contemplation of the non-arm’slength expenditure (NALE) rules? If no consideration is paid and the whole transfer is considered to be an in-specie contribution, then arguably the amount reflected in the books is unlikely to be considered NALE, but there are no guarantees. If, however, the trustees pay the seller the consideration on the form and then make up the difference as a contribution, then this is clearly in the scope of the LCR and NALE provisions would mean dividends and CGT will be NALI. That’s hardly the direction for which this law was introduced.

There is clearly a lot to play out in this space and a great deal of clarity required.

What is known is that despite the ATO position being released over 10 years ago, people still treat OMTs as if there is a magical three-month window to select a price. The fact is that simply hasn’t been the case for a long time, if ever. The easiest solution it to make sure all your dates and values align.

QUARTER I 2021 33

STRATEGY

Rethinking salary sacrifice/TTR strategies Strategies combining salary sacrifice arrangements with transition-to-retirement income streams have been significantly affected by legislative change in the past few years. Rob Lavery examines the opportunities that now exist with these plans.

ROB LAVERY is senior technical manager with knowIT Group.

Combining a salary sacrifice arrangement with a transition-to-retirement (TTR) pension has long been a strategic staple of pre-retirement planning. The tax savings combined with the ability to augment potentially reduced income has obvious appeal.

Over the past three-and-a-half years, however, there have been significant legislative changes that have impacted on the efficacy of salary sacrifice/TTR strategies. The introduction of personal deductible contributions for employees, the movement in tax brackets and offsets, and the changes to the preservation age have all shifted the goalposts.

It means now is a prudent time to take a look at salary sacrifice/TTR strategies with a fresh set of eyes to determine how SMSF members can make the most of the opportunity.

Salary sacrifice/TTR in a nutshell In brief, the strategy is for members who have reached preservation age, currently 58. The member: 1. Salary sacrifices part of their employment income into superannuation, and 2. Rolls part or all of their superannuation accumulation balance into a TTR pension, income from which can be used to supplement the sacrifice salary.

The lower rate of tax on pre-tax contributions to super, as compared to the member’s marginal tax rate, means they may be able to achieve a tax saving. If the member is aged 60 or over, the pension payments are tax free and this accentuates the tax saving.

Prior to 1 July 2017, further tax savings could be made as investments backing a pension were taxed at a lower rate than those supporting an account in accumulation phase. Since this date, assets backing a TTR pension have been subject to the same rate of tax as those in the accumulation phase. If the

34 selfmanagedsuper

member has unrestricted non-preserved benefits, or has met a complete condition of release, such as turning 65, they are able to commence a non-TTR pension and can again benefit from this tax saving on pension investments.

The strategic lens For the sake of the analysis that follows, only the taxable component of a pension is considered.

While the proportional drawdown rules don’t allow members to only withdraw the taxable component from a TTR pension, it is only the taxable component that can produce a true tax saving.

Withdrawing the tax-free component from super is similar to a member living off their accrued savings – they have already been taxed on that money before it was contributed to super, so its withdrawal does not represent a tax saving. For the purposes of this analysis, we are concerned with replacing income that is diverted to super.

Preservation age to 60 The preservation age represents the earliest time from which most members will be able to execute a potentially tax-effective salary sacrifice/TTR strategy.

On 1 July 2020, the preservation age moved from 57 to 58. Up until July 2016, preservation age was 55.

Previously, it had been common to look at salary sacrifice/TTR strategies in two groups: 1. preservation age up to the 60th birthday, and 2. those age 60 and over.

The age span covered by the first group has gradually dropped from five years to two. During that time, the tax saving on investment returns backing a TTR pension was also removed. These two factors have heavily eroded both the number of members who could benefit from such a strategy

in that age range and how much they stand to save in tax.

It should be noted tax savings are still achievable – as the example below shows. That said, the parameters here have been tailored to emphasise the benefit. The result is an example members very rarely see in real life.

Example

Joe, 58, is a sole trader. He earns $205,000 annually but does not currently contribute to superannuation. His net income is $137,983 after tax.

Joe has $500,000 (all taxable component) in superannuation. He rolls this over to start a TTR pension. The pension payment drawn from the TTR pension will increase income so he makes the maximum deductible contribution and draws the required pension payment of $19,485 to keep the same level of disposable after-tax income.

After executing the strategy, Joe will have paid $1765 less in tax when both personal income tax and contributions tax are considered. This additional saving will be in his super fund.

Given the limited benefit a salary sacrifice/TTR strategy offers members from preservation age up to age 60, the remainder of this analysis will focus on those aged 60 and older.

Salary sacrifice/TTR for members 60 and older For those aged 60 or over the simple equation to determine the member’s tax saving achieved by implementing a salary sacrifice/TTR strategy is: ax on each dollar of income sacrificed T versus Tax on that same dollar if taken as income

Lower income earners Changes announced in the 2020/21 federal budget, which have since been legislated, amended the personal income tax brackets, as well as the low income tax offset (LITO), and low and middle income

tax offset (LAMITO).

One of the peculiarities of these changes is the concurrent existence of LAMITO and the higher LITO during 2020/21.

This one-year situation erodes the value of a salary sacrifice/TTR strategy on taxable income amounts earned between $37,500 and $45,000.

In practice Tax on each dollar of income sacrificed consisting of 15% (contributions tax) Tax on that same dollar if taken as income consisting of 19% (marginal tax rate) plus 2% (Medicare levy) plus 5% (LITO reduction rate) minus 7.5% (LAMITO increase rate) equals 18.5% in total This means each dollar in this income range saves the member only 3.5 cents in tax. Even if enough was sacrificed to cover the whole income bracket, it would provide a tax saving of less than $265. Such a small saving brings the value of the strategy into question for such members.

It should be noted that from 1 July 2021, LAMITO is to be removed. This results in an 11 cents in the dollar tax saving

in this tax bracket. This will give a better outcome for members executing a salary sacrifice/ TTR strategy.

Middle to higher income earners Conversely, some middle to higher income earners get a bit of a strategic boost from LAMITO in 2020/21.

Those earning $90,000 to $120,000 in taxable income are now in the 32.5 per cent tax bracket, as opposed to the 37 per cent tax bracket. While paying a lower rate of tax is a good thing, it reduces the efficacy of a salary sacrifice/TTR strategy.

That said, in 2020/21 only, LAMITO gives the strategy a 5 per cent boost in this income range as it is part the associated taper range.

In practice ax on each dollar of income sacrificed T consisting of 15% (contributions tax) Tax on that same dollar if taken as income consisting of 32.5% (marginal tax rate) plus 2% (Medicare levy) plus 5% (LAMITO taper rate) equals 39.5% in total

Continued on next page

QUARTER I 2021 35

STRATEGY

Continued from previous page

The 24.5 per cent tax saving generated by the strategy has obvious appeal. Even in 2021/22, the 19.5 per cent saving may well be worth pursuing.

Highest income earners If an employee is on the highest marginal tax rate, the available concessional contributions cap to be filled with salary sacrifice contributions is small. Even at the lowest end of the tax bracket, superannuation guarantee contributions total $17,100.

That said, the percentage advantage in the highest tax bracket is significant (15 per cent as opposed to 47 per cent). Paying 32 per cent less tax on as little as $6250 still provides a $2000 saving – not a number to be sneezed at.

If the member’s income is not that of an employee (for example, it consists of trust distributions or company dividends), personal deductible contributions should be considered. For the strategy to work, such members must have enough super to make large enough pension payments to compensate for the lost cash flow.

Personal deductible contributions versus salary sacrifice In all the situations discussed, salary sacrifice is not the only contribution option. Since 2017, all members eligible to contribute to super have had the ability to choose whether they reduce their taxable income by salary sacrifice contributions, making personal deductible contributions or a combination of both. Salary sacrifice and personal deductible contributions both have their benefits and their drawbacks when considered in the context of a TTR strategy.

Salary sacrifice can be a set-and-forget solution. Once an agreement is established, it should be regularly reviewed, but it can be allowed to roll on in perpetuity without further action required on the part of the member. Employees will also have tax withheld at a lower rate that reflects their income net of the salary sacrifice. On the

36 selfmanagedsuper

negative side of the ledger, the member loses the use of the salary sacrificed money during the year, which could otherwise be used for a broader range of purposes, such as reducing interest repayments in a mortgage offset account.

Personal deductible contributions give greater control to the member.

It is straightforward to make the exact deductible contribution, down to the dollar, just before 30 June. The member just needs to remember to do so and not make errors in the notice. Money that sits in super for longer during the year is also exposed to investment returns for longer, which is positive in markets performing well.

Still, members need to be careful not to commence a pension that includes the contribution before the deduction is claimed. Cash-flow management is also harder in that the personal deduction is typically lumpier than regular salary sacrifice contributions and employees will have tax withheld on their salary without considering the larger deduction that will be claimed for the contribution.

The retirement/personal deductible contribution opportunity As of 1 July 2020, personal contributions to super, including those that are deductible, can be made by a member up to their 67th birthday without meeting any work test requirements. This provides a tax minimisation opportunity for those who generate significant retirement income from non-super investments. Before July this year, the same opportunity existed but it ended at age 65.

This age change is important as the age at which super is uniformly non-preserved remains 65. Thus a new two-year window has been created where preservation of super contributions, including those that are deductible, is no longer a potential drawback.

Example

Bart and Ronda are both aged 66 and have retired. They live off distributions from their family trust, rental income from their jointly-

While the concept of a salary sacrifice/ TT R strategy is not a new one, the legislative environment in which such a strategy is implemented has changed dramatically since 2017.

owned holiday house and Bart’s small account-based pension. Their assessable income is identical.

Bart takes the minimum annual payment from his account-based pension. As they approach the end of the financial year, the couple realise they have made more from renting their holiday house than usual and do not need $3000 of Bart’s pension payments.

They decide to contribute this excess income back into super. They each make personal deductible contributions of $1500 to reduce their tax bills. Even if the couple later discover they needed those funds in the short term, Bart can increase his annual pension payment and withdraw them immediately.

Resetting salary sacrifice/TTR expectations While the concept of a salary sacrifice/TTR strategy is not a new one, the legislative environment in which such a strategy is implemented has changed dramatically since 2017. It is crucial for members to rethink whether they will benefit from such a strategy and whether the degree to which they will benefit is worthwhile. Relying on pre-2017 conceptions of the strategy risks members experiencing unfavourable outcomes.

SAFAA 2021

ANALYSIS

A new cost perspective

Individuals who opt for an SMSF do so for many and varied reasons. Per Amundsen analyses why they now have the added comfort of knowing these retirement savings structures are also actually cost-effective.

PER AMUNDSEN is head of research at Thinktank.

38 selfmanagedsuper

At 30 June 2015, ATO figures showed there were 533,839 SMSFs. Five years later, at 30 June 2020, that figure stood at 593,375 – a gain of 11.1 per cent.

After exponential growth post the global financial crisis (GFC), the rate of increase of those choosing to personally manage their superannuation had fallen back to a more moderate pace.

The slowing growth rate encouraged critics of this super sector to suggest SMSFs were in decline – perhaps even terminal decline. In particular, they pointed to the 2018 and 2019 financial years when the increases were a small 1266 and 4694, respectively, to bolster their case. In 2020, that argument lost some of its validity when the increase in the number of SMSFs was 18,540, illustrating their ongoing attraction. Anecdotal evidence for 2021

suggests another solid gain, highlighting, yet again, an economic crisis does not deter individuals from setting up an SMSF. Quite the contrary.

The simple truth is a significant minority of those with superannuation balances, either in accumulation or retirement phase, want to take personal control of their retirement income strategy. Most appreciate this control comes at a price, that is, they must invest time and effort, especially if they choose not to use specialist advice. But it’s a price they are prepared to pay, even in the face of ongoing criticism that they would be better served by putting their superannuation with Australian Prudential Regulation Authority (APRA)-regulated funds.

No less a body than the Productivity Commission, in its final report into superannuation issued in January 2019, said an SMSF needed a balance of $500,000 to be cost-competitive with APRA-regulated funds.

In its draft report, it put that figure at $1 million, but retreated when it became apparent that number could not be justified.

The Australian Securities and Investments Commission (ASIC) also got into the debate with its

October 2019 fact sheet, “Self-Managed Super Funds: Are they for you?” To put it bluntly, this document cast SMSFs in a negative light, especially those funds with balances of less than $500,000. But what left the industry both angry and perplexed was ASIC’s assertion that the typical cost of running an SMSF was $13,900 a year, ignoring the fact that using averages ignores the distortions caused by large SMSFs and the use of extensive administration and investment services.

Although the document acknowledged the difficulty of comparing SMSFs with APRAregulated funds, it did just that, overlooking factors such as data consistency problems for investment returns or expense calculations and the retiree demographics of SMSFs (about 50 per cent of SMSFs are in pension phase) and the influence this factor has on asset allocation.

Unsurprisingly, the ASIC fact sheet (it has since been clarified by the regulator) caused much consternation in the SMSF community. So, it was with much relief when the ATO’s 2017/18 statistical overview of SMSFs, released in June 2020, showed the median ‘operating expense’ of SMSFs was $3923 a year. The tax office published more granular expense data, finally considering the significant distortions caused by large SMSFs and funds choosing to use borrowings and buy extensive administrative, insurance and investment services.

What the ATO overview did was issue new tables breaking down median and average expenses by type and fund size, as well as streamlining operating expenses to include auditor fees, management and administration expenses, other amounts and the SMSF supervisory levy. In doing so, it allowed the regulator to conclude an SMSF with a typical establishment balance of between $200,000 and $500,000 would have a median operating expense of about $3400 – a far cry from $13,900.

The final nail in the coffin for those arguing that SMSFs are not competitive on cost compared with APRA-regulated funds came when actuarial firm Rice Warner released

a comprehensive research report last November that conclusively showed SMSFs with balances above $200,000 were holding their own on a cost basis.

It is a similar story on investment returns.

Various reports have shown those who opt for an SMSF are not greatly disadvantaged compared with APRA-regulated funds, especially when the more conservative asset allocation reflecting a demographic profile much older than the average APRA fund member is considered.

On this issue, the Rice Warner report said: “It’s not possible to provide detailed statistics on the investment performance of individual SMSFs from public data because there is no reporting requirement. The annual ATO statistics do, however, allow an approximate aggregate return to be calculated for the whole sector and compared to the equivalent return for APRA-regulated funds.

“It should be noted that this approach aggregates funds and investment portfolios with different asset allocations and different investment objectives. Individual funds will therefore have performed both better and worse than these averages.

“Nonetheless, the approach provides a useful high-level comparison [and it shows] the SMSF sector has delivered equivalent returns to those of the APRA sector since 2005 in both good years and bad years.”

Something important to recognise is the report’s acknowledgement that: “These results may not support the proposition that SMSFs are better investment managers than APRA funds, but they do indicate that members of SMSFs, in aggregate, are not disadvantaged when compared to APRA funds. “[As would be expected], the larger SMSFs enjoy higher rates of return than the smaller ones, reflecting their more extensive and diversified investment portfolios.”

As a lender to the sector, Thinktank takes solace from these reports that have a positive story to tell about SMSF costs and investment returns. It is heartening to know this important part of our customer base largely competes on an equal

footing. But even if these reports were not as flattering of SMSFs, it’s my strong suspicion many trustees would still opt for this retirement income strategy.

I have long held the view that while costs and investment returns are important, they are certainly not the only reasons why SMSF trustees establish their own funds. Far from it. So, I was intrigued when the SMSF Association released the results of its survey, “Is an SMSF the right answer for you?”, of nearly 800 SMSF trustees during SMSF Week last November that showed the decision to set up a fund was not a simple analysis of costs and returns.

What it revealed, and this was unsurprising, was that an individual’s desire for control over their own personal retirement income goals was a major factor. Other reasons cited included flexible investment choices, dissatisfaction with an existing fund, and tax and estate planning. The survey also gave other insights into a trustee’s SMSF experience including: • eight out of 10 trustees believe their SMSF is good value for money, • nine out of 10 trustees believe managing and engaging with their own SMSF provides them with a level of satisfaction, • around half of all SMSF trustees own or have owned a small business, • the majority of SMSF trustees spend between one to five hours a month administering their SMSF, and • over half of the SMSF members surveyed have run their own fund for over 10 years.

For me this all helps explain why SMSF critics become so exasperated. From their perspective the evidence, or what they perceive to be the evidence, has them rhetorically asking: “Why take on all this responsibility, often at greater cost and for poorer performance, when an APRAregulated find can do it all for you?” They simply overlook the human factor; that for many it’s a conscious decision to ensure they are in the driver’s seat. Furthermore, they enjoy the drive.

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QUARTER I 2021 39

STRATEGY

Table 1: Median investment returns of SMSFs by fund size (2017-19) 2017 investment returns (%)

2018 investment returns (%)

2019 investment returns (%)

0-50,000

2.52

2.26

1.95

>50,000-100,000

2.53

2.29

2.42

>100,000-200,000

4.56

3.86

4.30

>200,000-500,000

7.07

6.02

6.43

>500,000-1m

8.64

7.00

7.76

>1m-2m

9.16

7.57

8.15

>2m-5m

10.28

8.11

8.49

>5m

11.83

8.35

8.47

Asset ranges ($)

Source: Rice Warner Report: Cost of Operating an SMSF 2020

Continued from previous page

When you consider the background of many SMSF trustees it is hardly surprising. Small business people, farmers, professionals, contractors, people for whom making financial decisions – often difficult ones – is part and parcel of their lives. Why would they think differently when it comes to their superannuation?

These qualitative factors aside, it is reassuring SMSF trustees are not being disadvantaged on cost. Indeed, the Rice Warner research went further than this, saying funds with balances of $200,000 or more are cost-competitive with industry and retail superannuation funds and those with balances of $500,000 or more are typically the cheapest alternative.

The numbers are revealing. Even balances between $100,000 and $150,000 are competitive with APRA-regulated funds, provided a cheaper service provider is used or trustees do some of the administration.

For balances of $250,000 or more, SMSFs become the cheapest alternative provided the trustees do some of the administration, or,

40 selfmanagedsuper

if seeking full administration, choose one of the cheaper services. It is only when SMSFs fall below $100,000 that they stop being competitive compared with APRA-regulated funds, while funds with less than $50,000 are more expensive than all other alternatives.

There is one final point worth making.

The lower an SMSF balance, the worse the investment performance compared with APRA-regulated funds. As the Rice Warner research shows, investment performance directly correlates to SMSF size (see table 1). For the average SMSF with a balance between $100,000 and $200,000, their average investment returns lag their APRAregulated cousins. But once an SMSF breaks through the $200,000 barrier in funds under management, the difference between the two superannuation sectors starts to narrow, a trend that becomes even more noticeable once the $500,000 milestone is achieved.

According to Chant West data, the average return of a median APRA-regulated growth fund for the 2017, 2018 and 2019 financial years was 10.8 per cent, 9.4 per cent and 7 per cent respectively.

This is hardly surprising. Once SMSFs hit

$500,000, and remember, 63 per cent of SMSFs had balances exceeding $500,000 and only 15 per cent had balances below $200,000 in 2019, they have greater investment flexibility, typically allowing them to enjoy higher returns. By contrast, funds with lower balances are weighted towards cash and term deposits and have less exposure to shares, property and managed funds.

But as the SMSF Association survey found, smaller SMSFs are prepared to play the waiting game, appreciating higher returns will come as their balances grow. And many grow quickly. The Rice Warner research shows that of 8043 funds with balances of less than $200,000 in 2017, 3208 or 40 per cent had broken through this barrier by 2019, with 24 per cent doing so in the first year.

Like any responsible lender, Thinktank would never suggest SMSFs are for everyone.

These funds do not suit everyone’s risk profile or simply a willingness to actively engage in their superannuation planning. But for those that do, the rewards, financial and personal, are there. The added comfort factor is they are largely doing so on a level playing field with their APRA-regulated cousins.

STRATEGY

A radical SMSF approach – part two

Grant Abbott continues to examine the possibility of having a multiplemember SMSF with a single trustee structure in the second part of this series.

GRANT ABBOTT is a director of I Love SMSF.

In the first part of my three-part series on a new radical way of running an SMSF I looked at the responsibilities of being a trustee. My argument is that, as advisers, we have been cavalier in setting up SMSFs where all members are trustees or directors of a corporate trustee. For many members, well advanced in age or lacking moderate financial and management skills, the role of trustee is an extremely high competency bar to attain. After all, consider your existing SMSF clients – how would they go sitting a basic SMSF trustee test?

The main focus in the first part was on the financial perils of being a trustee and to that end we looked at section 166(1) of the Superannuation

Industry (Supervision) (SIS) Act 1993 and also the commissioner of taxation’s statement on the impact of the section: Practice Statement Law Administration (PSLA) 2020/3 – Self-managed superannuation funds – administrative penalties imposed under subsection 166(1) of the SIS Act. In PSLA 2020/3, the tax commissioner noted that, quite apart from set administrative fines, that he could also use the following: • issuing a direction to educate, • accepting an enforceable undertaking, • issuing a direction to rectify, • disqualifying an individual and prohibiting them Continued on next page

QUARTER I 2021 41

STRATEGY

One of the first things I teach any student is the statutory right to be sued by members of an SMSF where the individual has made a loss as a result of a breach of the laws or fund trust deed by the trustee or their adviser, auditor and/or accountant.

Continued from previous page

from acting as a trustee of a super fund or as a responsible officer of a corporate trustee of a super fund, • issuing a notice of non-compliance to the fund, and • seeking civil and/or criminal penalties through the courts.

These actions by the commissioner are significant, but can also lead to member compensation laws that catch advisers, auditors and accountants in the compensation for loss or damages trap.

Legal actions brought by members One of the first things I teach any student is the statutory right to be sued by members of an SMSF where the individual has made a loss as a result of a breach of the laws or fund trust deed by the trustee or their adviser, auditor and/or accountant. I bring the accountants and advisers into the equation because advising on SMSFs is not just all upside – there are plenty of risks as auditors have found out in the last couple of years through negligence actions via the law of equity (a non-statutory law).

It is important to note if you are an SMSF adviser, auditor or administrator, the following legal analysis is probably the most important area under the SIS Act and one that can cause the downfall of an SMSF and all its advisers in quick fashion.

So commit the following to heart and make sure all your assets are protected.

Section 54C of the SIS Act deals with a breach of the governing rules of a superannuation fund, including an SMSF. The section provides: (1) A person must not contravene any other covenant contained, or taken to be contained, in the governing rules of a superannuation entity.

This section, designed to safeguard members’ interests in a superannuation fund, is cast wide such that a person (not just the trustee) who must not contravene the governing rules of a superannuation entity would include: • fund trustee,

42 selfmanagedsuper

• • • • • •

auditor to the fund, fund administrator, legal adviser to the trustee of the fund, fund insurance agent, commissioner of taxation, Australian Securities and Investments Commission representative, • fund accountant, • Australian financial services licensee.

Again, it is important to acknowledge the section applies to a person and not just the trustee. For example, if the trustee of an industry super fund refused to transfer superannuation benefits in a timely manner in accordance with its trust deed, then the directors of the corporate trustee are personally liable and can be sued jointly and severally.

What are the governing rules?

Section 10(1) of the SIS Act provides that governing rules in relation to a fund, scheme or trust means: a. any rules contained in a trust instrument, other document or

legislation, or combination of them, or b. any unwritten rules governing the establishment or operation of the fund, scheme or trust.

This means all the provisions of the deed form part of the governing rules of the SMSF. It also includes other documentation regarding the establishment and operation of the fund, including the establishment of a member interest, the commencement of a pension, the creation of an investment strategy, contributions minutes, the investment strategy, the valuation of assets of the fund, binding death benefit nominations (BDBN) and so on.

Application of the law To see the section in action, let’s look at the issue of investment strategies, which are currently the subject of much discussion by the ATO and auditors alike.

First off, we know the investment strategy of the SMSF forms part of the fund’s governing rules either directly through the fund’s trust deed or the deemed inclusion of fund investment strategy requirements under section 52B(2)(f) of the SIS Act. Importantly, if the investment strategy is not followed, then there is a breach of section 54C of the act. Likewise, if the accountant to the SMSF completes an investment strategy that provides for a 0 per cent to 100 per cent allocation to various asset classes, which does not constitute an investment strategy (see the tax commissioner’s public guidelines), then the trustee and accountant will be in breach of section 54C. This can include the SMSF auditor as well if they do not recognise this as a contravention.

Getting down into the weeds a bit further, consider an investment strategy that provides for 60 per cent to 80 per cent of the SMSF’s investments to be in equities and 30 per cent to 40 per cent allocated to cash. Now if the fund trustee sells the equity portfolio down to purchase residential property, without amending the investment strategy, then a breach of the governing rules will have taken place.

Likewise, if the trust deed of the fund is

old and only allows an allocated pension to be taken by a member under SIS Regulation 1.06(4), and this could apply to all deeds drafted before 2007, then the payment of an account-based pension under SIS Regulation 1.06(9) would breach the governing rules of the fund, notwithstanding that it is allowed under the superannuation laws. The action would contravene the SMSF deed and that is a section 54C breach.

Further, if the SMSF trust deed provides that any BDBN must be in accordance with the SIS Act, as the rules relating to BDBNs in section 59 do not apply to SMSFs, then if the fund is a regulated SMSF, the nomination cannot be binding. The deed would need to have its own policy on what is an effective BDBN. No policy and no binding nomination.

The legal action Now comes the fun part – who can get sued, who can be a party to the suit and for how much?

Section 55(3) of the SIS Act is pivotal and provides as follows (3) Subject to subsection (4A), a person who suffers loss or damage as a result of conduct of another person that was engaged in in contravention of subsection 54B(1), 54B(2) or 54C(1) may recover the amount of the loss or damage by action against that other person or against any person involved in the contravention.

The three keys are: 1. A person (see above) has contravened section 54C by breaching the fund’s deed, documents relating to the fund, such as pensions, investment strategies, death benefit nominations or the laws relating to SMSFs. 2. A person has suffered a loss or damages because of the breach by the person in 1 above.

3. The person suffering the loss has standing under the SIS Act (a statutory action) to commence an action to recover those losses and damages, which will need to be ascertained by a

court of competent jurisdiction.

It must be recognised this is not a negligence claim and there is no defence.

Simply show someone, be it a trustee, accountant, auditor or lawyer, has breached the fund’s governing rules and that your client has suffered a loss as a consequence of the breach and then head to court to recover the loss or damages suffered. Deadly simple in its perfection.

Section 55(3) of the act showed up in Dunstone v Irving [2000] VSC 288. In that case, the plaintiff Dunstone was suing the trustees of the fund for not paying his superannuation benefits as required under the fund’s deed. His business partner, Irving, was upset Dunstone’s super balance was twice the size of his. The case found its way to the Supreme Court of Victoria 20 months after the request for payment of superannuation benefits was made, thereby depriving Dunstone of his superannuation monies for the period, as well as any investment gains over the deprivation period.

Justice Hansen in his judgment noted: 141. The plaintiff sought a declaration as to his entitlement in the fund and it is appropriate to grant it. That was $1,365,478 as at 23 February 1998.

142. In view of the history of this matter I will also order that within a limited period, which Mr Garde suggested be in the order of 30 days, the defendant do all things necessary to effect a transfer to or at the direction of the plaintiff of the amount to which he is entitled.

143. The other aspect of relief is a claim for damages, being the loss suffered by the plaintiff as a result of not having the use of his entitlement. The plaintiff sought damages either under s 55(3) of the SIS Act or on account of the defendant’s breach of his obligations as trustee. Mr Berglund did not address a submission as to the basis on which damages, or an award of compensation in equity for a breach of trust, might be awarded, and in view of the conclusions I have reached it is unnecessary to do so. I have accepted the evidence of the

Simply show someone, be it a trustee, accountant, auditor or lawyer, has breached the fund’s governing rules and that your client has suffered a loss as a consequence of the breach and then head to court to recover the loss or damages suffered. Deadly simple in its perfection.

expert Romic in relation to calculations.

I also accept his opinion that, in effect, $1,614,340 is a conservative estimate of what the plaintiff’s entitlement would be worth as at 30 April 2000. This amount, being what the plaintiff would have obtained in a balanced fund, is less than the $1,692,974 he would have achieved if he invested the entitlement as he stated he would have, but in my observation the plaintiff is a cautious man and the return from investment in a balanced fund is more reflective of the likelihood of investment he would have made.

Given all of the above, is there any wonder a member of an SMSF might be reluctant to take on the responsibilities of acting as a trustee as well. However, section 17A(3) of the SIS Act provides an opportunity to avoid these potential trustee pitfalls and presents a path to the new way of running an SMSF. This will be covered in the next part of this series.

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43

COMPLIANCE

A potential auditor independence solution

The amended APES 110 independence standard threatens to wipe out SMSF audit revenues for many accounting practices. Kevin Bungard looks at how exchange programs may help, and outlines the strict requirements they must meet, in allowing firms to retain their SMSF audit businesses.

KEVIN BUNGARD is Australian general manager at MyWorkpapers

44 selfmanagedsuper

The APES 110 Independence Guide, released by the APESB in May 2020, has had huge implications for SMSF auditors and industry estimates are that 200,000 to 300,000 funds may be affected.

MyWorkpapers surveyed its client base in September 2020 and the results showed just over 60 per cent of accounting practices are impacted by the prohibition on ‘in-house’ auditing of SMSFs. The survey also showed that, on average, in-house audits made up just under 80 per cent of audits for the firms conducting them.

If these percentages are reflected across the entire industry, then 290,000 SMSFs will need to put in place a new audit arrangement effective from 1 July 2021.

Under the new standard, firms must outsource the audit of SMSFs they administer, and many firms have been looking for a way to avoid cutting staff

that would be made redundant by this measure and get a return on the investment put into building that part of their business.

After exploring the use of exemptions, business restructuring and the possibility of spinning out or selling their audit divisions, many firms remain deeply frustrated with the options available.

One option firms have explored is pooling or exchanging audits among a group of practices.

Before exploring the dos and don’ts of how audits might be ‘exchanged’ between firms, let’s quickly cover off some of the other options firms may have considered and rejected.

Exemptions and restructuring do not work Much has been written about the routine and mechanical exemption. Many firms had hoped there was a way to split responsibilities within the

Figure 1

What is the average SMSF audit fee that you charge?

706

$

What is the average SMSF audit fee you pay for an outsourced audit?

Margin available for admin firm to charge for preparing & facilitating audit?

536 +32%

$

firm or restructure related businesses so a firm or group could continue to do both the accounts and the audit for their SMSF clients.

Not only does use of the exemption and business structures not work, but attempting to do so is also clearly against the intent and spirit of the new standard.

The relationship between the accountant and auditor must be truly independent and, as such, even a partial ownership in the new business would put you in breach.

You need to completely separate the businesses via a sale or spin-off for a restructure to be compliant.

Too late to spin off If you had acted within the first couple of months of the new guide coming out in May 2020, then you could have spun off your audit division into a separate business and may have been able to meet the requirements of the independence standard that would allow you to perform audits for your former firm after 30 June 2021.

If, however, you had not acted by 30 June 2020, then the compliance challenges become significantly harder. The closer we get to 30 June 2021, the more impractical a stand-alone spin-off of the audit division becomes.

The standard’s two-year rule, which prohibits a former employee from auditing any work that was performed at their former employer while the auditor was previously

employed there, is likely to become an insurmountable challenge.

A more realistic option would be to sell the SMSF audit division into a larger SMSF audit firm, but, unfortunately, the timing for doing that is not great either.

Timing poor for SMSF audit arm sell-off Firms that have looked at selling their audit division have reported great difficulty in doing so, especially as it is essentially a forced sale.

Feedback from those firms that have tried this is that simply getting a valuation equal to a single year’s revenue is challenging.

When you consider specialist SMSF audit firms are expecting huge growth from accounting firms being forced to outsource the audit of perhaps 200,000 to 300,000 SMSFs across the country, it is easy to see why specialist audit firms are unlikely to be motivated to buy in-house audit businesses now.

On the other hand, it seems the valuations of established, independent audit businesses will in all probability have increased significantly given the extraordinary growth they are expecting in coming months.

Outsourcing is possibly best option The obvious option is for a firm to wind up their SMSF audit business and simply outsource the audit of the SMSFs they administer to a specialist auditor.

This option can meet some important goals for the business. Firstly, the firm is likely to retain the revenue, albeit at a different level of margin.

The revenue is kept because it is common practice for the accounting firm to bill the SMSF for the audit, either as a discrete service or as part of an administration package, rather than the fund paying the auditor directly – nothing in the new standard prohibits this practice continuing.

Secondly, this approach also allows the accounting practice to mark up the price of the audit and recoup the expense of engaging and managing the audit relationship and doing the extensive preparation work that is required to streamline and minimise the cost of getting an external audit done.

In the survey of MyWorkpapers users from September 2020 there was a difference of 32 per cent between the average fee a fund paid for an audit and what was paid to the outsourced auditor (see figure 1).

It also seems likely firms could justify an audit fee increase by explaining to the trustees that the amended standard has forced them to outsource the work and incur the additional costs of doing so.

In summary, outsourcing to a specialist auditor is the most straightforward solution while still offering the firm an opportunity to retain revenues, recover costs and make at least some margin.

Outsourcing best option for subscale audit divisions Outsourcing is probably the best option for firms that are not really committed to auditing as a service line. Certainly, for a practice performing less than 50 audits a year outsourcing is probably their only real option – other firms are generally reluctant to outsource their audits to someone who only does a handful of audits, so sub-scale firms are not good candidates for the exchange services we are about to discuss.

Continued on next page

QUARTER I 2021 45

COMPLIANCE

Continued from previous page

Firms don’t want to give the audit away Firms that have built a great SMSF audit team are, understandably, reluctant to downsize and most business owners would agree writing off a hard-won book of business should only be a last resort.

The independence standard means outsourcing itself is inevitable; you simply cannot audit your own funds. But what if your business could get something back for outsourcing work to another firm?

Doing this is the objective of an audit exchange program, and doing it in a compliant manner is the challenge.

Chaining, pooling and other ways to exchange audits Under the independence standard, reciprocal audit arrangements are not allowed; directly swapping audits with another firm does not deliver independence.

Some auditors have discussed the possibility of creating a chain of firms or creating pools of audits to avoid the direct swapping of audits between firms.

There are various models to consider when looking at doing this, but some of the simpler ones present both independence and operational challenges.

Chaining If you have three or more firms, you can chain them together to avoid direct swaps.

In this model, Firm A does audits for Firm B, which does Audits for Firm C, which then does audits for Firm A. Unfortunately, this model is unlikely to meet independence requirements for a number of reasons: • Networks are not allowed – the arrangement may be viewed as a network. The definition of a network is very broad in the standard: “a larger structure that is aimed at cooperation” and “is clearly aimed at profit”, is sufficient to meet the definition of a network, and ‘in-network’ audits are not allowed.

46 selfmanagedsuper

• Familiarity risk – if the parties all know each other, and particularly if they are from the same geographic area, then there is a familiarity risk to independence, which is highlighted in scenario 10 of the guide.

• Fee dependency – if the auditors are not generating enough other revenue outside of the audits gained via this chain, then they may be viewed as fee dependent on the arrangement. Under the standard, one referrer providing a large portion of an auditor’s work is seen as a self-interest and intimidation threat to independence.

Operationally, this model is limited in that: • Size matters – ideally each firm should be the same size and if they are not, then the exchange size is limited by the smallest party. For example, if firm C is half the size of firm A, then firm A will get back only half the audits they were expecting.

• Weakest link – if one party decides to not participate, then the whole chain may collapse.

Random audit pools are not practical

Pools

Rather than a random pool, at the individual audit level: a. an administrator would like to have as small a number of auditors to work with as possible (there is some debate in the industry about the benefit of panels and of being able to spread work across multiple firms, so the ideal number may not be one), and b. an auditor, once assigned to a particular fund, would generally like to maintain that relationship in future years.

Instead of pooling individual audits, a more practical and efficient model is one where firms wishing to exchange audits are matched and introduced to other firms while meeting the above criteria.

Another approach firms have explored is pooling arrangements. A pooling arrangement is where a group of accounting firms, having previously relied on Chinese wall arrangements to meet auditor independence requirements, place their SMSF audit clients into a pool to have them redistributed among the members of the group.

Pooling can address both of the operational challenges that chaining has around size and dropouts, provided there are enough participants in the pool.

Pools can also address the fee dependence issue as long as there are enough firms to meet the requirements.

The approach here is to allocate funds from enough other firms that the percentage of work coming from any one referrer is below the required threshold.

Pools may still have the familiarity risks and network problem that chains have, but before we look at those issues, let’s look at an operational challenge that is unique to pools.

A simplistic model for pooling might work by randomly allocating audits to a wide range of participating auditors each year (while avoiding reciprocal swaps, of course).

This approach would be inefficient and costly because: a. an administrator does not want to deal with too many separate audit firms that may all have different processes, and b. an auditor does not want to audit new SMSFs every year. Auditors typically perform a number of tasks when they first audit a fund and these go into a permanent file that is referred to in subsequent years and may only be revisited periodically thereafter. For example, once a trust deed has been reviewed, unless it changes, legislation changes or there is some other reason to review it, an auditor does not need to do so in each following year.

Matching and introductions versus audit pooling

Familiarity risk and co-ops versus independent operators The familiarity risk can be a factor in chains or pools using cooperative arrangements to exchange funds between firms. This risk can be eliminated by ensuring that rather than being run as a cooperative of

firms that all know each other, the program should be run by someone independent of the participants.

Additionally, the participants in the program should only know the other parties they directly interact with and ideally the parties should not be from a single region to ensure they are less likely to have other commercial or community relationships.

Networks and ongoing programs Whether a program is pooling audits individually or matching them at the firm level, there is still a risk of failing the independence standard if the arrangement is seen as being a network.

The network constraint is a significant problem for any program that has centralised and ongoing control.

Additionally, if an operator in one these ongoing models controls who gets what business over coming years, then they become the effective referrer of that work.

As noted above, a large referrer represents a self-interest and intimidation threat to the independence of the program participants. For example, an auditor may fear being expelled from the network if they did not toe the line when pressured to do so by a pool operator.

There may be ways to overcome these concerns and satisfy the regulators that an ongoing program does not compromise independence, but more straightforwardly, if there is no ongoing central operation at all, then there is no threat to independence.

The ongoing network can be eliminated by having the exchange program operator match and introduce firms based on what they contribute to a pool, but once introductions are made, the exchange operator plays no part in the contract the parties sign and has no further involvement in the future of that relationship.

Essentially, the exchange operator acts like an external sales agent, introducing parties but having no ongoing account management role.

Is exchanging audits in the spirit of the standard?

The stated goal of the standard is to address threats to independence in relation to audit, review and assurance engagements. Further, it makes clear the goal is to deliver actual and perceived’ independence.

If an exchange program delivers clearly independent relationships and addresses all the risks and threats outlined in the standard, then it should be compliant in both the letter and the spirit of the standard.

What about regulators?

MyWorkpapers is the operator of an exchange program that follows the principles discussed in this article. In that role, MyWorkpapers is committed to ensuring compliance with all aspects of the independence standard.

In addition to seeking professional advice around compliance, MyWorkpapers also asked the ATO to review what it was planning to do. Without implying, in any way, that the ATO has any position on the detail of what MyWorkpapers is doing, the regulator was kind enough to review and provide feedback on the plans.

The result was the regulator had no substantial objection to exchange programs that meet the principles that we have outlined.

The industry needs something like this Firms currently doing in-house audits have few viable options available to them to retain their SMSF audit business. The loss of this business, in the current pandemicaffected economy, could be devastating to those firms.

If, as estimated, upward of half of all SMSFs need to change auditor this year, then virtually all specialist auditors would, on average, need to double in size to meet demand.

Understandably, there is grave concern in the industry about whether all current specialist auditors can grow that quickly.

Is it practical to assume the auditors displaced from in-house audits will find a place with specialist auditors and if not,

The critical aspects of a compliant exchange program are: • It should be run by an independent operator to avoid familiarity risk, • It must not create an ongoing network – the arrangements, once established, must be truly independent of one another, • The parties must not be dependent on one another for any other reasons, such as having community or other commercial links, the level of referrals received from one source should be taken into consideration to avoid fee dependence, and practical matching and allocation are required – random allocation of audits should be avoided.

where will the required staff come from? If demand outstrips supply, what does that mean for the price of independent SMSF audits?

Audit exchanges offer a compliant way to lessen the business loss across many accounting practices, to act as a catalyst to restructure the industry around independence and to reduce the incredible demand that is expected to be placed on specialist auditors picking up displaced audits.

Conclusion Outsourcing your SMSF audits in exchange for audit work from other firms in a similar situation can, with care, be done in a compliant manner.

Accounting firms and the industry need a solution like this to have a hope of dealing, cost effectively, with the impact of the new independence standard in the time frame required.

QUARTER I 2021 47

STRATEGY

The ECPI evolution The rules around exempt current pension income are about to change significantly. Mark Ellem details how different the new parameters are and the impact they will have on SMSFs.

MARK ELLEM is head of education at Accurium.

Superannuation features in two parts of the three-pillar structure of the Australian retirement income system: compulsory saving through the superannuation guarantee and voluntary superannuation savings. Voluntary super savings are incentivised via income tax concessions, both in the contribution or accumulation phase and the retirement or drawdown phase. The tax concessions that apply in the retirement phase are set to be revised, with the federal government having proposed changes to the way an SMSF claims exempt current pension income (ECPI).

The tax concession for super funds with retirement-phase pensions A superannuation fund can claim a portion of its ordinary and statutory income as exempt from fund income tax where it pays retirement-phase pensions and complies with the relevant pension minimum standards in the Superannuation Industry (Supervision) Regulations. Over the years, the claims

by SMSFs for ECPI have amounted to a substantial portion of assessable income and consequently a substantial level of income tax concessions for the sector. This has resulted in a focus by the ATO on SMSFs’ claims for ECPI to ensure the income tax concessions are legitimately applied.

Further, with the introduction of the 2017 super reforms and particularly the introduction of the transfer balance cap (TBC) and the removal of eligibility to claim ECPI in relation to transition-toretirement income streams, we’ve seen a reduction in the claiming of ECPI by SMSFs, with the result being a saving to the government of this income tax concession to the budget bottom line. This is illustrated in graph 1, based on the 2017/18 ATO taxation statistics.

48 selfmanagedsuper

In the 2017/18 income year, around 43 per cent of SMSFs claimed ECPI, totalling $14 billion. While this is a very valuable income tax concession, we can see this is the lowest amount of ECPI claimed

by SMSFs covering the income years 2013/14 to 2017/18, inclusive. The greatest amount of ECPI claimed was during the 2016/17 income year. This makes sense, as 2016/17 was the final income year prior to the introduction of the TBC, which limits the amount of a member’s superannuation accumulation benefits that can be transferred to retirement phase and capped a member’s total existing retirementphase pensions at 30 June 2017 at $1.6 million.

The 2016/17 income year also was the year the capital gains tax (CGT) relief could be applied.

Where an SMSF did apply CGT relief under the proportionate method, any resulting notional capital gains that were not deferred would have had the effect of increasing the amount of total assessable income and also would have increased the amount of ECPI claimed. Further, as noted, from the 2017/18 income year, a TRIS not in retirement phase was ineligible for claiming ECPI, thus contributing to the reduction in total claims for ECPI in 2017/18.

An analysis of ECPI as a percentage of total SMSF income shows a reduction from around the low 50 per cent mark (ranging from a low of 51.11 per cent in 2015/16 to a high of 58.02 per cent in 2016/17) to around 35 per cent in 2017/18, the first year after the introduction of the super reforms. It will be interesting to see the ATO SMSF statistics for future income years to ascertain if the level of ECPI claims continues in a similar manner, that is, around 35 per cent.

ECPI evolves We know there are two methods an SMSF can use to claim ECPI: the segregated method and the proportionate (also known as unsegregated) method. Prior to the 2017/18 income year, it was industry practice to only use the segregated method in the following scenarios: 1. The SMSF trustee(s) prospectively and intentionally set aside fund assets solely to

$25.5b

$20.6b

$28.5b

$14.0b

Graph 1: Total ECPI claimed by SMSFs

$19.3b

discharge pension liabilities, or 2. The SMSF consisted wholly of pensions for the entire income year. This scenario is commonly referred to as deemed segregation, where all SMSF assets are funding member pensions.

Where an SMSF consisted wholly of pensions for only part of an income year, industry practice was to apply the proportionate method for the entire income year, similar to an SMSF that had a mixture of pension and accumulation accounts throughout the income year. Further, the industry approach was to apply only one ECPI method for the income year.

Claiming ECPI then took a dramatic Darwinian leap when in September 2017 the ATO confirmed its accepted approach to claiming ECPI was going to differ from the approach used by the sector for many prior income years. At this point it is important to note there was no actual change to the relevant Income Tax Assessment Act 1997 (ITAA) provisions for claiming ECPI. So, the new approach to claiming ECPI was not a consequence of a change in legislation, predicated by a government announcement, but was instead due to the ATO making the industry aware of its view on how the existing provisions in the tax act should be applied.

The new approach effectively only applied from the 2017/18 income year, as the regulator made an administrative concession in relation to its compliance approach for the 2016/17 and previous income years.

This new approach to applying the unchanged ECPI provisions in the tax act affected SMSFs that had a period of less than the entire income year where it consisted wholly of pensions. Where an SMSF has a period of the income year where it consists wholly of pensions, the segregated method will apply in relation to claiming ECPI for that period. This can result in the SMSF claiming ECPI under different methods during the income year.

Consider the scenario in figure 1 on the following page.

During the period 1 July to 31 December, there is one member with an accumulation interest and one member with a retirement-

2013-14

2014-15

2015-16

2016-17

2017-18

phase pension interest. The fund has not segregated any assets between pension and accumulation interests and consequently to claim ECPI for this period the proportionate (unsegregated) method will be used.

The accumulation member commenced a retirement-phase pension on 1 January with all of their benefits held within the SMSF. Consequently, from 1 January the SMSF consists wholly of retirement-phase pensions, meaning the segregated method will be used to claim ECPI for this period. Consequently, the SMSF will apply both ECPI methods for the income year.

However, section 295-387 of the ITAA dictates this does not affect an SMSF that has ‘disregarded small fund assets’ and, as such, funds in this situation are not permitted to use the segregated method to claim ECPI. That is, they would use the proportionate (unsegregated) method for the entire income year.

This approach to claiming ECPI has been applied to the 2017/18 and following income years.

The next evolutionary step for ECPI On 2 April 2019, as part of the 2019/20 federal budget, the government announced the following ECPI related proposals: 1. The government will allow

Continued on next page

superannuation fund trustees with interests in both the accumulation and retirement phases during an income year to choose their preferred method of calculating ECPI. 2. The government will also remove a redundant requirement for superannuation funds to obtain an actuarial certificate when calculating ECPI using the proportionate method, where all members of the fund are fully in the retirement phase for all of the income year.

These measures were to commence on 1 July 2020 but were deferred until 1 July 2021.

At the time of writing, no draft legislation has been released regarding this amendment.

The balance of this article focuses on the first proposed change.

The proposal to allow trustees a choice on how they calculate ECPI has come about from the disruption and complexity caused by deemed segregation. However, we have to ask if the new approach to claiming ECPI, applied since the 2017/18 income year, is still a problem.

From 2017/18 onwards the industry has allowed for deemed segregation in ECPI Continued on next page

QUARTER I 2021 49

STRATEGY

Figure 1 1 Jan

1 July

Unsegregated method Actuarial certificate required with ECPI% to apply Eligible assessable income x ECPI%

Continued from previous page

calculations. With the collaboration of service providers in the lead-up to the 2017/18 compliance reporting season, much work was done to facilitate this change. Most software platforms now allow for deemed segregation as part of the actuarial certificate and administration process. However, those who prepare annual financial statements manually or use spreadsheeting software will be adversely impacted by the complexity associated with deemed segregation.

In some cases, deemed segregation can lead to materially different tax outcomes, sometimes better and sometimes worse, than if the proportionate or unsegregated method was used. Generally this only occurs where there is a significant capital gain or loss, or lumpy income earned in the year.

For funds without disregarded small fund assets, deemed segregation presents an opportunity to think strategically and create or take advantage of deemed periods in order to optimise tax outcomes. However, those who inadvertently experience a deemed period can be caught unawares.

Optimal ECPI evolutionary design The language from the budget proposal suggests an SMSF not solely in retirement

50 selfmanagedsuper

+

30 June

Segregated method No actuarial certificate required Eligible assessable income

phase over an entire income year might be given the option of using the proportionate or unsegregated method for the entire income year, even if there are periods where the fund was solely in retirement phase – periods of deemed segregation. This would remove the complexity of deemed segregation for those who did not wish to allow for it.

What is unclear is whether this ‘choice’ can be made in arrears when completing the SMSF annual return, or whether it would need to be decided in advance.

Accurium’s actuarial certificate data for the 2018/19 income year revealed: • 11 per cent of funds that applied for an actuarial certificate had deemed segregation, • of those funds that had a period of deemed segregation, 89 per cent had only one deemed period and 11 per cent had more than one deemed period during the year, • only 0.1 per cent of funds that applied for an actuarial certificate had elected segregation, • it is estimated only 3 per cent of all SMSFs in 2018/19 used both the segregated and proportionate method to claim ECPI, due to the presence of deemed segregation, and

=

Total ECPI

• fewer than 0.01 per cent of SMSFs used both methods as a result of electing to segregate certain assets.

It will be interesting to see how this ‘choice’ is drafted in the legislation and whether any other complexities or inconsistencies will be introduced in trying to make this allowance, particularly as the complexity introduced from the 2017/18 income year was not as a consequence of amendments to the relevant ECPI provisions in the ITAA. Having choice may be best for taxpayers, but it may cause added complexity for those attending to the SMSF’s annual compliance requirements. Some might even suggest there’s an argument to retain the status quo, after all the industry has done all the hard work to accommodate the 2017/18 changes.

Others might suggest an alternative would be to constrain deemed segregation to SMSFs wholly in retirement phase for the entire income year, effectively returning to the industry’s pre-2017/18 approach.

Accurium will be releasing an Insights Report on ECPI, the proposed changes and further analysis of our findings of trends in claiming ECPI at the SMSF Association 2021 National SMSF Conference. We will also be asking for your views on ECPI changes, if any, you would like to see.

COMPLIANCE

After the relief

The COVID-19 pandemic saw short-term financial relief measures introduced to make the repayment of limited recourse borrowing arrangements a little easier. Mary Simmons examines the courses of action SMSF trustees must consider now these provisions are coming to an end.

MARY SIMMONS is technical manager with the SMSF Association.

52 selfmanagedsuper

Gearing has always been a popular wealth accumulation strategy, so it is hardly surprising limited recourse borrowing arrangements (LRBA) have been attractive to SMSFs as a way to invest in concessionally taxed superannuation.

The raw numbers tell the story. Since their introduction in 2007, LRBA growth has been steady, with ATO annual statistics confirming that in 2018, 10.2 per cent of SMSFs reported an LRBA, up slightly from the 9.5 per cent reported the year before.

These LRBAs accounted for 92 per cent of the total value of borrowings reported by SMSFs in 2018, also an increase from the previous year of 89 per

cent. In terms of their dollar value, LRBAs stood at $50.2 billion at 30 June 2020, up 11.1 per cent from $45.2 billion at 30 June 2019. At $50.2 billion, they comprised 7.1 per cent of net SMSF assets.

This growth has always attracted criticism.

Those opposed to SMSFs having access to this debt instrument primarily argue they pose too much risk, not just to the individual SMSF but the superannuation system. The Cooper review (2010) into superannuation noted those objections, but did not suggest stopping SMSFs from borrowing, although it did suggest a future review. The Financial System Inquiry went a step

With the current low interest rate environment, some SMSF trustees may be considering their refinancing options as it could mean significant savings in monthly repayments.

further and made their abolition one of its recommendations, one of the few the federal government chose to ignore.

But the government, like the Cooper review, hedged its bets, commissioning the Council of Financial Regulators and the ATO to monitor any risk. Their findings, released in February 2019, confirmed that assets held by SMSFs under LRBAs were unlikely to pose a systemic risk to the financial system.

Monitoring was set to continue with another report due in 2022.

Much of the criticism of LRBAs is based on a lack of understanding as to how they work. And there is a level of complexity with LRBAs and SMSFs are well advised to seek specialist advice before entering into such a loan agreement. What’s more, this level of complexity has gathered an extra layer thanks to COVID-19, especially as it relates to maintaining an existing LRBA. The ATO’s LRBA loan relief was only ever designed to offer SMSF trustees short-term cash-flow assistance where a fund was able to show that it was financially impacted

by COVID-19 and the relief provided was consistent with what commercial banks were offering.

Some SMSFs with either residential or commercial property were able to rely on the Australian Banking Association’s (ABA)

relief package as a guide to an arm’s-length arrangement to benefit from a temporary deferral of loan repayments for up to six months. For SMSFs that were subsequently able to demonstrate they genuinely needed an extension, they may have been eligible for an extension to March 2021.

This extension was not automatic, and documentation needed to be in place to support that a review of the SMSF’s capacity to start repaying the loan was undertaken.

With many loan deferral periods already ended and the remainder set to end in March 2021, now is the time to review LRBAs to ensure the loans are maintained in accordance with the law. Below is a snapshot of some of the issues trustees need to understand, depending on whether they opt to retain the loan, restructure the loan or discharge the debt at the end of any deferral period.

Restart LRBA repayments For SMSFs that can no longer rely on the ATO’s administrative concession to ensure the non-arm’s-length income (NALI) provisions will not apply, they will need to ensure they are back to full repayments and all repayments are at arm’s length.

Repayments should reflect that interest over the deferral period was accrued and capitalised. There needs to be evidence to indicate any loan contract variations that required interest to be capitalised and repayments to be made over an extended loan term are in line with the ATO’s relief.

This is to ensure the variations do not amount to a rescission or replacement of the original contract, or no fundamental changes were made to the character of the loan such that a new borrowing arises.

Where an SMSF is relying on the ATO’s safe harbour provisions, it is important to note the maximum loan terms acceptable to the tax commissioner to ensure that protection against NALI is not put at risk.

From 1 July 2018, NALI of an SMSF now also comprises the original NALI, that is, inflated income derived directly as a result of a non-arm’s-length scheme, and the new non-arm’s-length expenditure or

NALE provisions. This means trustees need to be even more careful now to ensure income derived on or after 1 July 2018 is not considered NALI. A simple example could be where an SMSF continues to capitalise interest accruing on a related-party LRBA for a longer period than was permitted under the ATO’s COVID-19 loan repayment relief.

Safe harbour Although the ATO did not alter Practical Compliance Guideline PCG 2016/5 to reflect any loan relief, the protection offered by the safe harbour is not lost, provided any changes to an existing LRBA arrangement are in accordance with the regulator’s COVID-19 relief requirements.

SMSFs relying on the safe harbour can continue to do so provided any temporary loan repayment relief matches what commercial banks were offering or the ABA’s requirements.

Where relying on the ATO’s safe harbour provisions, it is important to note the capitalised interest during any loan repayment deferral period reflects the correct interest rate.

The rate used by the ATO is the Reserve Bank of Australia Indicator Lending Rate for banks providing standard variable housing loans for investors, based on the published rate in May each year. For the year ending 30 June 2020, the relevant interest rate was 5.94 per cent a year, whereas from 1 July 2020 the interest will accrue at the reduced 2021 yearly rate of 5.10 per cent.

Source of funds There is no limitation under the law who the lender is, provided the LRBA is on commercial terms. However, where the lender is a related-party company, or even a trust in certain circumstances, the complexity of any COVID-19 loan relief is compounded by the need to comply with requirements set out in Division 7A of the Income Tax Assessment Act (ITAA). Unless the loan meets strict criteria, which includes Continued on next page

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the need for the SMSF to make a minimum annual repayment, it is at risk of being deemed an unfranked dividend.

Traditionally, an LRBA with a potential Division 7A issue needs to meet both Division 7A criteria and the ATO’s PCG 2016/5 to ensure the loan is not deemed a dividend under Division 7A and is on arm’s-length terms as required under the Superannuation Industry (Supervision) Act and the ITAA. When compared to the requirements under Division 7A, the PCG currently allows for a higher interest rate, allows a shorter maximum term, sets a lower maximum loan-to-value ratio, and requires a mortgage to be registered.

Therefore, given the ATO’s safe harbour guidelines are more restrictive, best practice has been for trustees to follow the safe harbour guidelines to ensure the loan satisfies both criteria.

Where COVID-19 affected an SMSF’s ability to make the minimum annual repayment required for Division 7A purposes by 30 June 2020, the ATO has allowed SMSFs to seek an extension of the repayment period. Should the ATO approve the extension, an SMSF will have until 30 June 2021 to pay any 2019/20 shortfall plus the minimum annual repayment required for 2020/21.

What is important to note is the ATO has recently confirmed its online content will be updated to clarify the Division 7A relief in relation to COVID-19 allows any unpaid interest on the loan for 2019/20 to be capitalised.

refinanced amount is the same or less than the existing LRBA. If these criteria are not met, the refinancing with a related party will be considered a newly established LRBA. As a result, all members of the SMSF whose interests are supported by the asset purchased with the related-party LRBA will have to include their portion of the outstanding balance of the LRBA in their total super balance calculation.

Where SMSFs are refinancing and wish to be afforded the protection of the ATO’s safe harbour, it is important to ensure the maximum term of the loan acceptable to the commissioner is not exceeded. The maximum loan term permitted is either 15 years for real property or seven years for listed shares/units and takes into account the duration of any previous loan(s) relating to the asset.

For SMSF trustees considering refinancing an existing arm’s-length loan with a related-party loan, the conservative approach is not to rely solely on complying with PCG 2016/5 as a ‘get out of NALI free’ pass. Reference to Tax Determination 2016/16 suggests there is an additional requirement for an SMSF trustee to prove they or it could or would have entered into the LRBA with an arm’s-length lender to ensure NALI does not apply.

Finally, where an SMSF trustee is considering refinancing, it is important to review the loan agreement to determine whether a penalty interest provision is included. Although this is not a feature of a related-party loan agreement prescribed by PCG 2016/5, it is possible one exists and could be triggered if the SMSF repays a loan early or refinances.

Restructure or vary an LRBA With the current low interest rate environment, some SMSF trustees may be considering their refinancing options as it could mean significant savings in monthly repayments.

Should an SMSF trustee opt to refinance an existing LRBA where there is a related-party lender, it is essential the new borrowing is secured by the same asset or assets as the old borrowing and that the

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Discharge the debt and/or sell the asset Despite any LRBA loan relief available to SMSFs, there is still the possibility some trustees may be forced to sell the underlying asset due to the loss of rental income and/ or fall in market value.

Where the asset is sold, the sale proceeds should be used to discharge the loan with any remainder paid to the SMSF.

With many loan deferral periods already ended and the remainder set to end in March 2021, now is the time to review LRBAs to ensure the loans are maintained in accordance with the law.

All borrowed monies under the LRBA must be repaid and the loan cannot be retained and used to acquire another asset.

Depending on the loan-to-value ratio, it is possible, with significant falls in the price of the underlying asset, that the SMSF may lose any amounts initially contributed to the acquisition of the asset. This is despite the safeguard offered by LRBAs that should the value of the asset be less than the value of the debt and a sale be forced, the lender does not have recourse to other assets of the fund.

Where an SMSF trustee is unable to meet their loan repayments and defaults on the LRBA, a lender may also have the option to call on any personal guarantees. If a guarantee is called on, and the guarantor pays the SMSF trustee’s debt to the lender, the guarantor should seek to recover its loss from the SMSF trustee, provided it is limited to the SMSF’s rights in the underlying LRBA asset. Where the SMSF holds onto the asset and the guarantor forgoes their right of indemnity against the SMSF trustee, this will result in a deemed contribution unless the value of the single acquirable asset is insufficient to meet the debt to the lender or the guarantor.

STRATEGY

A big yawn or brave new world?

Enthusiasm regarding the ability to have six members in an SMSF has somewhat waned. Peter Townsend lays out the opportunities and problems of running a fund using the new maximum member limit.

PETER TOWNSEND is principal of Townsend Business and Corporate Lawyers.

One of the many changes wrought by the COVID-19 pandemic has been the delay in the introduction of the six-member SMSF. The question is: does anybody care? For such a seemingly radical change the reform has provoked little interest.

It was a surprise when it was first mooted by the federal government and remains somewhat of a curiosity. It may come into law in the next session of parliament, but don’t expect to see any placard wavers out front on the day.

When she announced the reform in April 2018, then-revenue and financial services minister Kelly O’Dwyer said the change from a maximum four members in an SMSF to a maximum six would allow for greater flexibility. O’Dwyer didn’t mention exactly

why that would be so. Similarly, she did not explain why six was the magic number. If six provided so much extra benefit, imagine what 10 might achieve.

The explanatory memorandum for the bill was also suitably enthusiastic: “Increasing the allowable size of these funds increases choice and flexibility for members. SMSFs are often used by families as a vehicle for controlling their own superannuation savings and investment strategies ... This change will help large families to include all their family members in their SMSF.” Some of these statements are debatable, but even if accepted, don’t point to any significant Continued on next page

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need for the reform, or even any request or lobbying for it. Just on 93 per cent of SMSFs in Australia have one or two members. The vast majority of users of SMSFs therefore do not want their children in the fund. The average size of the Aussie family is 2.53 people. Not a major market there for funds permitting four kids to join.

Having said that, there are roughly 61,500 members of three-member funds and 82,000 members of four-member funds: material numbers if only relatively small at 7 per cent of the total.

Although several early surveys indicated planners thought half their clients might consider adding more members to their fund, that was based on concerns about Labor’s proposed changes to the handling of franking credits, and since that issue has been put to bed the interest in changing might be much less.

Jumbo funds are coming nonetheless and so we need to consider some of the important issues a jumbo fund gives rise to, including a usefulness away from just very large families.

Pros and cons Benefits of a six-member fund would include economies of scale through sharing compliance and administration costs, higher contribution inflows from five or six members as opposed to a lesser number and potentially sheltering small super guarantee contributions for the kids from high public offer account fees. Conversely, the challenges a jumbo fund would create might include the complexity of more member trustees, kids knowing more about their parents’ financial affairs and vice versa, different investment strategies for different age groups and possibly higher establishment costs to ensure the parents’ control issues are covered, as discussed later.

Trustees The maximum number of trustees a trust can have is regulated by state law. Some states have no limit, while others hover

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The average size of the Aussie family is 2.53 people. Not a major market there for funds permitting four kids to join.

around the four to six mark. If the fund’s home state’s trustee legislation has a limit of less than six, then a jumbo fund in that state will need a corporate trustee.

Control Three or four kids outvoting their parents at a meeting of individual trustees is not an ideal situation, though not all that likely either. The deed should permit weighted voting by the member’s account balance rather than by simply a raised hand at the meeting.

The same would need to apply to both meetings of shareholders and directors of the corporate trustee. For shareholders’ voting requirements it may be that classes of shares should be used to ensure greater control. Directors’ voting could be weighted in the same way as the voting of members of the fund. Changes like these may require careful scrutiny of an amendment to the standard trustee company constitution.

Estate planning A deceased member can’t simply leave his death benefit in the fund to be added to the accounts of the surviving members.

The benefit must be paid out (even if only virtually) and any addition to the surviving members’ account is then characterised as a contribution, needing to fall within the members’ allowable limits. But a jumbo fund might permit the surviving members to enjoy the benefits of certain assets in the

fund if other assets/liquidity are/is available to pay the death benefit. That particularly valuable real estate can then be available to other family members without the need for transfer or transfer duty.

Diverse investment strategy Creating an investment strategy that will suit at least two very diverse age groups while maintaining the benefits of the single fund with its pooled additional resources should prove challenging. Wondering if this will lead to an increase in investments with a wide range of underlying opportunities, such as exchange-traded funds and listed investment companies, is a valid query.

Increased contributions from the extra members could permit the fund to buy assets otherwise unavailable to it, or at least to borrow less to do so. The challenge might be to not get carried away with that additional buying power. This could be particularly so in the area of real estate where the current low interest rates and increased buying power could lead to the purchase of a property much larger than was previously possible. Serviceability of such a loan would be a paramount consideration, particularly if an older member were to die.

Liquidity A one or two-member fund would generally find it easier to handle the issue of liquidity that arises when a member must be paid their annual pension amount, becomes mentally incapable and needs to source their member’s benefit or dies. In a sixmember fund that liquidity could be more of an issue. Assets bought with a view to a long-term hold, in theory benefiting all the diverse age groups, may need to be liquidated to free up much-needed cash.

Not only does the younger generation lose the long-term benefit of the asset, but there is a capital gains tax issue following the sale.

One of the stated benefits of a jumbo fund is the ability to acquire assets otherwise not in reach. If those assets are not going to survive the exigencies and problems associated with the older members of the fund, then is there

any point in acquiring them in the first place? Putting aside some additional administration costs, the family may as well have their own separate funds.

The most obvious strategy to handle liquidity issues is life insurance for the older members, but the very fact they are the older members may make life insurance unviable as an option.

borrowing arrangement (LRBA), subject to appropriateness, the investment strategy and the LRBA rules. This can provide the SMSF with greater flexibility to invest in more substantial projects or further diversify investments. Loan interest and borrowing expenses are generally tax deductible to the SMSF.

Participants’ interests Looking beyond the family An SMSF is not an investment, but rather a structure to hold investments. As a structure it can be used in many of the same contexts as a company, discretionary trust or unit trust. The advent of the six-member fund may see more people view the SMSF as an appropriate structure for a wide range of investments, particularly those involving a group of people hoping to pool their resources.

The SMSF may be the structure business buddies use to purchase an asset rather than being restricted to being a structure only for jumbo families. The SMSF has much to offer.

SMSF members can contribute in equal amounts, but unequal balances can easily be accommodated. In the SMSF, each member maintains their own member balance or account to which investment earnings and expenses can be allocated on a fair and reasonable basis, subject to the governing rules.

Where the members are business partners or friends who have combined capital to invest for retirement, they can also have a second SMSF for family members or superannuation balances with public offer funds, for example, for their concessional contributions, including mandatory contributions.

Tax The SMSF has immense advantages over other commercial structures when it comes to tax both in terms of the applicable rate of tax and the use of franking credits. The lower tax rate potentially accentuates the compounding effect of earnings reinvestment in the fund.

Choice of investments SMSFs can choose to invest in any investments authorised by law and the trust deed, subject to the investment strategy.

This could include listed investments, unlisted investments unavailable through public offer funds, or projects that require a reasonable amount of capital to be worthwhile, such as start-ups, venture capital, innovative investments or real estate.

Borrowing The limited ability to resource the SMSF due to contribution limits can be overcome by borrowing. The SMSF may enhance its capital base through a limited recourse

Preservation and access restrictions Superannuation benefits are preserved.

Generally, the benefits can only be withdrawn on the member meeting an unrestricted condition of release, such as retirement.

However, payment of benefits from superannuation is not mandatory even after a member has met an unrestricted release condition. Cashing of benefits is only compulsory after a member has died. While the member is alive, there is the option to retain benefits in the fund in accumulation phase, with tax on earnings at a maximum 15 per cent rate. In addition, pensions that have commenced can be stopped and rolled back to an accumulation account.

Members can also make withdrawals and at the same time contribute to super in the same financial year, as long as they meet eligibility requirements.

In some circumstances, especially where members have substantial assets and income outside super, it may be

The advent of the six-member fund may see more people view the SMSF as an appropriate structure for a wide range of investments, particularly those involving a group of people hoping to pool their resources.

advantageous to retain their money in an SMSF, enjoying a lower tax rate for future withdrawal and upon death to devolve the benefits to dependants free of probate and, possibly, access by creditors (for lump sum benefits) or to the legal personal representative, including holdings in a super proceeds trust.

Asset protection A member’s interest in a regulated super fund is generally protected from the trustee in bankruptcy. Any lump sum paid to the bankrupt person on or after the bankruptcy date is also protected. Super pensions do not receive the same level of protection.

The exception is where the contribution of money or assets to super is made with the intention to defeat creditors. These actions will not be protected and may be clawed back by the trustee in bankruptcy.

In closing Although jumbo funds are unlikely to see an immediate uplift in the average number of members in funds across the country, they may open the opportunity for SMSFs to be seen more as an asset holding structure than simply a tool for families like the Brady Bunch.

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Bringing super home

Transferring retirement benefits accumulated while working overseas is not simple. Liz Westover details the rules advisers need to know when assisting clients with the process.

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

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A global economy has resulted in a transient workforce in which periods of living and working abroad has become commonplace.

The consequence of this, of course, is the accumulation of assets including superannuation in foreign jurisdictions and the small matter of what to do with them when the time comes to return home to Australia.

In many cases, overseas pension funds can stay exactly where they are – they don’t need to be repatriated back to Australia just because the individual has returned home – but there are consequences of delaying any rollovers of pension monies over into the Australian superannuation system or of receiving lump sums personally from these funds.

From a tax perspective, it can be more advantageous to roll benefits into Australia’s superannuation system, but limits on the amount

that can be rolled over, due to our contribution caps, can necessitate taking these benefits personally or via a combination of the two. Further, the rules of the foreign country may dictate how benefits can be taken at the time and, of course, it must be understood once amounts are in the Australian system, they are subject to our preservation rules.

For the purposes of this article, discussion is focused on the ability and consequences of rollovers to an Australian superannuation fund.

It can be a complex area of tax and superannuation law to navigate. As such it is highly advisable to get advice in both Australia and the country in which the funds are held. Some countries, including the United Kingdom, will not allow rollovers out of their system unless certain rules are met by the super fund in the receiving country or they may impose significant tax on rolled over

amounts. Australian funds, in particular, generally will not meet the requirements to be considered a qualifying recognised overseas pension scheme (QROPS), a UK requirement for the rollover of pension monies from that country, unless and until members of the fund are all over the age of 55. In other words, it is near impossible to roll over super monies from the UK until the individual has reached age 55 without serious tax consequences. Most Australian Prudential Regulation Authority (APRA)regulated funds are not QROPS, with most people transferring from the UK electing to set up their own SMSF – once they are 55 and with a special deed to ensure QROPS requirements can be met.

What Australia requires for an offshore rollover In order for an Australian super fund to receive a rollover from an overseas fund, the overseas fund must meet our definition of a foreign superannuation fund. A foreign superannuation fund is essentially a superannuation fund that is not an Australian superannuation fund. Tax legislation defines a superannuation fund as: a. a fund that: i. is an indefinitely continuing fund, and ii. is a provident, benefit, superannuation or retirement fund, or b. a public sector superannuation scheme.

Unfortunately, there is no clear set of attributes contained in legislation a fund must have in order to satisfy the definition of a superannuation fund as outlined above.

However, case law in this area indicates it must be clear the fund has a sole purpose of providing benefits for its members upon reaching a prescribed age. That is, the ability for payment of benefits to members is more restrictive than in a completely general sense. The purpose must not include provisions for the payment of benefits in circumstances other than those relating to retirement, invalidity or death.

For example, where benefits are used as a savings plan for non-retirement purposes or the fund contains provisions for preretirement withdrawals for non-retirement

purposes, such as housing, education or medical expenses.

Once established the fund is indeed a superannuation fund, it should be clear that it is not an Australian superannuation fund.

The tests for an Australian super fund are as follows and should be carefully assessed for the overseas fund: • fund was established in Australia or owns Australian assets, • central management and control is ordinarily in Australia, and • active member test.

It is typically the central management and control test that will require some analysis. Assumptions should not be made based on how or where a fund appears to be managed, but rather more probing questions asked on how the overseas fund is actually managed. Rulings from the ATO provide guidance on how the central management and control test is to be applied and are valuable tools in the analysis process.

It can be prudent to seek a private binding ruling from the regulator if there is any doubt about the status of the foreign fund or where large balances are involved.

Rolling over a lump sum Timing is critical when rolling over lump sums and can significantly impact any tax payable.

Lump sums received within six months of becoming an Australian resident Lump sums rolled over into an Australian super fund within six months of the superannuant becoming an Australian resident are generally tax free, but they will count towards the individual’s nonconcessional contribution (NCC) cap.

As such, no more than $300,000 will be able to be transferred. Because they are assessed against the NCC cap, individuals need to check any existing Australian total superannuation balance (TSB) as at 30 June of the prior year to confirm what their cap is. Individuals with a TSB of $1.4 million or more will either be limited on their use of

the bring-forward provisions or be unable to make NCCs at all. If their Australian TSB is $1.6 million or more, they will have no scope to roll over foreign superannuation in this period.

Lump sums received after six months of becoming an Australian resident These amounts will generally include an assessable component as well as an amount that is assessed against the NCC cap, noting the limitations of the cap as described above.

The assessable component, called applicable fund earnings (AFE), is essentially the earnings in the foreign fund from the date the individual became an Australian resident. Although less common, other amounts credited to an individual’s foreign super account can also be included as assessable income.

When rolling into an Australian super fund, an election can be made to treat AFE as assessable income of the fund and taxed at 15 per cent. AFE does not count towards the concessional or NCC caps of the individual.

If an election is not made, AFE is taxable to the individual at their marginal tax rate and will be assessed against the NCC cap.

Importantly, where an AFE election is made, there can be no balance remaining in the overseas fund following the election.

This may necessitate a rollover or, where possible, receiving an amount directly rather than rolling over to the Australian super fund.

While the above sounds relatively straightforward, it can become very complicated as AFE calculations can and will need to be modified where there have been contributions or other amounts credited to the foreign fund while an Australian resident if the individual has previously withdrawn lump sums from overseas and/or there have been multiple periods of residency and non-residency.

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and any other assessable amounts received will need to be reported at item F in the income section, and both assessable and non-assessable amounts reported in the member information section of the return (section F or G). Errors in reporting can give rise to incorrect tax calculations or excess contribution determinations being issued.

SMSF residency

In order for an Australian super fund to receive a rollover from an overseas fund, the overseas fund must meet our definition of a foreign superannuation fund.

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balances and by extension involve complex calculations and considerations.

There are a number of ATO rulings impacting foreign superannuation fund transfers, including that the regulator will assume assessable income (AFE) is transferred first, followed by nonassessable income. This can be an important feature for individuals with higher balances who may be seeking to do multiple rollovers over a number of years or partial rollovers to superannuation while taking the balance personally. In these cases, the timing of transactions can greatly

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influence tax outcomes.

The application of foreign exchange rates in the calculations also needs to be factored in. All calculations are based on the spot rate at the time of transfer to Australia.

Attention really needs to be given to ensure that NCC caps are not breached.

Prior to 2017, funds were unable to accept these rollovers if the amount exceeded the fund cap limit as it was then (three times the annual NCC cap). The removal of the fund cap limit rule means the safety net to ensure the NCC cap was not breached no longer exists. Therefore, larger amounts rolled over could be received by the fund and there are no legislative provisions to refund these excess amounts. Accordingly, the excess non-concessional contributions provisions would apply, which would result in additional tax here in Australia. Further, withdrawals from the fund to pay excess contributions tax, deemed earnings or to meet requirements to refund amounts out of super can cause issues in the foreign jurisdiction, particularly the UK. Specialist advice is always prudent when looking at foreign super fund transfers.

Reporting AFE in the SMSF annual return Additional care does need to be taken to ensure amounts rolled in are reported correctly in the SMSF annual return. AFE

Where an individual sets up an SMSF to receive a rollover from an overseas fund, it is worth remembering the SMSF must ensure it remains a complying superannuation fund by continuing to meet the definition of an Australian superannuation fund, as described above. Therefore, part of the considerations of rolling amounts over is the future plans of the individual members to remain in Australia, which could impact the residency status of the fund. Further, the residency of the members can have flow-on effects in the originating country. This is particularly so for the UK.

Receiving an income stream from a foreign superannuation fund Generally, foreign pensions received by an Australian tax resident will be assessable income to the recipient and taxed at their marginal tax rate. However, they may have an undeducted purchase price and be able to claim a foreign income tax offset. Tax treaties with the originating country should be reviewed to confirm tax treatment in Australia.

Advice is critical Transfers of overseas pension fund balances back to Australia will likely increase in years to come. It is important for advisers to at least have a broad understanding of how these transfers work to discuss with clients conceptually what can be done and the time frames around when transfers should occur (if at all). However, due to the complexity involved and the consequences of errors, it is highly advisable to seek specific advice from a specialist in this area and in particular one who can assist with obtaining advice in the originating overseas country.

STRATEGY

Steps involved in splitting

The splitting of an SMSF in the event of relationship breakdowns goes beyond court orders. Daniel Butler and William Fetes detail the steps required in these circumstances.

DANIEL BUTLER (pictured) is a director and William Fetes a senior associate of DBA Lawyers.

Where a relationship breakdown has occurred between spouses, the parties’ superannuation entitlements may be subject to an overall family law property settlement. Typically this involves one spouse agreeing to or otherwise being required to give up some of their superannuation benefits in favour of the other spouse based on appropriately drafted orders or financial agreements.

For ease of expression, we refer to the term splitting order to include a split under a court order,

a split pursuant to consent orders arrived at by the parties to family law proceedings and also to a split in accordance with a binding financial agreement.

Many advisers incorrectly assume that having a splitting order in place will broadly conclude the split from a legal and superannuation perspective.

However, this is not the case and advisers need to be aware of the additional steps required under the Superannuation Industry (Supervision) (SIS) Act 1993 and the SIS Regulations 1994 to ensure their

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clients are not exposed to penalties and other negative consequences.

This article examines the legal mechanics of properly implementing a superannuation split in an SMSF with a particular focus on what must occur after splitting orders have been obtained.

Who are the parties in a split?

As a preliminary matter, it is important to clarify a point on terminology. The superannuation splitting laws refer to the relevant parties as the member spouse (MS) and non-member spouse (NMS), which can be confusing to a layperson.

The key point to remember about this terminology is that the MS is the party whose superannuation interest is subject to a split, that is, they are the party giving up their super in relation to a particular split. In contrast, the member who receives the benefit of the split is referred to as the NMS. Though it is often the case that an NMS will depart the fund after the split is carried out, the terminology of ‘non-member’ and ‘member’ is not based on membership status in the SMSF. Indeed, it is possible to have an MS departing the fund and an NMS remaining in the fund.

Note also that if there is a split of each member’s interest in the same SMSF, both parties may be an MS in respect of their own interest and an NMS in respect of their former spouse’s interest (for example, where a cross split is being implemented).

The usual pathway for a an SMSF split As noted above, splitting orders must be implemented with regard to the additional steps set out in the SIS Act and the SIS Regulations. We set out below the major steps that must be implemented once splitting orders are in place.

Please note this article outlines the key steps required in relation to the usual situation for an SMSF, which is a split implemented under division 7A.2 of the

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Many advisers incorrectly assume that having a splitting order in place will broadly conclude the split from a legal and superannuation perspective.

SIS Regulations initiated by the NMS. We do not consider the trustee-initiated pathway in division 7A.1A of the SIS Regulations for implementing a split as this is far less common in an SMSF context.

Step 1: The NMS must provide the SMSF trustee with a copy of the splitting orders together with a notice under regulation 72 of the Family Law (Superannuation) Regulations 2001 regarding the split in their favour. The notice must include the contact details for the NMS. Step 2: The SMSF trustee must give each party a ‘payment split notice’ to formally notify the parties that the interest of the MS

is subject to a split under the terms of the splitting order.

In addition to the payment split notice, the SMSF trustee must at this time give the NMS a notice under regulation 2.36C of the SIS Regulations setting out the particulars of the split and certain other key information.

Step 3: Subject to the governing rules of the fund, and the requirements of the splitting order, the NMS must make a choice regarding how the split amount is to be treated and notify the SMSF trustee of that choice. In broad terms, the choices available to the NMS are as follows: Option 1: Allocation to a new interest in the SMSF, unless the fund deed precludes this.

Option 2: Transfer or rollover of the amount under the splitting order to the NMS’s nominated superannuation fund.

Option 3: Payment of a lump sum. This is available only where the amount being paid out to the NMS constitutes unrestricted non-preserved benefits split from the MS or where the member has met a relevant condition of release and therefore has unrestricted non-preserved benefits.

Note: The choice by the NMS must be exercised within 28 days from the payment split notice or such longer period as the trustee allows.

Naturally, sharing an SMSF after a

relationship breakdown is not advisable.

Therefore, option 1 is not commonly implemented unless it is part of preparatory work for one of the members to exit the SMSF. Where a condition of release has not been satisfied, option 2 is the usual option that is chosen, that is, the split amount (known as ‘transferable benefits’ in this context) is rolled over to another fund, such as a new SMSF or a public offer superannuation fund.

Step 4: Once steps 1 to 3 are carried out, the SMSF trustee is broadly obliged to give effect to the choice of the NMS, subject to the governing rules of the fund and the splitting orders. The SMSF trustee must then calculate the amount to be transferred (see the commentary below regarding relevant base amount adjustments), determine the tax components and the preservation components and notify each of the parties regarding the split being implemented.

Step 5: After completion of the allocation to the NMS, a rollover is prepared using the prescribed ATO forms if relevant, that is, pursuant to option 2 under step 3.

Note that the rollover may also need to include the departing member’s own superannuation entitlement where relevant.

Also, the fund’s records must be appropriately updated and relevant trustee resolutions prepared.

Base amount adjustment If the splitting orders specify a base amount split, the base amount must be adjusted from the operative time until the date of transfer of the transferable benefits, a term defined in regulation 1.03 of the SIS Regulations, by interest being calculated and added for the relevant period at the prescribed annual interest rate.

Failure to implement documents under division 7A.2 of the SIS Regulations As noted above, splitting orders are not self-executing and do not cover the additional obligations that apply to a

Failure to implement appropriate division 7A.2 documents after splitting orders are obtained will result in each individual trustee of an SMSF being liable, on a strict liability basis, for $4440 per contravention.

super split under the SIS Act and the SIS Regulations.

The giving of the various notices in relation to a division 7A.2 split noted under steps 1 to 4 above is an operating standard for regulated superannuation funds under regulation 7A.02 of the SIS Regulations.

Thus, failure to give these notices will result in one or more contraventions of section 34(1) of the SIS Act, with each contravention attracting an administrative penalty of 20 penalty units.

The value of a penalty unit is currently $222. Accordingly, failure to implement appropriate division 7A.2 documents after splitting orders are obtained will result in each individual trustee of an SMSF being liable, on a strict liability basis, for $4440 per contravention.

If the fund has a corporate trustee, each director will be jointly and severally liable for a $4440 penalty.

Additionally, the failure to implement appropriate splitting implementation documents under the SIS Regulations may result in further negative consequences including: • the other side seeking to reopen splitting orders and property

settlements, et cetera, and • claims being brought against advisers who were involved in the process, for example, if the adviser gave no consideration to the SIS Regulations documents required to implement a split.

Unfortunately, many advisers, including experienced family law practitioners, are not fully aware of the SIS Regulations criteria and thus may not point out these aspects to their clients or the clients’ other advisers, such as accountants and financial planners, who may also be involved with a split. In recent times, however, we are seeing SMSF auditors becoming more aware of this situation, subsequently increasing their detecting and reporting of contraventions in relation to these compliance requirements, which may result in more accountants and financial planners becoming aware of the SIS Regulations requirements.

Other considerations Super splitting in an SMSF context is likely to give rise to other technical concerns, including restructuring the SMSF as a single-member fund, transfer balance account issues, income tax consequences (including capital gains tax liabilities and whether any capital gains tax rollover relief should be claimed) and stamp duty treatment.

Conclusions Many advisers are unaware splitting orders in respect of an SMSF are not self-executing and must broadly be implemented in accordance with the steps set out above in accordance with the relevant criteria and documents required by the SIS Regulations.

Accordingly, to ensure clients are not exposed to significant penalties and further negative risks, it is critical advisers obtain appropriate advice regarding the proper process to follow so that the various notices and other steps are followed in accordance with the operating standards in the SIS Act and the SIS Regulations.

QUARTER I 2021 63

LAST WORD

JULIE DOLAN CONSIDERS WHETHER OR NOT TO PUT A BDBN IN PLACE

JULIE DOLAN is enterprise director at KPMG.

64 selfmanagedsuper

Superannuation is fast becoming a significant family asset and it is a non-estate asset of the member unless directed into the member’s estate. Therefore, it is a common question among superannuants on whether or not to put in place a binding death benefit nomination (BDBN). There is no simple answer. Many factors need to be determined and most importantly in context of the wider estate planning objectives of the member.

Too often this document is completed without a lot of thought, rather seen as a simple default form to be completed and kept in the member’s permanent file.

Before even contemplating the position of whether to bind or not to bind for SMSF members, a review of the trust deed is critical. The conditions and validity of the BDBN are dictated by this document and not the Superannuation Industry (Supervision) (SIS) Act. The next step is to get a good understanding of the family matrix of the member, whether any potential beneficiaries have ‘at risk’ factors, tax position, residency status, potential family claims, providing for subsequent generations, overall estate objectives, the list goes on.

Once you have gone through all these factors, you are then in a stronger position to guide your clients on the most appropriate approach.

Leaving the nomination discretionary is like leaving a statement of wishes to the remaining trustee/executors for them to pay out the death benefits to whomever they wish within the legislated pool of beneficiaries. The advantage of this approach is it allows the decision maker(s) to seek specialist advice at the time and then make payments accordingly. It also avoids the situation where a current BDBN has not been kept updated and the wishes of the member have changed due to circumstances like a family breakdown. The main disadvantage is the inappropriate control this discretion can result in, leading to the trustee’s decision being reviewed and challenged in the courts by disgruntled potential beneficiaries. Many recent legal cases have highlighted this situation.

On the other hand, having a BDBN in place alleviates this inappropriate discretion risk and provides certainty on who is to receive the member’s death benefits. Death benefits can be paid to specific super dependants, as defined under the SIS Regulations, or through to the legal personal representative (LPR) of the estate. Once

again, whether to pay the death benefits directly to the beneficiaries or via the estate is a question that requires careful consideration and planning.

Directing the payment to the LPR is a common approach. Many people have in place on the triggering of their death one or more testamentary trusts for their beneficiaries, which includes the distribution of the super death benefits into these trusts. Testamentary trusts have many advantages, especially if the will maker wishes to place conditions around the amount, to whom and when payments are to be made. Depending on the level of conditions, a veil of asset protection can also be placed around the capital of the trust for situations such as marriage breakdown, solvency and third-party claims, special needs beneficiaries, spendthrift tendencies, et cetera. These trusts also allow for income streaming and for minors to benefit from adult tax thresholds. The Medicare levy also does not apply to any super death benefits paid into the estate. Due to the level of flexibility, testamentary trusts can be established to cater for multi-generations as they have a lifespan of up to 80 years.

The main disadvantages of a testamentary trust are the additional administration and cost involved. As it is a separate legal entity, annual financial statements need to be prepared and a tax return lodged with the ATO. To avoid family disputes, a clear succession of both the trustee and appointor roles is recommended to be spelt out in the will. Assets of the estate are also subject to family claim provisions, however, if this is a concern to the will maker, it may not be the best course of action to send specific assets to the estate. This can be especially relevant for blended families.

For example, the will maker may want to give their super to the new spouse and may want to make sure the new spouse does not face any disputes or challenges from adult children from a previous marriage. Sending the super to the estate opens the amount to a potential claim as opposed to the benefit being paid directly to the new spouse.

Therefore, as you can see there is no simple answer to whether or not to make a death nomination binding. Careful consideration, client discussions and pre-planning are required. Once this has occurred, drafting of the nomination can be done by an estate lawyer where applicable. It is important to note that only a legal practitioner can draft and finalise this important document.

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