CPA

A looming policy sandwich for trustees

RICHARD WEBB is financial planning and superannuation policy adviser at CPA Australia. Greater transparency and accountability for Australia’s $3 billion superannuation sector is a net benefit, right? But what if the cure is worse than the disease? The new ‘best financial interests’ obligation sounds good, but could put well-intentioned SMSF trustees in a bind. The passing of the Your Future, Your Super Bill, currently before parliament, will implement the government’s commitment to make the Australian superannuation system more transparent and accountable.

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

In addition, the bill reverses the burden of proof for Australian Prudential Regulation Authority fund trustees. Although this change does not apply to SMSF trustees, they will need to be able to justify fund expenditure in the event the ATO decides to investigate. Moreover, there are no materiality thresholds. Also relevant is the recently passed Hayne Royal Commission Response Bill, which extends the indemnification provisions in the Superannuation Industry (Supervision) Act to prohibit the payment of criminal, civil or administrative penalties incurred by trustees or trustee directors.

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

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

The requirement that payments be in members’ best financial interests brings trustees squarely into conflict with the requirement to comply with the non-arm’s-length income (NALI) requirements. Essentially, the NALI requirements operate as a brake on ‘mate’s rates’ arrangements. Such arrangements could be used to achieve artificial results in relation to income or expenses recorded by the fund. These results could in turn be manipulated in order to arbitrage between tax environments. By recognising normal commercial arrangements, the NALI requirements ensure an appropriate rate of tax is applied. However, sometimes the NALI requirements can have severe outcomes.

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

The decision to undertake fund expenditure in line with members’ best financial interests is a prospective requirement. By contrast, any meaningful financial benefit derived by members is assessed in hindsight as an absolute benefit without a ‘best financial interests’ qualifier. This means the new requirements can and will come into conflict. Take, as an example, a training course undertaken by the directors of a fund. The trustees of the fund determine a particular course may improve their operational decision-making in respect of the SMSF. However, they are unable to quantify how the course is in members’ best financial interests. Consequently, they don’t charge the cost of completing the course to the fund. As the costs have been met by trustees themselves, it is possible the ATO may assess this as NALI by the fund. Furthermore, given the training may have a nexus to improved fund income, the ATO may determine the trustees’ decision to not indemnify the training expense has a nexus to the fund income in total, thereby incurring the punitive NALI tax rate on all income recorded by the fund. It is worth mentioning NALI is an emerging area of work at the ATO, with significant resources presently dedicated to finalising a draft law companion ruling in this area, which has been contentious.

It is hard to argue against a policy objective of providing additional accountability and transparency for Australia’s $3 trillion superannuation sector. However, if the end result produces absurd outcomes such as this, it would be a clear policy failure. The time to prevent issues like this is now, not once SMSF members and trustees find themselves in a lose-lose situation after the new requirements commence.