Self Managed Super: Issue 38

QUARTER II 2022 | ISSUE 038 | THE PREMIER SELF-MANAGED SUPER MAGAZINE

SMSF CHESS THE INVESTMENT STRATEGY

FEATURE

STRATEGY

COMPLIANCE

STRATEGY

Investment strategy Obligation examination

Family SMSF Inclusion of children

Competency standards Minimum acceptable levels

Pension toolkit Options available QUARTER II 2022 I

SMSF PROFESSIONALS DAY 2022 SYDNEY HYBRID EVENT | 31 MAY

Give yourself the opportunity to consider new strategies and glean a better understanding of the latest technical information.

Our presenters, recognised as the best in the industry, will take delegates through the most important issues in the sector and the resulting implications and strategic opportunities for clients.

FEATURED SPEAKERS

Graeme Colley

Executive Manager, SMSF Technical and Private Wealth SuperConcepts

Philip La Greca

Executive Manager, SMSF Technical and Strategic Solutions SuperConcepts

EVENT SPONSOR

EDUCATION PARTNERS II selfmanagedsuper

Paul Delahunty

Mark Ellem

Director, Self-managed Super Funds, Approved Auditors Portfolio Superannuation Australian Taxation Office

Head of Education Accurium

Tim Miller

Darin Tyson-Chan

Education Manager SuperGuardian

Publisher, Editor Selfmanagedsuper

COLUMNS Investing | 20 Infrastructure as an inflation hedge.

Investing | 26 The Australian equities outlook.

Strategy | 30 The inclusion of children in an SMSF.

Compliance | 33 Pension transfers from overseas.

Strategy | 36 End of financial year considerations.

Compliance | 40 Complications of lost trust deeds.

Investing | 42 A new investment structure on the horizon.

Compliance | 46 Minimum competency standards.

Strategy | 49 Pension planning toolkit.

Strategy | 52 Importance of reviewing estate plans.

Strategy | 56 Overall tax implications of ECPI.

PLAYING SMSF CHESS THE INVESTMENT STRATEGY OBLIGATIONS Cover story | 12

REGULARS What’s on | 3 News | 4 News in brief | 5 SMSFA | 6 CPA | 7 Tax and Super Australia | 8 IPA | 9

FEATURE

CAANZ | 10

Completing the performance picture | 16

Super events | 60

Assessing SMSF returns

Last word | 62

Regulation round-up | 11

QUARTER II 2022 1

INAUGURAL SMSF ASSOCIATION TRADE MEDIA JOURNALIST OF THE YEAR

Let’s see what happens next It’s official: Australians have had their say and we now have a Labor government in power for the next three years. So what will this likely mean for superannuation?

Well as I’ve reported several times this year, the ALP did say on more than one occasion its aim will be to make superannuation savings play a bigger role in the economic management of this country. One obvious arena we might see this happening is in the development of infrastructure.

That in itself is not a bad idea, but we probably won’t know what this means until we find out how it will be implemented and executed.

Hopefully it will be introduced using incentives to channel retirement savings toward parts of the economy the government has recognised require some heavy lifting. The one thing we do not want to see is any sort of prescriptive element included in the policy dictating exactly how superannuation portfolios have to be constructed with regard to a specific asset class.

It goes without saying SMSFs would certainly not want this prescriptive approach as it is a principle that is diametrically opposed to the philosophy behind running your own super fund.

However, we all know there are no guarantees in life and the reaction to a popular measure during the height of the coronavirus pandemic along with a development late in the election campaign does worry me a bit.

I’m referring to the legal early release of super in 2020 and 2021 and the Morrison government’s announcement it would fine tune the policy that allows superannuation to be used to help Australians, particularly younger

2 selfmanagedsuper

Australians, fund the purchase of their first home.

The new initiative included a provision to ensure monies drawn upon from super in the pursuit of owning an individual’s first home were at a later date returned to the retirement savings system along with any gains generated from the portion of the initial capital used.

Yes, we needed to see more detail, but ostensibly it deserved some consideration, not just in my opinion but also in the minds of the Financial Planning Association.

But there was immediate criticism of the scheme from most of the usual suspects, including the ALP and the industry fund sector.

To me it reinforced the train of thought we also saw when the COVID-19 financial hardship measure involving legal early access to super was announced.

The attitude seemed to be that it is the super fund’s money and it is up to the trustee’s discretion as to what to do with it.

In reality it is the members’ money and that’s a fact that should never be lost.

So if their own savings can be used in a more beneficial way in the short term without great damage to the integrity of the system, I fail to see why in certain circumstances this can’t happen.

Further, research has shown a good proportion of people who withdrew money from their superannuation during the height of the pandemic have already looked to recontribute those amounts to their super fund, showing they can be trusted to do the right thing.

I’ve said before the evidence is there the majority of Australians treat their retirement savings in an appropriate and responsible manner and Canberra should recognise this in its attitude towards superannuation policy.

Editor Darin Tyson-Chan darin.tyson-chan@bmarkmedia.com.au Senior journalist Jason Spits Journalist Tia Thomas 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 Professionals Day 2022 – hybrid event Inquiries: Jenny Azores-David (02) 8973 3315 or email events@bmarkmedia.com.au

NSW 31 May 2022 SMC Conference & Function Centre 66 Goulburn Street, Sydney 8.00am-5.00pm

DBA Lawyers Inquiries: dba@dbanetwork.com.au

SMSF Online Updates 3 June 2022 12.00pm-1.30pm 8 July 2022 12.00pm-1.30pm 5 August 2022 12.00pm-1.30pm

Chartered Accountants Australia and New Zealand Inquiries: 1300 137 322 or email service@charteredaccoutantsanz. com

SMSF Day 2022 7-8 June 2022 Online

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

Heffron

Live Q&A

Smarter SMSF

Inquiries: 1300 Heffron

25 August 2022 Webinar 2.00pm-3.00pm

Inquiries: www.smartersmsf.com/event/

SMSF Clinic Online 7 June 2022 1.30pm-2.30pm 16 August 2022 1.30pm-2.30pm

Tax and Super Australia

2022 Year End Accountants & Auditors Update

Quarterly Intensive

28 July 2022 11.30am-1.00pm

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

SMSF pension planning toolkit 8 June 2022 Webinar 12.30pm-1.30pm

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

Sole purpose test and investment strategy 14 June 2022 Webclass 12.30pm-2.00pm

Quarterly SMSF Update 11 August 2022 Webinar 2.00pm-3.00pm

Inquiries: (03) 8851 4555

QLD 20 June 2022 AICD Business Centre Level 9, Riverside Centre 123 Eagle Street, Brisbane 9.00am-12.30pm

SMSF Day 2022 VIC 14 July 2022 The Victoria Hotel Melbourne 215 Little Collins Street, Melbourne 8.30am-4.00pm QLD 19 July 2022 Sofitel Brisbane Central 249 Turbot Street, Brisbane 8.30am-4.00pm

NSW 22 June 2022 AICD Business Centre 18 Jamison Street, Sydney 9.00am-12.30pm

NSW 20 July 2022 Rydges Sydney Central 28 Albion Street, Surry Hills 8.30am-4.00pm

VIC 24 June 2022 AICD Business Centre Levels 26 & 27, Optus Centre 367 Collins Street, Melbourne 9.00am –12.30pm

SA 2 August 2022 Adelaide Rockford 164 Hindley Street, Adleaide 8.30am-4.00pm

Conference 2022 VIC 17 August Sofitel Melbourne on Collins 25 Collins Street, Melbourne 9.00pm-5.30pm

WA 3 August 2022 Fraser Suites East Perth 10 Adelaide Terrace, Perth 8.30am-4.00pm

SMSF Association

SuperConcepts

Inquiries: events@smsfassociation.com

Inquiries: 1300 023 170

Technical Summit 2022

Virtual SMSF Specialist Course 12-14 July 2022 10.00am-2.00pm

QLD 27-28 July 2022 RACV Royal Pines Resort Gold Coast Ross Street, Benowa

19-21 July 2022 10.00am-2.00pm

QUARTER II 2022 3

NEWS

Director ID application process user-unfriendly

By Darin Tyson-Chan

Trustee feedback supplied to selfmanagedsuper has demonstrated how difficult the application process for a director identification number can be, particularly for elderly SMSF trustees.

The response was received from a subscriber to selfmanagedsuper’s sister publication, smstrusteenews, and revealed a mature-age trustee’s experience in applying for a director ID number that spanned from December 2021 to early March 2022 without a satisfactory resolution.

The trustee admitted they were not very technologically literate, but nevertheless began the process attempting to use the myGovID application. The trustee, unfortunately, could not complete the process using this method and so rang the dedicated helpline, only to be directed back to the online facility.

This prompted the individual to write to the Albury headquarters dealing with director ID number applications, a course of action that did not receive a timely response.

“Two-and-a-half months later I received a reply, enclosing the necessary forms,” the trustee told smstrusteenews.

The next difficulty involved the sources of identification required for the application.

“Three forms of identification are needed. In my case producing a passport and a Medicare card was no problem, but I don’t have a car so don’t have a driver licence. It meant I needed a copy of my birth certificate,” the trustee said.

“I do have one, but it was folded and when I got it out of the box I discovered it had stuck together.”

This resulted in the person having to contact another government department, the Births, Deaths & Marriages Bureau for Victoria, to apply for a new birth certificate, further complicating and delaying the process.

ID complications for users.

The response from this agency again was not immediate, but was eventually received.

At the time of contacting smstrusteenews, the individual was informed the relevant forms had been sent out.

“I didn’t like to ask when that would be, but with a bit of luck I will have that director ID before the November deadline,” the trustee concluded.

Investment strategy a source of great angst

By Darin Tyson-Chan

A lack of definitive instruction and poor trustee attitudes regarding the SMSF investment strategy are creating confusion and anxiety among practitioners.

The obligation to formulate and formalise is one aspect of the requirement to have an investment strategy that is still relatively unclear. The majority of practitioners agree formalising the investment strategy in writing is best practice, but there is no direction as to who should be performing this task.

“Who can write it for the

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trustees, because accountants won’t write them? That’s not their fault because they’re not allowed to do it without considering all of the overall financial position of the client,” Advisers Digest founder Peter Johnson told attendees at the recent SMSF Auditors Association of Australia Conference held in Melbourne.

“Plus if they get something wrong they get sued. Or if it’s a financial adviser that does it, they get sued.”

During the same session, a conference delegate suggested action is required by industry bodies to encourage the ATO to find solutions for these issues.

“I think it would be good

Peter Johnson for [the SMSF Auditors Association of Australia and others like it] to go to the powers that be to say ‘we’re auditing something that the trustees are putting no effort into’,” the practitioner said.

“Also, when you pull the wording [of the investment

strategy obligations] apart, they’re really onerous and we don’t really see the point.”

According to Johnson, the risk practitioners expose themselves to with regard to the investment strategy highlights a larger problem the SMSF advisory community is currently facing. “[You can get sued even if the client says:] ‘I wanted to lend money to my mate, the mate borrowed the money, but you didn’t [prepare] a good enough SOA (statement of advice), you didn’t warn me I wasn’t going to get my money back, even though I still would have lent it to him, so it’s still your fault,’” he pointed out.

“It’s just lunacy.”

NEWS IN BRIEF

Jump in SAN misuse Responses to the ATO’s most recent mail-out asking auditors to check the veracity of information contained on fund annual returns have shown instances of SMSF auditor number (SAN) misuse increased in the 2021 financial year.

The regulator undertook the latest mail-out in September last year, with the exercise indicating the issue had worsened in the previous income year.

“We detected more SAN misuse than in previous mail-outs, with more than a third of instances of SAN misuse relating to SARs (SMSF annual returns) that were lodged late,” the ATO said on its website.

Specifically, the information gleaned from the September 2021 mail-out uncovered 1896 instances of SAN misuse, with 65 per cent, or 1230 instances, relating to SARs for the year ended 30 June 2020 and a further 25 per cent, or 481 cases, pertaining to SARs for the 2021 income year. Further, the exercise found the SAN misuse was associated with 683 tax agents and 24 trustees who lodged a fund’s annual return themselves.

Statistics uncovered a significant amount of service providers had committed multiple offences, with 50 tax agents found to have been connected to more than five instances of SAN misuse involving 812 funds. In addition, it was discovered 411 tax agents were connected with one instance of SAN misuse.

Minimum pension cut popular A poll of financial advisers and accountants has shown the financial relief measure reducing the minimum pension requirements by 50 per cent for the 2020, 2021 and 2022 financial years, extended now to

include the 2023 income year, has resonated well among retirees.

The survey, conducted by Accurium at a recent webinar, showed 74 per cent of the attendees indicated their clients have reduced the amount they are drawing down from their income streams as a result of the relief measure.

A further 18 per cent of practitioners revealed their clients had taken advantage of the measure but had not actually reduced the amount they are drawing down from their pensions. Instead, they have treated any income stream payment amounts above the required minimum pension as a partial commutation to enjoy a transfer balance cap benefit.

Finally, only 8 per cent of participants said their clients had continued to draw the same level of pension as before the measure was introduced.

for your information, subject to terms and conditions,” the ATO said on its website.

Perfection not expected The Australian Securities and Investments Commission (ASIC) is not expecting financial advisers to hold perfect compliance files and recognises the current state of regulation is too complex and prescriptive.

ASIC chair Joseph Longo made the comments during a question and answer session at the Stockbrokers and Investment Advisers Association (SIAA) 2022 Conference held in Sydney recently.

SuperStream list updated The ATO has updated its register of SMSF messaging service providers that can facilitate transactions via the use of SuperStream by giving their users an electronic service address, with only 15 available options now for trustees.

When last revised in November 2021 the list contained 16 service providers, however, original participant SMSF Dataflow is now no longer included.

Further, in November Australia Post was classified as a work in progress due to the fact it was only able to process contributions via SuperStream at the time.

SMSF trustees can now use Australia Post for both contributions and fund rollovers.

No other noticeable changes to the register have been made.

The regulator reiterated the purpose of providing the register as part of the update.

“We do not recommend or endorse any of the listed SMSF messaging service providers. We are providing this register

Joseph Longo When asked whether advice professionals should be concerned about ASIC looking for a perfect compliance file, Longo replied: “I’ve been in financial services most of my life, I don’t go for perfection.”

He noted the corporate regulator recognised financial advice legislation was complex and prescriptive as a result of many cases of poor advice leading to a wave of re-regulation going through the sector.

“We’ve now reached a point where it’s time to implement and make work what we’ve got,” he said.

“We can all agree on what we wanted to achieve, and we wanted consumers to trust the system and for advisers to act in the best interest of their clients.”

QUARTER II 2022 5

SMSFA

A particularly special national conference

JOHN MARONEY is chief executive of the SMSF Association.

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The 1600 delegates who attended the 2020 National Conference on the Gold Coast left the event well sated. Subject topics that hit the mark, the excellent calibre of speakers, the networking opportunities and the myriad social events, when coupled with the location, made for a memorable occasion.

It followed a long tradition of successful SMSF National Conferences where the specialist advisers to our super sector willingly surrender three days out of their busy schedules for what’s become their annual pilgrimage to the holy grail of SMSF events.

The association has long appreciated how this event captures their imagination, garners their enthusiasm and stimulates their learning. They’re the reasons why it’s widely regarded as the premier superannuation conference.

And, if your association ever needed a gentle reminder, a light tap on the shoulder of the importance of this event to our members, then the 2022 National Conference at the Adelaide Convention Centre provided it. In spades.

After more than two years of COVID restrictions, of interminable Zoom conferences and meetings, delegates could meet in person, share a laugh, enjoy a beer and hear the latest industry gossip.

There was no need to dress like the Lone Ranger either – masks were not compulsory.

To walk around the convention centre almost seemed like taking a step back in time, to when the 1.5-metre social distancing rule wasn’t a dictate and a handshake almost a social taboo.

It reminded me just how important face-toface interactions are as a way of learning from our peers and how we have all missed this important component of learning. It’s not just about attending sessions and listening to speakers. It’s also very much about being able to collaborate with peers and learn from others – pre-COVID we just took this for granted. I don’t think we will ever do that again or, at least, not for a long time.

If the event needed some stimulus, then it came via the federal government in the run-up to calling an election when it cleared a backlog of super measures, some relating as far back as the 2019 budget. So it meant there was plenty to cover at this year’s event in terms of the legislative changes that have been enacted over the past six months, and

certainly provided the grist for SMSF Association deputy chief executive and director of policy and education Peter Burgess’s hardy annual session titled “Your conference compass. Hit the ground running with this legs & regs update.”

As Peter explained, many of these changes apply from 1 July 2022 and will provide older Australians with greater flexibility to contribute to super, so it was no surprise several sessions at the national conference were devoted to the changes to the contribution rules and associated strategies.

The workshop on cognitive decline, during which practitioners were exposed to common behaviours that can evidence a client’s cognitive impairment, proved very popular, along with the panel session on Treasury’s Quality of Advice Review and our first-ever symposium on providing retirement income advice.

The Thought Leadership Breakfast has established itself as an institution that kicks off the event for many delegates. This year the five-member panel teased out the broad trends in technology, with the discussion generating keen audience participation.

On day two, the plenary session covering “The contribution strategy landscape in 2022” looked in detail at the changes to contribution caps, noting there are changes for the current year and some to take effect from 1 July 2022 that will see concessional (not taxed), non-concessional (aftertax) contributions and age requirements for bringforward non-concessional contributions change.

In listening to the strategies that advisers could employ with their clients, it became apparent the longer timeframe for larger contributions may cause a rethink by some SMSF members who may have thought the opportunity to use these strategies had passed. At the very least, it’s worth a discussion.

On the other side, the requirement to draw a pension may now be able to be met while still contributing and the reduction in the downsizer age to 60 presents opportunities for those who may be planning a lifestyle change.

No doubt those who attended will have their own thoughts on which sessions were the most valuable, but for my mind just seeing a crowd of people in the exhibition hall, all with smiles from ear to ear, made Adelaide 2022 extra special.

CPA CPA

Where to for wholesale product advice

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

Treasury’s Quality of Advice Review provides an opportunity to clarify some burning issues involving wholesale investments for SMSF trustees. But in an environment where so many Australians are having difficulty accessing quality retail financial advice, will there be space for these issues?

The federal government released the terms of reference for the Quality of Advice Review in March. The intention of the review is to see how the regulatory framework can better enable the provision of high-quality, accessible and affordable financial advice. The review came about as a result of the recommendations in the final report of the Hayne royal commission.

It should be noted that while the review is underway, another is also being undertaken by the Australian Law Reform Commission, which is reviewing the legislative framework for financial services law more broadly.

One issue that provides a level of confusion for trustees and their advisers is the rules around wholesale investment. Although the terms of reference do not consider how these terms should be defined, the review will consider consent arrangements in place for wholesale clients.

When products are available to wholesale clients, it is usually the case that a number of protections provided to retail investors are not required. The rationale for this policy is that wholesale investors, a term that also includes sophisticated and professional investors, are better able to understand the risks and disadvantages of such products.

Consequently, a much larger selection of investment opportunities is available to wholesale investors. However, it comes at a price. Eligibility to invest in these products is limited to high net worth investors, such as those with an initial investment of $500,000 or more, net assets of $2.5 million or more or gross income of $250,000 annually.

SMSF trustees often consider that a benefit of pooling a small group of investors’ funds may be to obtain the critical mass needed to invest in such products. However, superannuation is normally ringfenced from the net assets total, unless the fund

holds $10 million or more. Following restrictions imposed by the total superannuation balance limits since 2017, recently lifted from $1.6 million to $1.7 million, it is expected fewer and fewer funds will be able to achieve this scale in the future.

Mixed messages from the Australian Securities and Investments Commission (ASIC) on this issue have caused confusion. In 2014, ASIC issued a media release suggesting it would not take action where trustees were determined to be wholesale by a person providing advice in the event the fund had net assets of more than $2.5 million. However, by 2017, the corporate regulator returned to issuing guidance that did not mention this previous commitment and emphasised an SMSF with $10 million or less would be treated as a retail client.

The issues paper to the review notes the terms of reference include the ability to look at financial advice generally, not just financial product advice.

This is a refreshing change to the lens through which financial advice has been viewed since the Financial Services Reform Act regulated financial services in 2001. It is perhaps this view of financial advice that may finally provide a direction for trustees looking to access wholesale products where access to advice is presently difficult.

However, there are considerable drawbacks to the idea that financial advice not related to retail financial products could be made available to SMSFs. For example, wholesale financial products are not subject to the design and distribution obligations, meaning there are fewer responsibilities on product providers. Neither are they subject to the same fee and cost disclosure regime that applies to retail products.

Another question arises as to how financial advice that is not reliant on the use of retail financial products might be subject to regulation if property is involved.

We expect the review will improve the advice experience for many Australians. However, it is likely the problem of financial advice involving wholesale products will be kicked down the road. This will be a considerable lost opportunity to improve the quality of financial advice.

QUARTER II 2022 7

TSA

Super stocktake – where we are at

NATASHA PANAGIS is head of superannuation at Tax and Super Australia.

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Prior to the calling of the federal election, a number of superannuation measures either did not make it to parliament or the draft legislation failed to pass into law.

Whether these lapsed bills and proposed measures will ever see the light of day will be dependent upon the outcome of the election and the agenda of the next government, whoever that may be.

It was also no surprise to see superannuation was largely untouched in this year’s federal budget given the election was just around the corner. As they say, sometimes no news is good news and I think it’s safe to say many in the superannuation industry let out a sigh of relief. No changes to super will deliver welcome stability to the sector, which in turn will help individuals plan for their retirement with confidence.

So, with the budget now over and the countdown to the federal election almost at an end at the time of writing, it’s worthwhile conducting a stocktake of what superannuation measures remain outstanding.

There were two main superannuation measures announced in last year’s budget that are still up in the air. These are proposals to relax the residency requirements for SMSFs and small Australian Prudential Regulation Authority funds (SAF) and allowing certain legacy income streams to be converted to newer-style products.

Relaxing the residency rules for SMSFs and SAFs will see the extension of the temporary absence rule from two to five years. Under current rules, SMSF trustees/directors living overseas who intend to return to Australia at some point can be away for a period of up to two years and the fund will still meet the central management and control test. Under the proposal, trustees/directors will be able to be temporarily away for up to five years and still meet this test.

The second proposal as part of relaxing the residency rules is removing the active member test for SMSFs and SAFs altogether. This measure will allow SMSF and SAF members to continue to contribute to their fund while temporarily overseas.

Under the current rules, contributions are prohibited unless an active member test is satisfied.

Both of these changes were proposed to take effect from the start of the first financial year

after the changes receive royal assent, with the government aiming for a 1 July 2022 start date.

Both measures are welcome changes considering the workforce is becoming increasingly globalised with many people able to work remotely from anywhere in the world. It’s comforting to know the current government realises things have changed and many people out there are global citizens.

However, considering we still haven’t seen any draft legislation or consultation on either of these measures, it will be nothing short of a miracle if these measures are introduced into parliament and passed as legislation with a start date of 1 July.

The third measure from last year’s budget was the proposal to provide a two-year window for people to exit certain legacy income streams.

Under this measure, members will be able to commute and transfer the capital supporting their income stream, including any associated reserves, back into accumulation phase. The member can then decide whether to commence a new account-based pension, take a lump sum benefit or retain the balance in the accumulation account.

This change was also proposed to take effect from the start of the first financial year after the changes receive royal assent. However, like the above two measures, this proposal is also yet to be drafted as a bill or amending regulations.

Lastly and most importantly, the government finally announced in late March that it will amend the law to ensure the non-arm’s-length expenditure (NALE) provisions for superannuation funds operate as intended. Although the superannuation industry has welcomed this news, it doesn’t have much clarity on which SMSF arrangements with non-arm’slength parties will remain caught by the NALE rules.

We look forward to a constructive consultation process with the government so the superannuation industry ends up with a practical solution.

It remains to be seen whether the next government reintroduces existing lapsed legislation or advances previously announced measures that have not made it that far. Whoever is ultimately elected on 21 May, let’s hope the election promises of not overhauling the superannuation system and not introducing any new taxes carries throughout their parliamentary term and beyond.

IPA

A reporting revolution

MATTHEW CAVICCHIA is sustainability and policy adviser at the Institute of Public Accountants.

Environmental, social and governance (ESG) issues have emerged as central for business, to the extent that the notion of corporate social responsibility (CSR) is increasingly obsolete. The management of ESG is strategic and at the core of everything an organisation says and does, whereas CSR was considered an optional act of exceeding legal obligations to benefit society or the environment, or both. The accounting profession plays a significant role in ESG as there is a demand for sustainability-related disclosures to be reliably captured and communicated – skills that underpin the profession’s existence.

The problem The past decade saw several organisations introducing standards designed to assist entities with sustainability-related disclosures, including the Global Reporting Initiative, Sustainability Accounting Standards Board standards, Climate Disclosure Standards Board framework and the Task Force on Climate-related Financial Disclosures (TCFD).

Meanwhile, the Integrated Reporting Framework completely reinvented the annual report, encouraging organisations of all sizes to adopt an integrated mindset and explore how their entity creates, maintains and erodes value over the short, medium and long term.

However, the absence of standardisation created overlapping guidance and downright confusion, deterring many organisations from engaging with sustainability-related information and reporting.

The IFRS Foundation and the International Sustainability Standards Board The International Financial Reporting Standards (IFRS) Foundation is a not-for-profit organisation committed to establishing high-quality, global accounting standards. At COP26 in November 2021, the IFRS Foundation launched its second standards-setting board – the International Sustainability Standards Board (ISSB), dedicated to delivering globally comparable sustainability disclosures building on the existing alphabet soup of standards and frameworks.

In late March 2022, the ISSB released two draft standards for consultation – the first focusing on general sustainability disclosures, while the other is specific to climate-related disclosures. Both standards capitalise on the four content elements of the TCFD framework – governance, strategy, risk management, metrics and targets – which should, preferably, be

presented with an integrated approach.

Is there any guidance for SMEs? The ISSB has established disclosures of sustainabilityrelated financial risks and opportunities to inform the decision-making of investors.

Despite only certain types of organisations being mandated to prepare external reports, this has never made the role of accounting and monitoring financial performance obsolete for small and medium-sized enterprises (SME). Considering the ISSB standards from a management accounting perspective, they could be used to guide the effective management of sustainability-related risks and opportunities internally. Furthermore, there will always be other stakeholders, such as customers, employees, suppliers, banks, lenders and so forth, with a vested interest in how businesses of all sizes manage these risks and opportunities. For example, sustainability performance is an increasingly common criteria to access finance.

Does climate discriminate?

Yes, it does. For example, we know countries with a higher reliance on agriculture as a proportion of their gross domestic product are at an increased risk of being impacted by climate change. While the location of a business is one example in which the extent of climate risk and opportunity is unequally distributed, there will be very few businesses that go entirely unaffected by climate change.

The ISSB effectively distinguishes between physical risks and transition risks of climate change.

Physical risks include the damage and interruptions caused by increased instances and/or severity of floods and other extreme weather events. While some businesses will face minimal physical risks, transition risks are inescapable. Transition risks capture the changing regulatory environment and market dynamics that stem from decarbonisation and gradually stronger action on climate. Examples include access to finance, changing customer demands, talent retention and the adaptability of competitors in the evolving marketplace.

Thus, while SMEs may avoid mandatory disclosure requirements, there is an exciting opportunity for these smaller organisations to leverage global developments and better understand their ESG-related risks and opportunities. Rather than waiting for specific SME guidance, the ISSB presents a chance to level up without reinventing the wheel.

QUARTER II 2022 9

CAANZ

Pressing issues requiring action

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

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At the time of writing, the federal election was just under two weeks away and while the outcome was unknown, the online bookies were all expecting an ALP win.

Regardless of which major party forms government, I think the list of items that need to be addressed by them is very similar. To date both major parties have not said much about their plans for superannuation and financial services. Here are three important items the next government will need to seriously look at.

1. Non-arm’s-length income/expenditure (NALI/ NALE) provisions – the whole superannuation sector needs a solution to the mess created by widely drafted law and an expansive administrative interpretation taken by the ATO. There is a need for an anti-avoidance provision in the tax laws in relation to super fund investments.

The tax breaks given to the super sector are an irresistible attraction to many individuals. The problem is those who want to unreasonably access these concessions by ‘foul’ means.

Many professional and industry associations have been advocating for months to have the current NALI rules narrowed. In late March, Superannuation, Financial Services and the Digital Economy Minister Jane Hume issued a press release stating the coalition would seek to amend the law.

We understand the ALP agrees the current provisions need to be amended, however, at the time of writing, it had not made an official announcement.

In our view, this area of the law requires urgent amendment that is backdated to 1 July 2018.

2. Financial advice regime – the regulation and supervision of the financial advice sector was made worse by the Future of Financial Advice changes and this bad situation was made even worse by the creation of the Financial Adviser Standards and Ethics Authority and the enactment of some of the financial services royal commission recommendations.

At present, the cost of providing advice to a new client far outstrips what many clients are prepared to pay. It is quite common for many advice practices to absorb some of these initial costs in order to reduce client outlays.

Some clients seek advice from various places, including ‘finfluencers’.

It also not unknown for some product providers and financial advisers to seek to deal with

investors who have been declared by an accountant to satisfy the definition of a wholesale or sophisticated investor because it reduces the provider’s or adviser’s disclosure obligations under the Corporations Act. For example, no statement of advice is required for a wholesale or sophisticated investor. Further, clients who fit into the wholesale or sophisticated categories cannot access the Australian Financial Complaints Authority when disputes arise.

Over the remainder of this year the governmentinitiated Quality of Advice Review will continue.

In addition, over the next few years the Australian Law Reform Commission will be looking at ways to simplify the Corporations Act and related regulations and delegated legislation.

Chartered Accountants Australia and New Zealand welcomes both reviews and will actively participate in them. We hope they lead to better outcomes for all participants in the advice sector, especially clients including those who currently cannot access advice.

However, we are concerned that both reviews are too narrow. While the provision of financial advice is regulated by the Corporations Act, there are many other areas of the law that impact what a financial adviser might be able to recommend to a client. The following might be important too – trust law, income tax laws, superannuation laws, Centrelink or Department of Veterans’ Affairs entitlements, state/territory property law and stamp duty provisions.

All of these areas are complex in their own right and when two or more of these areas are combined together within a Corporations Act financial advice setting, the whole process of providing that advice can be intricately complex, requiring great care, time and effort to ensure nothing is missed.

While the simplification of laws should be welcomed and encouraged in nearly all cases, we would be concerned if anyone thinks the financial advice cost structures will dramatically fall if the regulation of financial advice in the Corporations Act on its own is improved.

3. Binding death benefit nominations (BDBN) – before the end of the year the High Court will hand down its judgment about BDBNs in the Hill v Zuda case. Regardless of this decision, we think BDBNs as allowed for in the Superannuation Industry (Supervision) Act need significant reform for all super funds.

REGULATION ROUND-UP Contribution changes Treasury Laws Amendment (Enhancing Superannuation Outcomes for Australians and Helping Australians) Bill 2021

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

A number of 2021 federal budget measures have now been passed as law.

These changes come into effect from 1 July 2022 and include removing the $450 per month income threshold to be eligible for superannuation guarantee (SG) contributions, ensuring all salary and wages of eligible employees qualify for SG, reducing the downsizer contribution eligibility age to 60, extending the eligibility to use the nonconcessional bring-forward rule up to age 75, and removing the work test to make non-deductible personal contributions under age 75.

From 1 July, a person who is under age 75 at any time during the financial year will be able to make non-concessional contributions up to three times the annual non-concessional cap for that financial year. Once a person reaches age 75 (with a 28-day allowance), the fund may only be able to accept employer and downsizer contributions.

Pension minimums extended Superannuation Legislation Amendment (Superannuation Drawdown) Regulations 2022

Regulations have been registered to extend the 50 per cent reduction in minimum pension drawdowns for another year. This reduction now applies to 30 June 2023.

value over the period, and contributions are included as gross of tax.

Retirement Income Covenant Corporate Collective Investment Vehicle Framework and Other Measures Bill 2021

Trustees of Australian Prudential Regulation Authority funds need to develop a retirement income strategy for beneficiaries who are retired or are approaching retirement. This needs to be a written strategy that is publicly available from 1 July 2022. This change may encourage the development of more innovative retirement income products and place a greater focus on retirement planning. Aged-care advice is specifically mentioned in the covenant as an important issue to consider in retirement income planning.

COVID-19 rental deferral Superannuation Industry (Supervision) SelfManaged Superannuation Funds (COVID-19 Rental Income Deferrals – In-House Asset Exclusion) Determination 2022

The legislative instrument extending the rental deferral relief for in-house assets was registered on 2 March 2022. Provided conditions are met, SMSFs that offer rental deferrals in 2021/22 will not cause a loan to, or investment in, a related party to become an in-house asset.

Arm’s-length terms for LRBAs Practical Compliance Guide (PCG) 2016/5

ECPI checklist www.ato.gov.au at QC69231

Changes to the exempt current pension income (ECPI) rules have been granted royal assent and apply from the 2022 income year onwards.

SMSFs that hold all fund assets in retirement phase for part of the year can choose to treat them as non-segregated current pension assets for that period and instead use the proportionate method.

The ATO has published checklists to help trustees determine the correct method to use. Separate checklists have been developed for 2021/22 onwards and for the prior years from 1 July 2017.

SMSF performance calculations 2019/20 SMSF statistical overview report glossary

The ATO has changed the methodology used to calculate median investment returns for their SMSF performance calculations due to concerns the performance of SMSFs was being underestimated.

The changes allow a closer approximation to the method used by Australian Prudential Regulation Authority-regulated funds. Key changes are using the fund’s value at the beginning of the period rather than the average

This PCG sets out the ATO safe harbours under which an existing related-party limited recourse borrowing arrangements (LRBA) is treated as an arm’s-length arrangement.

New paragraph 17A has been inserted to confirm that as long as conditions in this PCG have been met, the ATO will not apply compliance resources to enforce the non-arm’s-length income provisions in section 295-550 of the Income Tax Assessment Act 1997 for assets subject to an LRBA in 2018/19 or later years.

Term-allocated pensions and transfer balance cap excesses Income Tax Assessment (1997 Act) Regulations 2021

Amendments to the Superannuation Industry (Supervision) Regulations allow SMSF members who choose to commute a complying life expectancy pension or a term-allocated pensions, that existed at 1 July 2017, to remove any excess transfer balance amounts that arise when a new term-allocated pension is started. SMSF trustees will be able to action a commutation authority issued by the ATO to remove the excess amount for commutations transacted from 1 July 2017.

QUARTER II 2022 11

FEATURE

PLAYING SMSF CHESS

The SMSF investment strategy is like a game of chess and operates under a prescribed set of parameters. These rules have not changed, but more people should be giving this aspect of running their fund greater focus, writes Jason Spits.

12 selfmanagedsuper

FEATURE INVESTMENT STRATEGY

Investment strategies have always been a requirement to running an SMSF, but a simple letter sent by the ATO to around 18,000 funds in 2019 redirected attention to this often overlooked and underappreciated obligation.

At the time, there was a range of responses in regard to the letters, which were sent to funds with more than 90 per cent of investments in a single asset or asset class – typically property. These responses induced panic from trustees, as well as concerns the ATO would be assessing the suitability of strategies, something it is not empowered to do, and questions around what makes a compliant investment strategy.

Given the ATO will not mandate what should be included in a strategy and it was already providing plenty of guidance around their creation, the regulator released updated recommendations for trustees outlining its expectations and repeated warnings about using a cookiecutter approach. It also admitted the letterwriting campaign had an impact beyond the funds targeted, with many more trustees reviewing their investment strategy.

Looking back, however, through the mists of COVID-19 and comparing the situation today, the ATO has not taken further action, perhaps because of the impact of the pandemic, but its stance on what is required remains unchanged and is outlined in Superannuation Industry (Supervision) (SIS) Regulation 4.09.

Putting it on paper One thing that is not mentioned is the requirement the strategy be in writing, a point raised by some critics of the ATO letters.

Heffron managing director Meg Heffron agrees there is no written obligation for an investment strategy to be in writing, but counters by asking if that had to be spelled out under law.

“There have been calls for the law to state it must be in writing, but that would seem self-evident if there are any plans at all to have it included as part of a fund audit,” Heffron says.

“If someone has an SMSF and they plan to communicate their intention to invest in certain assets, it would seem ridiculous not to have that in writing.”

Super Sphere director Belinda Aisbett says the absence of clear directions in the law to have a written strategy is a non-issue from her perspective as an auditor.

“There is a recognition that auditors can’t audit what is in someone’s head and the only obvious way we can be sure they are meeting their obligations regarding an investment strategy is for it to be written,” Aisbett says.

Speaking at a recent SMSF Auditors Association Conference, Advisers Digest founder and SMSF specialist adviser Peter Johnson says the lack of an investment strategy can also be a problem for advisers and accountants when they are being examined by the ATO. “From your point of view, when you get an audit from the ATO and have a note that says ‘I asked the client if they’ve got a strategy and they said yes, but not in writing’, will the ATO consider you have an adequate audit file?” Johnson says.

“Every client in the country has an adequate investment strategy in their head, but who gets in trouble if the ATO checks your files and look at the investment strategy and you haven’t picked it apart?”

“If someone has an SMSF and they plan to communicate their intention to invest in certain assets, it would seem ridiculous not to have that in writing.”

Meg Heffron, Heffron

Buying off the shelf Evolv Super Audits client services director Carol Scholes-Robertson concurs nonwritten investment strategies is not an area of concern and almost every SMSF trustee understands the requirement, but things get looser in underlying documents related to specific investments.

“We do see unwritten arrangements and handshake agreements around leases, particularly in rural areas where they have deep relationships, but not in the investment strategy,” ScholesRobertson says.

“Where we do have problems with undocumented investment strategies is when people are using off-the-shelf SMSF establishment packages. In these

situations the investment strategy is often forgotten, meaning at year end they have a compliance issue with the auditor because they can’t demonstrate an investment strategy has been in place for the year.”

She says off-the-shelf investment strategies can create problems, yet their widespread use is due to change in the structure of the SMSF sector.

“We find software-generated, off-theshelf strategies generic and if they don’t match what a trustee is doing, we will push Continued on next page

QUARTER II 2022

13

FEATURE INVESTMENT STRATEGY

“The reality is a one size does not always fit all. If we have trustees seeking a boilerplate strategy and they just sign the bottom of it because they think that is all that is needed, they will inevitably run into issues.”

Belinda Aisbett, Super Sphere

Continued from previous page

back and request this be reviewed as they lack personal data, expected retirement ages, risk profiles and other things an investment adviser would go into detail,” she says.

“The use of off-the-shelf solutions results from the structure of the industry and what is easy for advisers to do may become difficult if they don’t know the clients or if clients choose to document their own investment strategy.

“Accountants have also shifted out of this space and they were the people that were assisting clients in documenting their thoughts, and that gap hasn’t been filled.”

A place to start Heffron sees off-the-shelf investment strategies having a place, but only as the starting point to building out an investment strategy and not as the endpoint for trustees.

“Most off-the-shelf templates pay lip service to the things in the law that you have to consider, such as liquidity and diversification, so you wonder if it can ever be a useful tool when every SMSF is different,” she says.

“A template can only go so far and be a guide. The problem was the first templates were quite blunt instruments with tables to be filled in with asset allocation ranges and member details, turning what was a carefully considered decision into something that looks cookie-cutter and

14 selfmanagedsuper

doesn’t reflect the strategy.”

While Aisbett does not see off-the-shelf investment strategies as being dangerous for trustees, she highlights the fact they are limited and most trustees will reach those limits as soon as they decide to make changes that are specific to the needs and objectives of their SMSF. “The reality is a one size does not always fit all. If we have trustees seeking a boilerplate strategy, and they just sign the bottom of it because they think that is all that is needed, they will inevitably run into issues,” she observes.

“When the auditor looks at the strategy and notes it is worded in a particular way and the trustees have done the exact opposite, it is clear the trustees have not given effect to the strategy. We see it when trustees sign a boilerplate strategy that talks about a diverse portfolio with a broad range of assets but the fund only owns property.”

To prevent this, she recommends trustees creating their own strategy should examine whatever templates they have acquired, read them closely and edit the strategy to ensure it aligns with what their SMSF will be doing. In many cases she says this will lead to a good strategy for them.

Making it better On a positive note, Heffron says, unlike so many other documents in financial services, an investment strategy does not need to be long or overdone, even when complex investments are involved.

However, a strategy will be well served by having some commentary around what it is aiming to achieve, she adds.

“We try to approach it differently and help people pull out of their head the things they have already thought about when setting up a strategy,” she says.

“An example might be why there is a lack of diversification and a large investment in property, which might include questions about having a secure tenant and regular cash flow or an opportunity the trustee could take advantage of because they have particular expertise in this area.

“There are a number of elements people often take into account, whether they know it or not, in making decisions as to where to focus their asset allocations and what we are trying to do is create space for the trustee to articulate the strategy they already have.”

Following the ATO letters of 2019, the regulator discouraged the practice of stipulating an SMSF could have anywhere between 0 and 100 per cent of its investments in any given asset class and suggested the use of specific ranges that were more likely to be held by the fund in the coming year.

Conversely, Johnson says investment strategies should not go to the other extreme and contain allocation bands that are too small or exact to allow any flexibility within the portfolio.

“Remember that you don’t want to go too tight and state things like the strategy

FEATURE

will include Australian shares at 23 per cent as those types of details are not necessary,” he advises.

“A strategy that runs through buying a property and maintaining enough cash to cover cash-flow requirements for the fund, as well as allows for the acquisition of some Australian shares, sounds like it is considering the overall asset mix rather than ‘we will do what we want whenever we want to’.”

DBA Lawyers special counsel Bryce Figot says trustees still unsure of what to do can use regulation 4.09 of the SIS Regulations and guidance from the ATO to tick the necessary boxes, but he cautions consideration must be given to the life insurance needs of members.

“The big issue when using something off the shelf for advisers is the need to think about insurance, and if an off-the-shelf template adds a line stating the members should have insurance, and someone dies or is injured and there is no insurance, that adviser could be liable,” he warns.

“I haven’t seen it happen in practice, but it certainly does not require much imagination to see how it could.”

Carrot and stick As a consequence of the ATO’s shot across the bow, auditors are now expected to have a greater role in identifying and addressing problems with an investment strategy, a view reinforced by the Ryan Wealth Holdings Pty Ltd v Baumgartner case, in which the auditor was found liable for failing to detect irregularities in the investment strategy.

In fact, Scholes-Robertson sees this as the chief outcome of the exercise. Further, she suggests the carrot is being held out to trustees to encourage them to change, but auditors are getting the pointy end of the stick if they fail to observe and correct any problems.

“As an auditor it is really difficult because the ATO has put us in a tricky position by telling trustees their auditor will be asking how they have addressed any issues with a strategy,” she says.

“As an auditor it is really difficult because the AT O has put us in a tricky position by telling trustees their auditor will be asking how they have addressed any issues with a strategy.”

Carol ScholesRobertson, Evolv Super Audits

“We had to work out what our audit response was going to be and ask trustees to specifically articulate what the ATO has asked them to do. But it has not really changed the things the regulator was attempting to address in terms of a change of behaviour.”

Despite this, Evolv client services senior manager Blair Hornick says auditors have other tools they can use to encourage compliance with investment strategy standards apart from a management letter or an auditor contravention report (ACR),

and calling upon the skill and influence of other SMSF professionals is a central way to improve trustee behaviour.

Hornick explains the use of general language in newsletters, particularly around specific asset classes and investments, provides broad information that can be built upon by accountants and advisers.

“Some of the best leverage we have in terms of influencing behaviour are management letters and ACRs for individual trustee issues, but in terms of influencing and educating trustees we do that indirectly via our efforts and that of accountants and advisers,” he reveals.

“We also make it very specific around particular issues and we will talk about unlisted investments, for example, and how they fit within a compliance framework so we can be more specific about areas for trustees to focus on.”

Moving forward by looking back It has been close to three years since the ATO raised its investment strategy concerns, so does this mean we should be seeing an improvement in this area?

Aisbett says this may not be the best way to assess where the sector should be and instead the regulator’s perceived intent needs to be taken into account.

“What the ATO has tried to do, which I think is helpful, is remind trustees that this is an obligation they need to look at and that there are certain things needing to be addressed on an ongoing basis,” she notes.

“If you read the ATO guidance on investment strategies, it is not designed for SMSF professionals. It is for trustees and as soon as they incorporate that guidance in their investment strategy the audit process is really easy and it becomes a checking process.

“I joke with people that if you run an SMSF, your sole goal, besides providing for retirement, should be to make the auditor happy and you’ll achieve this with an investment strategy that is simple to follow and really clear about what is required.”

QUARTER II 2022 15

FEATURE

COMPLETING THE

PERFORMANCE

PICTURE The investment performance of SMSFs has never been accurately or adequately measured. Research and analysis released this year, however, may have changed this situation for good, Tia Thomas reports.

FEATURE INVESTMENT PERFORMANCE

Conjecture has always existed as to how SMSFs compare with Australian Prudential Regulation Authority (APRA)-regulated funds on both a cost and performance basis. Research commissioned by the SMSF Association and SuperConcepts and conducted by Rice Warner in 2020, titled “Cost of Operating SMSFs 2020”, covered off the argument from a cost perspective. It found SMSFs with a balance of $200,000 or more are as cost effective as their public offer counterparts and further, SMSFs with an asset balance of $500,000 or greater are in fact the most cost-effective superannuation option period.

But what about the performance of SMSFs? How does it compare with APRA funds? For so long this has been very difficult to determine given the differences in portfolio construction and the lack of information providing the level of granular detail required to make a valid comparison. This state of affairs has allowed preconceived ideas about the lacklustre returns SMSFs have generated to linger, much to the joy of sector critics.

However, research released in February this year by the University of Adelaide in conjunction with the SMSF Association, titled “Understanding self-managed super fund performance”, provided a more scientific and accurate measurement of how SMSF investment performance compares to APRA-regulated funds.

Data for the study was sourced from BGL Corporate Solutions and Class between 1 July 2016 and 30 June 2019 and analysed information from more than 318,000 funds in order to more accurately identify the asset threshold needed for SMSFs to deliver comparable returns with larger public offer funds.

The motivation to conduct the research was instigated by consistent messages from the Australian Securities and Investments Commission (ASIC) and other government agencies stating SMSFs required a minimum member balance of $500,000 before they should

“As the fund balance increases, the performance of the fund improves and then once you hit $200,000 that alignment starts to level off. It is essentially a straight line from thereafter.”

Peter Burgess, SMSF Association

be considered a viable retirement savings option for Australians.

According to ASIC, SMSFs with balances less than $500,000 had lower returns after expenses and tax in comparison to APRA-regulated funds.

However, the research from the University of Adelaide’s International Centre for Financial Services (ICFS) challenged this belief and found only a minimum $200,000 balance was needed to gain competitive investment returns with

APRA-regulated funds.

SMSF Association deputy chief executive and director of policy and education Peter Burgess says the research has challenged popular opinions.

“As the fund balance increases, the performance of the fund improves and then once you hit $200,000 that alignment starts to level off. It is essentially a straight line from thereafter,” Burgess says.

“What that is saying is ‘yes, the performance of the fund improves as you approach $200,000, but beyond that the fund size has no relevance to the performance of the fund’.

“This really challenges what APRA has said and the information made available to licensees about how much people should have as a minimum to start an SMSF. “For example, ASIC guidance 206 – which is guidance issued to licensees around self-managed super funds – notes that people should have around $500,000 before considering setting up an SMSF. This research really challenges that.”

These findings closely align with the conclusions of the Rice Warner study that, as referred to earlier, also identified an asset balance of $200,000 as a prudent threshold to justify SMSF establishment on a cost basis.

“The research shows that if you have a balance of $200,000, it is viable to start an SMSF and when you have particularly over a million dollars, then it can be a lot cheaper than a APRA-regulated fund,” actuary and Rice Warner co-founder Michael Rice says.

However, Rice acknowledges the importance of having performance measurement data to complete this finding.

“Now, price is not the only criteria. Of course there is no point being cheaper than APRA-regulated funds if you have a terrible performance,” he notes.

With reference to the University of Adelaide study, he notes that while its Continued on next page

QUARTER II 2022 17

FEATURE INVESTMENT PERFORMANCE

“The research shows that if you have a balance of $200,000, it is viable to start an SMSF and when you have particularly over a million dollars, then it can be a lot cheaper than a APRA-regulated fund.”

Michael Rice, actuary

Continued from previous page

conclusion regarding the $200,000 threshold may seem like an anomaly, it can be achieved, but the trustee still requires a sound understanding of investment strategies or support from a financial adviser to enhance performance.

He illustrates his point using the recent strengths and weaknesses of some popular asset classes among SMSF trustees.

18 selfmanagedsuper

“A lot of people buy property or shares and that can really improve returns when things go right, but you can also wipe your money out if they go wrong. It is important to note we have been living in a period where equities and property have done very well,” he explains.

“If you have a portfolio largely invested in growth assets, then your returns will have been sound. But anyone who invested in government bonds over the last 15 years will not have experienced good returns because interest rates have been very low. Worse still, most ATO statistics indicate that quite a lot of SMSF money is in cash, further hampering returns.”

Looking at specific elements of return generation and the comparison between SMSFs and public offer funds, the University of Adelaide found median APRA funds outperformed SMSFs in two of the three years analysed, but this result was reversed once smaller SMSFs with balances below $200,000 and less than 80 per cent of cash or term deposits were excluded.

To this end, the SMSF Association noted self-managed funds with significant cash holdings were associated with performance impairment during the financial years analysed.

This was particularly noticeable in 2017 when SMSFs were found to have experienced a median return of 6.9 per cent, while APRA funds enjoyed a median performance of 7.8 per cent. However, when cash-heavy funds were excluded from the analysis, SMSFs achieved a median return of 8.0 per cent.

“What the research found is that SMSFs with very large exposures to cash – funds which had 80 per cent or more of their investments allocated to cash – underperformed compared to larger funds. I do not think that is surprising when you look at interest rates, which are very low,” Burgess notes.

According to Burgess, this finding emphasises one of the report’s key messages regarding the importance of SMSF portfolio diversification as a means of improving fund performance.

University of Adelaide lead researcher and ICFS business school deputy director George Mihaylov reveals there is a subgroup of SMSFs that hold excessive cash balances, which are further negatively impacted by the low interest rate environment.

Despite this, he says cash may become a more attractive asset class given the inflationary environment that economies globally are now experiencing.

SuperConcepts SMSF technical and strategic solutions executive manager Philip La Greca points out performance measurement and the role cash allocations play may not be as straightforward as it appears.

“How many of those funds with large cash holdings are SMSFs wholly in pension phase? That is something that was not determined in the research and that is because trying to extract that information is not easy,” La Greca explains.

“SMSFs entirely in pension phase by their nature are going to be more conservative in their investments and require more cash. Of course, if you are more conservative, your returns tend to also be a bit lower.

“The old argument is over a 10-year cycle, you have three negative years. The impact of having those three negative years to a pension fund upfront, compared with at the end of 10 years, can reduce the drawdown someone receives from that fund by 30 per cent.”

Still, SMSFs that have pursued diverse investment options across various asset classes, including listed Australian equities, listed international equities, listed trusts and unlisted trusts, have been shown to produce better performance outcomes.

The University of Adelaide found the least diversified SMSFs recorded the lowest performance outcomes, but enjoyed a strong performance benefit across all financial year periods by simply including one additional asset class.

“We found that there is a strong performance diversification relationship,” Mihaylov confirms.

“Systematically, there are

FEATURE

“SMSFs entirely in pension phase by their nature are going to be more conservative in their investments and require more cash. Of course, if you are more conservative, your returns tend to also be a bit lower.”

Philip La Greca, SuperConcepts

underperforming funds that are holding assets in two or three classes. But that relationship becomes slightly weaker after three asset classes are included.”

From a financial adviser’s perspective, La Greca notes the research highlights the benefits of diversification and the subsequent need to encourage SMSF clients to move away from significant allocations to cash or conservative assets that have a history of underperformance.

Further, he says the study has supported the belief that funds need to prioritise their performance rates more.

“We have not really had a proper comparison between APRA funds and SMSFs before. I think this will actually start to impact the funds themselves to begin to look at their performance and to benchmark it,” he says.

The difficulty in fund performance comparison to date has stemmed from incompatible methodologies used by different sources.

Historically the method by which the performance of SMSFs has been evaluated stems from the ATO’s ability to produce a return on assets (ROA) measure based on information collected from annual returns.

By contrast, APRA gathers data from the financial statements of funds in order to determine a rate of return (ROR) gross of contributions tax and insurance flows.

The research highlights the significant differences that have made accurately comparing SMSFs and APRA-regulated funds difficult, due to inconsistent

measurement methodologies.

To illustrate the inaccuracy of the traditional performance measurements, the University of Adelaide study obtained a median ROA for SMSFs during the same period as the ATO statistics to compare the primary performance ratio differences.

This exercise shows the median SMSF ROA is underestimated by more than 1.9 per cent in the three-year period. As such the study recognises how the gap between ROA and ROR has become increasingly severe.

Moreover, these traditional techniques have to date been used by government agencies to assess the appropriateness of SMSFs. “The Productivity Commission a few years ago did a review of the efficiency of the superannuation sector based on ATO calculations of returns,” Burgess recalls.

“In the research they were able to replicate the ROR performance calculation.

We think it is a much more accurate calculation than what has previously been available to the Productivity Commission when they have been asked to look in the past.”

Given the magnitude of how SMSF performance levels have been underestimated, the conclusion is that future methodology should involve a more critical analysis with an inclusion of behavioural impacts in summary statistics.

To this end, Mihaylov notes the sector continues to advocate for updated summary statistics.

“Unfortunately, there are some structural limitations in the whole process, which means that the comparisons can’t be completely fixed. Return on assets will never be fully compatible with rates of return,” he says.

Burgess concurs, but reveals the SMSF Association has approached ASIC with copies of the University of Adelaide research paper with a view to initiate a change in evaluation and guidance practices.

“We have written to ASIC and provided copies of the research. In light of the findings in this research, we have asked them to review their guidance materials that are made available to licensees who provide advice to clients about selfmanaged super funds,” he says.

“ASIC is looking at the research and is considering the issues that have been raised in this letter back in February.”

While the research papers have both challenged traditional perceptions of SMSFs, Rice notes this may not be enough to alter assessment procedures from Treasury and other government bodies.

“The real fear for Treasury and government is that some of these SMSFs are not paying enough tax because they have money squirreled away in these funds. It has led to APRA suggesting capping people’s super balances at $5 million,” he says.

“It is sort of a little bit baffling but that is because it’s politics not policy which is how our system works.”

QUARTER II 2022 19

INVESTING

Infrastructure assets as an inflation hedge Certain infrastructure assets can play a defensive role against an inflationary economic environment such as that impacting global markets currently, writes Sarah Shaw.

SARAH SHAW is chief investment officer at 4D Infrastructure.

Inflationary pressures have been building across the international economy over the past 18 months to two years, broadly due to COVID supply chain disruptions causing product shortages, together with very accommodative fiscal and monetary policy boosting aggregate demand. As a result, global monetary policy is now moving to become more contractionary, with interest rates increasing around the world. Russia’s invasion of Ukraine is also adversely impacting the global economic outlook, pushing up energy costs.

Infrastructure, contrary to common belief, is an asset class that can provide investment portfolios with some protection against inflation and rising interest rates, depending on the type of infrastructure assets held.

However, before we examine the relationship between infrastructure and inflation, we provide a brief outline of the prevailing macroeconomic environment below.

Global economic environment The Ukraine-Russia conflict presents risks for slower global growth and higher inflation. The International Monetary Fund (IMF) recently identified the main potential economic impacts of the war as: • higher prices for commodities such as food and energy, • neighbouring economies to Ukraine to grapple with disrupted trade, supply chains, large refugee flows and remittances, and • reduced business confidence and higher investor uncertainty may weigh on asset prices, tightening financial conditions and potentially spurring capital outflows.

The IMF also forecasts that beyond its immediate and tragic humanitarian impact, the war will slow economic growth. It said overall economic risks have risen sharply and has revised its projection for global growth downwards to 3.6 per cent in both 2022 and 2023. Activity in Russia is forecast to shrink by 8.5 per

20 selfmanagedsuper

cent and in Ukraine by 35 per cent in 2022. The IMF is also predicting global inflation will be 5.7 per cent in advanced economies in 2022.

The worst economic impacts of COVID look to have passed – although a new wave/variant is always possible – while the COVID position and lockdowns in China are a concern. Should this lead to a slowing in Chinese economic growth, the IMF growth forecasts above could be challenged further to the downside.

Infrastructure investment is key to stronger longer-term growth While the Russian invasion of Ukraine will slow growth, especially in Europe, and the COVID outbreak in China will be a further headwind, ultimately we believe the global economy will emerge stronger for the recent experience. Much of the fiscal and monetary spending by governments in response to COVID is focused on essential infrastructure investment around the globe, including the energy transition. Much of this investment is yet to be fully deployed. In a recent publication, “IMF: Putting Public Money to Work, August 2021”, the international financial institution illustrates how effective infrastructure expenditure can be in boosting jobs and growth. In this research the IMF evaluated the direct employment effect of public investment in the key infrastructure categories of electricity, roads, schools, hospitals, water and sanitation. Using data from 41 countries over 19 years, it estimates US$1 million of public spending in infrastructure creates three to seven jobs in advanced economies, 10 to 17 jobs in emerging market economies and 16 to 30 jobs in low-income developing countries. This research highlights just how significant the economic multiplier of infrastructure spend is (see Graph 1).

As part of the global COVID response, infrastructure investment became a key stimulus focus for governments around the world. For example, late last year United States President Joe Biden passed into law a US$1.2 trillion infrastructure plan, including US$550 billion in new federal investment, representing the biggest burst of spending on US public works in decades. It includes new spending for roads and bridges, power grid upgrades and broadband

Graph 1: Jobs multiplier – job content per $1 million of additional investment

60 50 40 30 20 Max

Medium

Advanced economics

Emerging market economics

2021, consumer prices accelerated at the fastest pace since 1982, hitting 7 per cent (annualised), and the US Federal Reserve (the Fed) eventually began its tightening cycle in March 2022, with as many as eight more hikes forecast by the market for this year.

Common market belief has it that all infrastructure stocks underperform as interest rates and inflation rise. This is often associated with the perception of these stocks as being a ‘bond proxy’. The logic then flows that, just like a government bond, as interest rates rise, share (bond) prices fall Most recent rising cycle as the present value of their ‘fixed’ future Inflation, interest rates and started in December 2015 1 cash flows is now worth less and the required infrastructure Fed fund rate bottoms May 2004 yield from the asset must increase to match Critical to0our current outlook is the issue of the rise in market interest inflation.

As noted above, global inflation Mar ‘08 Mar ‘12 rates. Mar ‘16 Mar ‘00 Mar ‘04 However, this is a simplistic has been emerging as a key economic assessment and ignores the varied risk since last year. In the US in December

expansion.

In India, Prime Minister Narendra Modi launched a 100 trillion rupee (US$1.35 trillion) national infrastructure plan that will help generate jobs and expand use of cleaner 7 fuels to achieve the country’s climate goals.

These6recent infrastructure-specific programs follow the European Union, 5 which was a very early proponent of the 4 infrastructure-led recovery, having launched % billion NextGenerationEU recovery its €750 3 fund in the second half of 2020.

2

Water & sanitation

Schools & hospitals

Road

Energy

Water & sanitation

Schools & hospitals

Road

Energy

Water & sanitation

Schools & hospitals

Road

Min

Energy

0

Developing countries

characteristics of assets in the infrastructure sector. In an inflationary scenario, some parts of the infrastructure universe, namely userpays assets, may enjoy the perfect storm over the short to medium term, being interest rates supportive of future growth, economic activity flowing through to volumes and explicit inflation hedges through their tariff mechanisms to combat any inflationary pressure they may experience.

In contrast, regulated utilities can be more immediately adversely impacted by rising interest rates and inflation because of the regulated nature of their business.

The flow-through of inflation is dictated by whether the utility’s return profile is ‘real’ or ‘nominal’. If the utility operates under a ‘real’ Continued on next page

QUARTER II 2022 21

7

Sources: Compustat, Orbis and IMF staff calculations.

10

30 20

7

Min

6 5

Advanced economics

Emerging market economics

Source: Bloomberg.

Road %

4 3 2 1

7

6

6

5

5

4

%

3

1 0

Mar ‘00

Continued from previous page

Yield increases

Mar ‘16

Mar ‘00

Mar ‘04

charged. As a result, both the regulatory review process and the final outcome can be quite unpredictable.

These key differences between the assets should see user-pays and real return utilities fundamentally outperform during a rising inflation/interest rate period due to a more immediate and direct inflation hedge.

7 return model, inflation is passed through into tariffs much like a user-pays asset. This model 6 is more5 prevalent in parts of Europe and Brazil, 4for example, and limits the immediate % of inflationary pressure and, in fact, impact 3 can positively boost near-term earnings.

2 By contrast, if the utility is operating 1 under a ‘nominal’ return model, must bear Testing the thesis Yield it increases 0 the inflationary uptick reflected in certain We tested the thesis that user-pays assets Mar ‘04 Mar ‘08 Marcan ‘12offer some Mar ‘16 costsMar until‘00 it has a regulatory reset, when protection from rising interest the changing inflationary environment rates and inflation, while regulated utilities is acknowledged by the regulator and can be more vulnerable. Since 2000, there approved to be incorporated in new tariff/ have been two Fed funds rate hike cycles revenue assumptions. This nominal model is (Graph 1) and three periods during which the the standard model for the US utility sector.

US T-Bond yield rose by more than 1 per cent As such, those utilities in a real model will over consecutive months (Graph 2). weather inflationary spikes a little better than To test the thesis that user-pays assets can their nominal peers. outperform in periods of rising interest rates/ However, in terms of interest rate shifts, inflation, we: the issues for both real and nominal models • segregated 4D’s investible universe are consistent. For a regulated utility to of more than 300 global listed recover the cost of higher interest rates, it infrastructure stocks into user pays (the must first go through its regulatory review 4DUP index) and regulated utilities (the process. While a regulator is required to have 4DUts index), regard for the changing cost environment • examined how these two indices, as the utility faces, the process of submission, well as the S&P Global Infrastructure review and approval can take some time Index (S&PI), performed versus the or can be dictated by a set regulatory MSCI World Index (MSCI – as a proxy period of anywhere between one to five for global equity market performance) years. In addition, the whole environment during the above time periods – namely, surrounding costs, household rates and rising Fed funds rate and rising US 10utility profitability can be highly politically year T-Bond yields, and

22 selfmanagedsuper

Mar ‘16

3

0

Mar ‘12

Mar ‘12

4

1

Fed fund rate bottoms May 2004

Mar ‘08

Mar ‘08

2

Most recent rising cycle started in December 2015

Mar ‘04

Fed fund rate bottoms May 2004

0 Developing countries Mar ‘00 Mar ‘04

7

2

Most recent rising cycle started in December 2015

Graph 3: US 10-year T-Bond yield from 2000

Graph 2: US Fed fund rate from 2000

%

Energy

Water & sanitation

Schools & hospitals

Road

Energy

Water & sanitation

Schools & hospitals

Road

0

Water & sanitation

INVESTING

Schools & hospitals

Medium

Energy

Max

10

Mar ‘08

Mar ‘12

Mar ‘16

• separated performance over the first six months and second six months (that is, months seven to 12) after rates started increasing to better understand the performance behaviour of the indices.

As shown in Graph 2, since 2000 there have been two periods in which the US Fed funds rate rose by more than 1 per cent over consecutive months. The performances of our infrastructure indices versus the MSCI during these periods are shown in Table 1.

As shown in Graph 3, since 2000 there have also been three periods during which the US T-Bond yield rose by 1 per cent over consecutive months. Performance of our infrastructure indices during these periods is shown in Table 2.

Performance conclusions We conclude from the analysis in Table 1 that a rising US Fed funds rate did not significantly impact the performance of the 4DUP, which outperformed the MSCI in all four measured periods. However, the performance of the 4DUts and S&PI were not as strong and significantly underperformed the MSCI during months seven to 12 of the November 2015 rate hike cycle.

Table 2 suggests rising US bond yields are far more influential for listed infrastructure equity market performance than the US Fed funds rate. Notably, the 4DUP outperformed the MSCI over four of the six measured time periods, underperforming only during the

Table 1: MSCI World v 4DUP, 4DUts & S&PI Relative performance from the date the US Federal funds rate started rising Period 1: FF rates start increasing in May 2004 Performance months 1-6 (%)

Performance months 7-12 (%)

4DUP

4DUts

S&PI

4DUP

4DUts

S&PI

21.6`

18.2

22.8

6.8

9.0

7.2

MSCI World

9.2

9.2

9.2

2.5

2.5

2.5

Outperformance

12.4

9.0

13.6

4.3

6.5

4.7

Outperform v MSCI

Yes

Yes

Yes

Yes

Yes

Yes

Index performance

Period 2: FF rates start increasing in November 2015 Performance months 1-6 (%)

Performance months 7-12 (%)

4DUP

4DUts

S&PI

4DUP

4DUts

S&PI

Index performance

5.5

13.2

7.8

8.9

-2.1

-1.3

MSCI World

0.4

0.4

0.4

3.4

3.4

3.4

Outperformance

5.1

12.8

7.4

5.5

-5.5

-4.7

Outperform v MSCI

Yes

Yes

Yes

Yes

No

No

Source: Bloomberg. We used the S&P Global Infrastructure Index (S&PI) as a proxy for global listed infrastructure performance; it only became available in November 2001, but is th longest running index for GLI stocks. The 4DUP and 4DUts indexes are market cap weighted. All performance numbers are total return, converted to US$ equivalent using Bloomberg formulas.

first six months of periods two and three, and recovering much of that underperformance during months seven to 12; and both the 4DUts and the S&PI underperformed the MSCI during the first six months of each of the three periods of rising yields before outperforming during months seven to 12.

These results highlight how user-pays assets can be resilient through periods of rising interest rates/inflation, while regulated utilities are more inclined to demonstrate the ‘bond proxy’ profile.

Stock analysis We also looked at this analysis at a company level, considering the fundamental impact of higher inflation leading to faster-than-

anticipated interest rate hikes on a number of companies across user-pays, regulated utilities (nominal return) and regulated utilities (real return). Taking the example of user-pays asset Transurban, we considered the impact on earnings before interest, taxes, depreciation, and amortisation (EBIDTA) and net profit after tax (NPAT) of inflation two percentage points above our current base-case assumptions for the next three years. In this scenario, bond rates move up by 1 per cent in 2022 (relative to current assumptions) and a further 1 per cent in 2023.

Cost of equity also increases by 0.5 per cent a year. Under this scenario, both EBITDA and NPAT increase across all three years. Even under a more extreme test case of inflation

moving three percentage points above base-case assumptions, EBITDA and NPAT for Transurban increase across all three years.

Overall conclusion There are risks to the global economic recovery that were emerging post COVID. These include increasing inflationary pressures leading to rising interest rates, and the invasion of Ukraine by Russia. The invasion will put further pressure on inflation, which we believe remains a key risk, with global central banks responding with higher interest rates. However, even in such an environment, significant components of the Continued on next page

QUARTER II 2022 23

INVESTING

Continued from previous page

infrastructure asset class remain appealing.

As outlined above, user-pays infrastructure assets can outperform during a rising inflation/interest rate environment due to

more overweight real rate utilities at the expense of some of the growth-sensitive user-pays assets. Finally, if the market were to overreact to the economic outlook, we would use it as a buying opportunity across all infrastructure sectors.

an inherent inflation hedge in their business structure. At 4D we remain overweight userpays assets and, within the regulated utility sector, favour those with real returns. Further, if we move beyond inflation to a stagflation environment, our positioning would shift

Table 2: MSCI World v 4DUP, 4DUts & S&PI Relative performance from the date the US 10-year T-Bond yield started rising Period 1: 10-year T-Bond yields start increasing in May 2003 Performance months 1-6 (%)

Performance months 7-12 (%)

4DUP

4DUts

S&PI

4DUP

4DUts

S&PI

Index performance

16.4

7.0

12.6

9.4

10.4

10.1

MSCI World

14.9

14.9

14.9

8.1

8.1

8.1

Outperformance

1.5

-7.9

-2.3

1.3

2.3

2.0

Outperform v MSCI

Yes

Yes

Yes

Yes

Yes

Yes

Period 2: 10-year T-Bond yields start increasing in August 2010 Performance months 1-6 (%)

Performance months 7-12 (%)

4DUP

4DUts

S&PI

4DUP

4DUts

S&PI

Index performance

23.3

11.0

19.6

-0.9

1.3

-6.4

MSCI World

26.3

26.3

26.3

-8.9

-8.9

-8.9

Outperformance

-3.0

-15.3

-6.7

8.0

10.2

2.5

Outperform v MSCI

No

No

No

Yes

Yes

Yes

Period 3: 10-year T-Bond yields start increasing in April 2013

Source: Bloomberg.

Performance months 1-6 (%)

Performance months 7-12 (%)

4DUP

4DUts

S&PI

4DUP

4DUts

S&PI

Index performance

7.2

1.2

3.8

9.4

11.1

9.7

MSCI World

10.0

10.0

10.0

6.6

6.6

6.6

Outperformance

-2.8

-8.8

-6.2

2.8

4.5

3.1

Outperform v MSCI

No

No

No

Yes

Yes

Yes

24 selfmanagedsuper

SMSF TRUSTEE EMPOWERMENT DAY 2022 SYDNEY HYBRID EVENT 15 SEPTEMBER 2022

Attending SMSF Trustee Empowerment Day 2022 will allow trustees, to be armed with the most critical information and strategies to ensure your fund is the best it can be from all perspectives.

Don’t miss this opportunity to hear from key sector participants such as the ATO and other technical experts about the most current legislative, compliance and strategic issues affecting them.

FEATURED SPEAKERS

Julie Dolan

Head of SMSF & Estate Planning

Tim Miller

Education Manager

SAVE THE DATE

INVESTING

Where to next for the Australian equity market

Investors are experiencing market conditions not seen in roughly 30 years. Hamish Tadgell identifies the existing headwinds and the sectors in the Australian share market currently offering the best opportunities.

HAMISH TADGELL is portfolio manager at SG Hiscock.

26 selfmanagedsuper

The shift in Reserve Bank of Australia (RBA) policy and timing of the first interest rate rise in 11 years may have been somewhat of a surprise to equity markets, but the direction certainly wasn’t. In fact, credit markets have been anticipating interest rates may need to be 2 per cent to 2.5 per cent higher by the end of the year as result of more persistent inflation concerns.

This suggests inflation has moved beyond transitory and financial conditions need to tighten.

But we are increasingly of the view it also supports a broader view of regime change and transition from the last 30-year deflationary cycle to a more inflationary-driven environment, which creates very different challenges for investors.

Economic conditions Higher inflation

There are a number of factors that have driven inflation higher. The COVID-19 pandemic

arguably has been the epicentre. The conflux of a radical pivot to fiscal policy, explosion in the money supply, supply chain disruptions and border closures has seen demand outpace supply, pushing up prices. The Russian invasion of Ukraine has further exacerbated the supply of key commodities and inputs and contributed to rising costs.

There has been a strong suggestion these inflationary forces are transitory, caused by events that will prove temporary. There is unquestionably some truth to this and as border and isolation restrictions are lifted, supply chain and labour constraints should ease. However, there would also seem to be more emerging permanent and structural forces at play that could see inflation stickier and higher than we have been used to over recent decades.

Firstly, the rise of populist politics in recent years and governments now being more prepared to intervene in fiscal policy to address perceived inequality, inequity and hardship following COVID-19 is a structural factor contributing to ongoing inflation.

Another is decarbonisation and the energy revolution towards renewables and electric vehicles. The electrification and rebuilding of energy networks will not be cheap and will be highly commodity intensive, leading to higher demand and prices for key inputs and likely energy and food prices.

And then there is also the geopolitical realignment that has been brewing, awakened by the United States-China tariff war in 2019, but which in the wake of COVID-19 has seen a rise in nationalism and the desire to build supply chain resilience in trade and critical commodities. Russia’s invasion of Ukraine is arguably the most overt demonstration of this.

Over and above the event-driven inflation shocks, these structural issues are contributing to disruption and a shift in supply and demand dynamics that is driving a higher inflation impulse that risks being more entrenched and persistent.

Higher interest rates

A key consideration in whether inflation will prove structurally higher and more persistent in the months ahead depends on how central banks around the world engage in monetary policy tightening.

COVID-19 saw governments and central banks, including the RBA, focus on providing income relief and minimising economic scarring. The uncertainty and inequitable way in which the pandemic affected different business and consumer groups has seen a cautious approach to removing policy support and raising rates and managing inflation, with a greater emphasis on maximising employment.

The event-driven nature of the coronavirus crisis and strong deflationary forces at play over the past 20 years has seen central banks wrestle with the forces driving the recent increase in inflation and how persistent it will be.

Over the past few months, there has been increasing acknowledgement by central banks they are behind the curve and need to move off emergency settings and lift interest rates.

Until recently the official line from RBA governor Philip Lowe was there would be no rate increase until 2024. In March we saw a pivot and Lowe saying “it is plausible that the cash rate will be increased later this year”, and in May the central bank increased the cash rate by 25 basis points for the first time in years.

In its post-rate-hike press conference in May, Lowe acknowledged an earlier forecast that rates in Australia would not rise until 2024 was wrong and the economy had performed much better than forecast during the initial heat of the pandemic.

“I acknowledge that this increase in interest rates comes earlier than the guidance the bank was providing during the dark days of the pandemic. During that period, especially in 2020, the national health situation was precarious and the economic outlook was dire and clouded by great uncertainty,” he said in the accompanying rate rise statement, going

on to add: “As things have turned out, the economy has been much more resilient than was expected, which is clearly a welcome development.”

History suggests that when rates move, they are rarely one-off. In Australia, credit markets are now pricing in rates to be 1.5 per cent to 2 per cent higher by the end of the year and the 10-year bond yield is 2.97 per cent. The US markets are now expecting as much as another seven rate rises from the Federal Reserve this year versus just one in March last year. The risk is that the market is potentially pricing in rate increases over and above what is achievable.

Ultimately, central banks are now trying to tighten financial conditions and raise rates to manage inflation, but it is a delicate balancing act. If they raise rates too fast, it will undermine economic growth and could drive a mid-cycle slowdown or worse, recession. Raise them too slowly or the market begins to expect they will pause, or even reverse course, and financial conditions are unlikely to tighten enough to rein in inflation.

Our base case is interest rates will continue to rise until there is a clear sign the economy cannot handle it if there is a financial shock that causes central banks to take action.

Australian equity market outlook There is a simple axiom in finance, that the price of money determines the price of assets. Higher interest rates translates to a higher cost of money, which by implication suggests lower asset prices and valuations.

This is effectively the reverse of what we have experienced for the past 30 years with falling interest rates and paints a very different investment environment.

With inflation and not deflation, you’ve got tightening, not easing, and potentially lower productivity and higher labour costs.

All of these factors create an environment for change and different type of market leadership and likely higher volatility.

Continued on next page

QUARTER II 2022 27

INVESTING

Continued from previous page

For investors, the problem is it is no longer just about managing to a ‘nominal’ world in which deflation has been the predominant force. Now we need to think about the ‘real’ world of inflation and rising prices. Looking back over periods of higher inflation and when rates are rising, for equities this has tended to see valuations typically fall and returns more driven by earnings and dividends.

Under the scenario discussed, we remain quite constructive on Australian equities. The Australian economy and equity market are in the fortunate position of being relatively removed from many of the current geopolitical issues and risks.

Considered a ‘safe-haven’ internationally, Australia’s political stability, well-capitalised financial system and rich resource base provide a positive backdrop in the current environment.

Of course, we live in a highly connected world, but Australia is still considered a good place to be and will

28 selfmanagedsuper

The Australian economy and equity market are in the fortunate position of being relatively removed from many of the current geopolitical issues and risks.

continue to benefit from immigration and strong population growth relative to a lot of other countries. Australia is commodity rich, in both the soft and hard commodities that will be in high demand as we go through the energy revolution, as many renewables contain significant

amounts of copper and lithium.

As a resource-rich nation and exporter of both hard and soft commodities, in a relative sense Australia’s economic growth stands to benefit versus most other developed countries, and particularly those heavily reliant on commodity and energy imports. The effects of higher commodity prices are also likely to magnify the impact of inflation in those high commodityconsuming countries, adding the risk of monetary tightening and consequent risk of growth slowing. The probability of Europe now entering recession has increased materially and history shows the US consumer market and growth tend to slow during periods of strong commodity price and oil price inflation.

Apart from the obvious gross domestic profit uplift Australia stands to benefit from, for the first time in several years there also seems to be a growing interest by international investors to invest in Australian equities, but also more broadly in infrastructure and property assets given the tailwinds favouring the economy and potential strengthening in the Australian dollar (AUD).

We would not normally expect the AUD to rise in periods where the US cycle is slowing, but high commodity prices and capital inflows stand to see the AUD strengthen. A simple model using commodity prices and Australian bond yield differentials suggests the AUD should currently be trading at US$0.96. It is worth remembering in July 2011 during the last commodities boom the AUD rose to US$1.10.

Higher interest rates do provide a headwind for the housing market and household balance sheets. While we recognise these risks and expect this will see downward pressure on house prices, it is important to recognise the starting position in terms of record low real rates and employment and household savings is better than during previous hiking cycles.

This should provide some economic buffer.

Sectors to focus on A rising interest rate environment favours a higher weighting to quality cyclical stocks, including commodities and energy, and interest rate-sensitive companies.

An example of an interest rate-sensitive company that we’ve added to our portfolio recently is speciality platform provider Netwealth. We continue to see Netwealth benefiting from the broader growth in SMSFs, mandatory superannuation savings and the shift to technology and consolidation in the financial planning system. In addition to those factors, Netwealth receives some benefit, at least initially, from rising rates in its cash administration fee.

Energy is another sector we’ve been very positive about. We were earlier than some in moving to an overweight position on energy last year, but the Russia-Ukraine situation has really brought that home.

A core tenet of our initial thesis for investing in Woodside was based on the need for liquefied natural gas (LNG) in providing baseload electricity supply in the transition to a lower-carbon world, which we believed the market was underappreciating. This was brought home last year during the European winter when changing weather patterns saw a drop in renewable wind generation at the same time as European countries like Germany have been decommissioning nuclear power. The Russia-Ukraine war and Europe’s dependence on Russian gas only complicates the situation further and is likely to see a strategic rethink around European energy security.

There are also still a number of good reopening opportunities from the coronavirus. COVID-19 is something we’re going to have to live with and Australia is making good progress towards a postCOVID economy. In terms of which sectors and companies could benefit, the travel sector has been one that we’ve had our eye on and we have a position in corporate travel management.

Acknowledgement by central banks that they are now behind the curve and need to move off emergency settings and tighten financial conditions to manage inflation means interest rates are moving upward.

Companies like biotech CSL, logistics company Cube and Cleanaway Waste Management are also good reopening trades that will benefit as economies start to open. This should be positive for large low-cost LNG producers like Woodside and more broadly the Australian LNG sector.

Another sector of interest is the social infrastructure space. One of the areas that has really benefited following the coronavirus is fibre connectivity. In a higher inflation environment, it should also prove to be defensive, particularly where players have monopoly, or near monopoly, positions and pricing power.

We’ve had a large position in Uniti Group, which provides fixed wireless broadband and which recently received a takeover offer. Chorus, which is the New Zealand equivalent of the NBN, is another attractive

company we hold in this area.

While historically social infrastructure has been thought of in terms of assets like airports and toll roads, COVID-19 showed how those assets could be more economically sensitive than people previously thought. There has been a greater realisation of the importance of technology connectivity and data, which has seen a closing of the valuation gap between these fibre networks relative to premium, more traditional social infrastructure assets. The recent Uniti Group bid is a case in point, with the price offered putting the company on a similar valuation multiple to Sydney Airport.

Where to from here Acknowledgement by central banks that they are now behind the curve and need to move off emergency settings and tighten financial conditions to manage inflation means interest rates are moving upward. How high is the million-dollar question.

Economically and politically there are real questions about whether the current market rate expectations of six to eight increases this year are realistic. But it is also important to recognise market expectations that central banks will pause, or even reverse course, if economic growth slows may be misguided, as this has been what has been preventing tightening of financial conditions in the first place.

It is also important to realise history shows central banks generally don’t put through just one or two rate increases.

What typically happens is they keep raising rates until the economic data stops them.

Most importantly, and after such a long time of living in a low-inflation low-rate environment, there is a risk of becoming anchored to the prevailing view and think we will continue on as we have. History has taught us there are always cycles and regime shifts. Understanding them and positioning for them is essential for one’s wellbeing as an investor.

QUARTER II 2022 29

STRATEGY

Would you like children with your SMSF?

The ability now for an SMSF to have six members in it has reignited the notion of including children in, what would be considered, a family fund. Graeme Colley puts forward the arguments both for and against this course of action.

GRAEME COLLEY is SMSF technical and private wealth executive manager at SuperConcepts.

Now SMSFs can have six members in them, it begs the question: Is it worthwhile to set up a family fund and have mum, dad and the children as members or expand mum and dad’s SMSF to include the kids?

Ultimately the decision to be made is whether the kids should join the existing fund, set up their own SMSF or go elsewhere to an industry or retail fund.

On the positive side, SMSFs provide an excellent way of building retirement savings and when done properly can boost the financial literacy of all members regardless of age. So why not have one exclusively for the whole family?

Would you recommend a family SMSF? Recommending a family SMSF really depends

30 selfmanagedsuper

on the circumstances of those involved and how committed they will be to their personal superannuation fund. There are those who wouldn’t recommend children as members or trustees of a family SMSF, but others have experienced the benefits and acknowledge children played an important part in the operation of the fund. It can engender a high level of respect among family members and especially if decisions can be made collaboratively to the overall benefit of fund members.

On the downside, however, there is an everincreasing number of court cases that are littered with sad stories. Most involve the lack of adequate documentation, which leads to disputes over

what was intended. However, some cases involve outright fraud involving children stealing money from the family fund and others where children weaselled their way into the fund as trustees only to subsequently take over their parents’ super.

Reasons to include family members All members of a family are different and therefore only the right type of person should be allowed to become a member of a family super fund. A child who has difficulty managing their own personal finances will probably have similar issues if they become a member or trustee of an SMSF. That child may be better off as a member of a retail or industry fund where professional managers will look after their superannuation.

As I see it, children can be split into three categories by age and circumstance – those under 18, single adult children and those children in a relationship and possibly with their own family.

Children under 18 Super can be provided for children under 18 by a parent or relative making child contributions up to $330,000 over a fixed three-year period, with those contributions not tax deductible. If the child happens to be working, contributions may be made by an employer or the child may qualify for a personal tax deduction. Any contributions made for the child help provide a bigger pool of money for investing.

A child under 18 can be a member of the SMSF, but can’t be a trustee or director of a trustee company. The child’s parents, guardian or legal personal representative will act as trustee in their place until the child turns 18.

Age 18 and over A child 18 or older who has legal capacity can become an individual trustee of an SMSF or director of the corporate trustee. In conjunction with the remaining trustees or directors of the SMSF they are responsible for the operation of the whole

fund, as well as all the fund members, not just themselves. This can be a catalyst to get a child involved in the investment of their super savings and understanding the workings of an SMSF. Whether you would allow an adult child who has a spouse but no family themselves to be a member of an SMSF depends on the situation. It may be worthwhile to include the child in the SMSF until they accumulate enough to start an SMSF for themselves and their partner.

Children with their own family The time may come when a child and their spouse have their own family. Whether they should become members of the family SMSF or have their own will again depend on the situation. The same outcomes could be achieved by the child having their own SMSF as it is possible for the fund to make investments jointly with the parent’s fund.

There can be many benefits from including children and other family members as part of an SMSF. But considerable thought must be given to the potential risks that can arise when family and money are combined.

Introducing family members to the ‘family’ SMSF One way of introducing children to a family SMSF is to split the responsibility for investments among the members.

Investments supporting the children’s super balances can be segregated from their parents’ investments within the fund.

This could be done by using separate bank and investment accounts and the records left to an SMSF accountant or administrator who has the skills and systems to handle segregated investments without incurring additional administration costs.

Having children in the family SMSF may also enable an intergenerational transfer or family assets, such as a commercial property used in the family business or other real estate. However, a word of warning, if this strategy is used, it must be structured and handled correctly otherwise compliance problems can occur. There are a number of ways in which the investment could be owned by the fund either jointly with family members, as a company or unit trust. The strategy can allow ownership of real estate by one SMSF or it can be split

across different SMSFs and allows flexibility if one fund wishes to purchase units or the property in future.

Case study Mal, Irene (both 62) and their two children, who are in their 30s, are members of a family SMSF that owns the shop from which the family business operates. The shop is currently mortgaged to the bank. The members’ balances in the fund are just about high enough to purchase the property on commercial terms after the mortgage has been paid out. However, to ensure the purchase can go ahead successfully it will require the members to make additional contributions to the family SMSF. The four go to see their tax accountant who is an SMSF specialist and she tells them there are probably a few ways in which the shop could be purchased. The options to be considered are: Continued on next page

QUARTER II 2022 31

STRATEGY

Continued from previous page

• The fund could purchase 100 per cent of the property, but it will require cash from the members’ contributions. This may have some issues as the fund will own a very lumpy asset and the fund’s cash flow will be tight for some years.

If the children decide to roll over their super to another fund, the shop may have to be sold.

• The fund could purchase part of the property as tenants in common with the current owners, which would be possible from a cash-flow perspective.

However, the property cannot be mortgaged and the fund may be able to pay out the mortgage as part of the fund.

• A fixed unit trust or private company could be established, providing there is no mortgage over the property. The fund could purchase units in the trust, as well as other family members who would own the units personally.

Whatever strategy is chosen, the purchase is helped by family members combining their resources from the SMSF to purchase the shop. In addition, the taxdeductible rent from the shop is paid to the owners, which would include the SMSF either directly or indirectly. If the children wished to run the business after the parents retire, the shop can remain in the SMSF so it is transferred through each generation without any taxation issues.

Reasons for not having a family SMSF So far we have looked at some of the positive aspects of the family SMSF, but unfortunately there is probably a longer list of situations where things could go dreadfully wrong.

Dipping into the fund When children become members and trustees of the family SMSF they may find themselves in a position where they can access the fund’s resources. Access to the fund without proper controls over the

32 selfmanagedsuper

some cases involve outright fraud involving children stealing money from the family fund and others where children weaselled their way into the fund as trustees only to subsequently take over their parents’ super.

fund’s bank accounts and investments can have tragic consequences.

There was a court case some years ago where membership of the SMSF consisted of a husband and wife and a drug-addicted son. The son was an authority on the SMSF’s bank account and resulted in the fund being left almost penniless and subsequently taxed as non-complying. If better control had been put in place over the operation of the fund and the trustees understood their responsibilities, maybe the loss could have been avoided.

is not isolated to just the break-up of the parents as the children may also be going through a relationship breakdown that splits their superannuation benefits.

Control on death When it comes to estate planning and SMSFs, control and decision-making over the superannuation benefits is going to be the most important factor to ensure the wishes of the deceased member are carried out correctly. There are many court cases where children have been appointed as trustees of an SMSF as the legal personal representative of their parents.

In one case, a father and daughter were members and trustees of an SMSF. The father completed a non-binding death benefit nomination requesting the trustee split his super balance equally between his daughter and son. The son was not a member or trustee of the SMSF at the time of the father’s death, so the daughter appointed her husband and proceeded to pay 100 per cent of her father’s benefits to herself. The court found in her favour, concluding as trustees, the daughter and her husband had discretion as the nomination made by the father was not binding.

Even if the nomination was binding, the fact the daughter was in control of the SMSF could have caused a protracted and costly legal battle between the beneficiaries. Therefore, consideration needs to be given to the loss of control over the SMSF in the event of a trustee or member dying or losing capacity.

Relationship breakdown

To include or not to include, that is the question

In there is a relationship breakdown, superannuation forms part of a partner’s assets for purposes of the marriage settlement. This means an ex-spouse may have access to their former partner’s superannuation when the court hands down the conditions of the divorce. It could mean selling the family business assets to free up cash as part of the dissolution of the marriage. The situation

There can be many benefits from including children and other family members as part of an SMSF. But considerable thought must be given to the potential risks that can arise when family and money are combined.

Anyone contemplating establishment of a family SMSF should weigh up the pros and cons before making the decision as the different needs and motivations of parents may conflict with those of the children.

COMPLIANCE

Transferring from the dark side – part one Bringing pension scheme payments back to Australia from overseas is a multi-faceted process. In part one of this multi-part feature, Jemma Sanderson provides some useful tips and traps to look out for regarding these situations.

JEMMA SANDERSON is a director and head of SMSF and succession at Cooper Partners.

With our global workforce, and particularly many people having being trapped in Australia or overseas due to COVID, or perhaps now intentionally, their superannuation position across multiple jurisdictions has become an increased area of practice. It is desirous to transfer their benefits to Australia (once they have settled here for good) for the following reasons: • control/flexibility over the investments, • to mitigate the foreign exchange risks, • to have an asset that can be left to their beneficiaries when they die, and • to obtain a more efficient taxation position.

Navigating through the various jurisdictions is challenging and requires a comprehensive understanding of the Australian superannuation and tax provisions. There is much misunderstanding about how such transfers are undertaken in practice, with many individuals receiving advice that only covers one side of the transaction – the ‘dark side’ of the jurisdiction where the money is currently held, which can have substantial adverse implications in Australia. Without proper consideration, the above intentions may not be met, particularly the last one.

Overall, where a member has benefits in a United Kingdom pension account, to transfer that benefit to Australia, several things must be in place: • the member has to be 55 or older, • the receiving superannuation fund needs to be a Registered Overseas Pension Scheme (ROPS), • any rollover needs to take into consideration: a. the taxation implications in Australia, b. the contribution limits in

Australia, and c. the taxation implications in the UK (this is dependent on b. above and whether any amount rolled over is refunded back to the member in Australia), and • if the money is to be taken as a lump sum directly to the individual (from a UK perspective), the Australian and UK taxation implications need to be considered.

There are obviously a substantial number of other foreign jurisdictions where individuals may hold pension benefits. Each jurisdiction will have different rules and different ways that they will interact with the Australian rules. We recommend specialist advice in this regard is always sought to address all the relevant considerations.

Australian taxation of foreign pensions Where an individual receives pension payments from a foreign pension, generally they are fully Continued on next page

QUARTER II 2022 33

COMPLIANCE

Where an individual receives pension payments from a foreign pension, generally they are fully taxable at their marginal tax rate in Australia.

Continued from previous page

taxable at their marginal tax rate in Australia.

There is an avenue for an annual deductible amount to apply, depending on the level of personal contributions made to the scheme by the individual, and it can be claimed by completing form NAT 16543.

Where an individual receives lump sum payments from a foreign pension, the taxation treatment depends on whether the foreign pension is a foreign superannuation fund (FSF) under the Australian rules.

As a rule of thumb, a scheme based in the UK would satisfy this requirement, however, schemes in the United States, that is, 401(k) or individual retirement accounts, do not. Other jurisdictions depend on the local legislation regarding pensions, as well as the trust deed for the scheme itself.

Where the scheme is an FSF Where the FSF provisions are satisfied, the taxation in Australia of a lump sum payment is as follows: • within six months of the date of residency – not assessable income or exempt income (effectively tax-free), or • outside six months of the date of residency – tax is payable on the increase in value since the individual became a resident of Australia, taking

34 selfmanagedsuper

into consideration any contributions over that time, as well as the proportion of time the individual may have been a resident of Australia since first becoming a resident. This is called the applicable fund earnings (AFE).

The default position is the AFE is taxable at the individual’s marginal tax rate.

However, there is an opportunity for this tax to be paid at the superannuation fund level at 15 per cent where: • the benefits are paid directly from the FSF to an Australian superannuation scheme, and • there are no benefits remaining in the source scheme subsequent to the transfer.

This is of substantial benefit with respect to UK transfers as the schemes in the UK are familiar with and prefer a transfer direct to a fund in Australia that would satisfy the UK ROPS provisions. An SMSF can meet these requirements.

Contribution provisions In the situation where such a transfer direct to super can occur, there would be two components of a transfer, which are treated differently for Australian superannuation contribution purposes: • the AFE is not assessed towards the concessional cap or the nonconcessional cap, and • the balance of the transfer is classified as a non-concessional contribution (NCC).

The second point above can be a concern where the ultimate transfer results in the individual breaching the NCC cap or where they don’t have any NCC cap available as their total superannuation balance (TSB) is over $1.7 million.

In situations where this arises it doesn’t necessarily mean the transfer can’t occur, however, alternative options are required to be considered: 1. The potential to release an excess NCC from any other non-ROPS superannuation benefits in Australia.

2. Structuring the account in the UK before transfer such that any transfer would not give rise to an excess NCC.

Item 2 above can be challenging in terms of navigating the UK provisions and requirements, particularly given the increased regulation in the UK at present.

Avoid – proportionate transfers It is important to note that to achieve the 15 per cent tax on the AFE, any transfer to superannuation in Australia can’t be proportionate. It must be 100 per cent from the source fund. This is one area where all good intentions to transfer don’t accomplish the objective.

Example

Luke is 56 and has a benefit in the UK worth £450,000. He has been in Australia for 15 years and when he came to Australia, his account was worth £300,000. The components of Luke’s benefit if transferred to Australian super are as in Table 1.

If Luke transferred 100 per cent of his benefit to an Australian ROPS, then he would have an excess NCC. If Luke wanted to manage that position and thought the AFE was proportionate and only transferred A$490,000 equivalent (about £280,000) direct to superannuation in Australia, then the components would be as in Table 2.

AFE is not taken out proportionately – it is the first component that is attributed to a lump sum when one is made. Accordingly, the AFE would be the first component out.

A further sting in the tail however is that by doing a proportionate transfer, Luke’s strategy will have substantial other tax and superannuation implications: • the AFE can’t be included in the assessable income of the fund as there is still a benefit remaining in the source fund, • Luke will be taxable on that AFE at his marginal tax rate. Again, this isn’t the proportionate AFE of 33.33 per cent of the £290,000, but the full £150,000.

That is A$262,500 Luke will have to pay tax on personally at the highest tax rate, resulting in a A$123,375 tax liability.

• as the money was transferred directly into superannuation and Luke is only 56, he

Table 1 £

%

AUD (1:1.75) $

Applicable fund earnings

150,000

33.33

262,500

Non-concessional component

300,000

66.67

525,000

Pension account balance

450,000

100

787,500

Table 2 £ Applicable fund earnings

150,000

Non-AFE component

130,000

Pension balance transferred

280,000

can’t access any of the money for at least another four years from superannuation to pay this tax. Therefore, Luke will need to come up with A$123,375 to pay the tax.

• As there is no AFE component of the transfer to the super fund where the fund can elect to pay the tax (ineligible due to the proportionate transfer), the entire transfer amount to super in Australia is treated as an NCC – £290,000/ A$480,000. That would then result in Luke having an excess NCC of at least A$150,000, and • dealing with an excess NCC where the benefits are sourced from the UK could have additional tax implications of between 47 per cent and 55 per cent on the excess NCC. As is evident, tripping up on one element of the transaction has substantial compounded implications.

In Luke’s situation, it would have been more appropriate to consider splitting an amount from his current account to a completely new scheme in the UK so

that any transfer would be eligible for the concessions. This also needs to be undertaken correctly, as if not implemented properly, it can have adverse tax implications.

Avoid – PCLS Other nasty tax implications can arise where individuals only receive advice on the UK tax implications and not the complementary Australian provisions. For example, advice to take out a pension commencement lump sum (PCLS) from their UK benefits, which is the equivalent of up to 25 per cent of their benefits (up to their lifetime allowance) as a lump sum payment. Such a payment is very tax effective in the UK as it is tax-free.

However, that is not the tax position in Australia.

Let’s revisit Luke’s scenario, where he seeks advice in the UK. He is advised not to conduct a transfer to superannuation in Australia as an initial step, but to take a PCLS. He takes out £112,500, or 25 per cent, from his UK account and no tax is

payable in the UK. However, from an Australian tax perspective, the first lump sum payment an individual receives is AFE, so 100 per cent of the £112,500 will be taxable in Australia at Luke’s marginal tax rate, resulting in tax of up to A$92,531. At least in this situation Luke would have received cash in his own name and could pay the tax. However, this is an incredibly nasty tax outcome for him.

Further, the extraction of the remaining £337,500 out of the UK can be a challenge as this account is then classified as being ‘crystallised’ under the UK rules and can then only be transferred either: • 100 per cent direct to superannuation in Australia, which would give rise to an excess NCC position, or • to Luke as regular (and flexible) pension payments, which would likely be fully taxable to Luke in Australia.

Therefore, what seems to be a good outcome in terms of enjoying 25 per cent of his benefits tax-free, once again has a terrible consequence for Luke.

A PCLS can be of benefit where the individual is not a resident of Australia at the time of the payment or they manage to request the payment within six months from their date of residency. However, there is then a challenge to extract or transfer the remaining 75 per cent into Australia due to the subsequent nature of the remaining balances (being a crystallised account).

Strategies Although there are warnings above regarding transfers, there are substantial opportunities in this space for individuals to transfer their entire benefits to Australia in a tax-effective and timely manner. This is also regardless of the amount of the benefit.

Alluded to above is the situation where a benefit is split to another UK scheme before it is transferred to Australia. This is quite commonly undertaken and is one of the options available to achieve an effective transfer. There are nuances in every situation and therefore it is important to obtain specialist advice.

QUARTER II 2022 35

STRATEGY

The SMSF EOFY checklist

The end of the 2022 financial year presents SMSF trustees with perhaps more legislative amendments to consider than usual. Bryan Ashenden provides a useful checklist of the items requiring attention.

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

36 selfmanagedsuper

As 30 June approaches, the focus inevitably turns towards end-of-financial-year (EOFY) planning opportunities and requirements. In the world of SMSFs it is no different whether you are talking to clients in their capacity as a trustee and their related obligations or whether you are talking to them as a member.

Is 30 June 2022 going to be any different to previous EOFYs? In some respects, many things

remain the same, but with changed thresholds for this financial year and new contribution rules from 1 July 2022, this EOFY is not the same as usual.

Non-concessional contributions and total super balance considerations When talking to members of SMSFs, or any clients in terms of their retirement goals, we need to remember this financial year marks the first year

of an increase in the non-concessional contribution threshold to $110,000 a year.

For members looking to invoke the bringforward non-concessional cap this financial year, this means an ability to contribute up to $330,000.

In addition, we saw two other changes that took effect for this current financial year that also need to be considered.

The first of these was an increase in the total super balance threshold, which impacts on the ability to make a nonconcessional contribution, whether annual or using the bring-forward provision. The total super balance threshold has increased to $1.7 million, up $100,000 from that which applied in previous financial years.

In order to make a non-concessional contribution, a member’s total super balance, measured across all super accounts and not just their SMSF interest, needs to be below that threshold as at the previous 30 June, in this case 30 June 2021.

This has particular relevance for clients who last financial year were ineligible to contribute, due to their balance having been above the previous $1.6 million threshold. These clients may now be re-eligible to make non-concessional contributions this financial year. If their balance has also fallen, for example due to market movements, they may even be eligible to use the bring-forward opportunity. To use the three-year bringforward opportunity, clients need to have a total super balance as at 30 June 2021 below $1.48 million. To use a two-year bring-forward opportunity, the total super balance needed to be below $1.59 million as at 30 June 2021.

The other change relates to the agebased criteria to contribute and work test requirements. Due to legislative amendments at the end of the previous financial year, clients are now able to make non-concessional contributions up to the day they turn age 67, without the need to satisfy the work test requirements of 40 hours of gainful employment within a 30-day period. This change in age also applies when determining whether

a client can also use the bring-forward opportunity, with the qualifying age also rising from the year in which you turn 65 to the year in which you turn 67. Similar to the increased opportunity to contribute as a result of the increase in the initial super balance threshold, the age rise may also reopen the opportunity for some members to now make additional non-concessional contributions.

While the opportunities discussed above apply to all qualifying superannuation members, whether in an SMSF or not, there is one additional consideration for SMSF trustees to consider. This is whether the fund’s trust deed can accommodate these legislative changes. The majority of SMSF trust deeds prepared today would likely be drafted in flexible terms to cater for potential legislative changes, such as changing contribution rules and thresholds, however, you cannot just assume this is the case.

Each year, the trustees should arrange for a review of their trust deed to ensure it caters for, or captures, any relevant legislative amendments that have occurred in the past 12 months to guarantee members are not inadvertently prevented from accessing or maximising the available opportunities.

Concessional contributions Similar to non-concessional contributions, for this financial year we have seen an increase in the cap that relates to the level of concessional contributions a member can make to their superannuation fund, from $25,000 to $27,500.

It’s important to remember concessional contributions will include employer contributions, salary sacrifice, superannuation guarantee or other contributions over and above these by an employer, as well as personal deductible contributions by a member.

When considering how much of their cap a member has used, or potentially will have been used, don’t forget the super guarantee rate increased to 10 per cent this year so is a good approximation for contributions from an employer given

the timing of those contributions can vary.

When considering if there is any cap space left for a member to make additional concessional contributions, if the member had less than $500,000 as a total super balance as at 30 June 2021, they can also use the carry-forward concessional contribution opportunity. Under this strategy, if a member had concessional contributions in any of the years ended 30 June 2019, 2020 and 2021 that were less than concessional contribution caps for those years, which were $25,000 each year, the unused amount of their concessional cap can be carried forward and added to the concessional cap for this year. This strategy effectively increases the level of concessional contributions allowed this financial year.

When looking at personal deductible contributions it is also important to remember there are procedural requirements to be completed by both the member and the super fund. The member must lodge a notice of intent to claim a tax deduction for the amount of the concessional contributions with their fund and this needs to be done before they lodge their tax return for the relevant financial year, or the end of the financial year following the one in which the contributions were made. However, if there is an intent to claim a deduction for contributions made and the member is about to move all or some of those contributions into an income stream, or roll over to another super fund, the notice needs to be completed and provided to the fund before the income stream is commenced or the rollover occurs.

From the perspective of the SMSF, it is important to confirm acknowledgement of the receipt of the notice of intent to claim a tax deduction as, if the acknowledgement is not provided by the due dates mentioned, the member will be denied the tax deduction. As we approach the end of this financial year, trustees of SMSFs should therefore consider: Continued on next page

QUARTER II 2022 37

STRATEGY

Continued from previous page

• whether acknowledgement has been provided to members for notices received for concessional contributions to be claimed as a tax deduction for the year ended 30 June 2021. As the trustee is also typically a member, they would know if the deadline has been passed if they have already lodged their tax return for the year ended 30 June 2021, • what amounts are expected to be claimed as personal tax deductions for the current financial year, and ensure the relevant notices and acknowledgements are completed as required in the new financial year, and • whether there is a plan to move any of the member’s accumulation account into a pension in the new financial year, for example, as of 1 July 2022, in which case the notice requirements, including acknowledgement, need to occur before that time.

Transfer balance caps and reporting requirements For the year ended 30 June, the general transfer balance cap is $1.7 million, being the maximum amount a member can transfer across from accumulation to pension in the superannuation environment. However, the general transfer balance cap is only available in full to a member if they hadn’t commenced an income stream from their super before 1 July 2021.

If an income stream had commenced before that time, the member’s transfer balance cap would be somewhere between $1.6 million and $1.7 million and determined by the level of their unused transfer balance cap as at 30 June 2021.

Importantly, the level of a member’s transfer balance cap is not strictly relevant to the trustee of an SMSF, in their trustee capacity, as the impact is at the member level. However, with penalties potentially applying where a member exceeds their transfer balance cap, there is clearly a need for trustees to be aware of where members

38 selfmanagedsuper

EOFY considerations for superannuation members and trustees of SMSFs continue to be important, especially in a year like the present where we have seen a number of changes made to super rules.

stand when it comes to their own SMSF. The obligation for SMSF trustees is to ensure they lodge their transfer balance account reports (TBAR) by the relevant due date. Where all members of the SMSF have a total superannuation balance of less than $1 million at the previous 30 June, the SMSF can report this information to the ATO at the same time as when its annual return is due.

However, where an SMSF has at least one member with a total superannuation balance of $1 million or more, the TBAR is required to be lodged within 28 days after the end of the quarter in which the event, such as the commencement of a pension, occurs. Importantly, the quarterly reporting requirement applies even if the member commencing a pension has a total super balance below the $1 million threshold.

SMSF trustees also need to remember, given the reporting timeframes are based on a member’s total superannuation balances, this means adding the balances across all of their super accounts and not just those in the SMSF itself. And while reporting may only be required on an annual basis in some situations, there is nothing preventing the SMSF

reporting more frequently, which may be advantageous to ensure ATO records are up to date and any potential excess transfer balance cap issues are identified and potentially resolved earlier than would be the case if reporting occurred annually.

There has been some discussion about whether SMSFs should simply be reporting on a more frequent basis, in line with Australian Prudential Regulation Authorityregulated funds, but this has not yet been legislated.

Other annual requirements There are a number of other annual requirements SMSF trustees should be considering as a matter of course, whether it be at the end of the financial year or not.

These include: • a regular review, as required by law, of the fund’s investment strategy, including risk, diversification and liquidity needs, • a review of the insurance needs of the fund and its members, and • a review of the trust deed to ensure it is up to date with current legislative requirements and opportunities, or is flexible enough for them to be accommodated in current wording.

This could include changes, such as the ability now to have up to six members in a single SMSF and the new contribution rules applying from 1 July 2022, allowing members to make nonconcessional contributions, including bring-forward contributions, up until age 75 without the need to satisfy the work test.

EOFY considerations for superannuation members and trustees of SMSFs continue to be important, especially in a year like the present where we have seen a number of changes made to super rules.

A good approach to assist in meeting compliance and regulatory requirements is to establish a checklist that can be added to throughout the course of a year when changes are announced. This can assist in ensuring no opportunities are missed when it comes to maximising the value and flexibility of the SMSF environment.

SM M5F mhzΑ

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events@bmarkmedia.com.au Smstrusteenews

COMPLIANCE

Trust deed lost

The trust deed is the foundation of an SMSF and if this pivotal document is lost, there can be significant adverse consequences for the fund, Daniel Butler and Bryce Figot write.

DANIEL BUTLER (pictured) is a director and BRYCE FIGOT specialist counsel at DBA Lawyers.

The court case Mantovani v Vanta Pty Ltd (No 2) [2021] VSC 771 sheds light on the implications of lost trust deeds. Advisers who work with SMSFs or family trusts or any form of trust established by deed should be aware of its implications.

In short, due to a lost deed, a family trust was ordered to have failed. The assets of that trust were ordered to be transferred back to the deceased’s estate of the person who had transferred them to the trust over 40 years earlier.

Facts Teresa was the matriarch of the Mantovani family.

She had four children, who are now all in their 60s.

40 selfmanagedsuper

Sometime in 1976 a family trust was created with a company called Vanta Pty Ltd acting as trustee. A schedule, which all parties accepted as accurate, stated the settlor was Teresa’s father.

Although the schedule was available, no other portion of the deed was available, despite extensive searches.

In the late 1970s and early 1980s Teresa transferred several real estate titles to Vanta Pty Ltd as trustee for the family trust.

In 2015, Teresa died. All parties agreed the family trust had been created and Vanta Pty Ltd owned the real estate as trustee of the family trust.

One of Teresa’s four children, Giovanni, was

the plaintiff in this case. Giovanni had lived in one of the family trust’s properties for the entirety of his life. Giovanni asserted he had spent substantial sums of money maintaining and improving that property.

He deposed that Teresa told him the property in question would be his upon her death.

However, Giovanni was not a director of Vanta Pty Ltd. Rather, two of Giovanni’s siblings were directors, being Nicola and Salvatore.

Accordingly, at its core, this case is possibly a dispute between siblings: Nicola and Salvatore appeared to maintain that Giovanni’s home was part of the trust and stated it was unclear whether Giovanni was a beneficiary of that trust. They did not appear to want to treat the property as part of Teresa’s estate.

Giovanni on the other hand sought a declaration that the family trust failed due to the lost deed and as such all assets

by Vanta Pty Ltd actually formed party of Teresa’s estate.

Findings All accepted the family trust had been established and that the establishing deed at least at some stage existed, even if the deed could not be found now.

The schedule and the way the financial statements and income tax returns had been prepared were evidence of what the deed’s contents might have been.

However, Justice McMillan found that if the trust was allowed to continue on the balance of such evidence, the administration of the trust would involve “mere guesswork”.

McMillan noted that where the contents of a trust deed cannot be ascertained, the trustee cannot discharge its obligation to act in strict conformance with the terms of the trust. Accordingly, she held that the trust failed.

Teresa was not the settlor of the family trust. However, she had provided the bulk of the trust property. Accordingly, the judge held that the properties she had transferred to the family trust were

effectively still Teresa’s and formed part of her estate.

Trust or SMSF deed updates There are many document suppliers these days offering trust or SMSF deed updates that either do not review prior deeds or have non-qualified lawyers review these documents in a superficial manner.

One popular service we offer is our SMSF Deed History Review. Almost all SMSF strategies and arrangements rely on a ‘firm foundation’ being the trust deed.

The trust deed is like the foundations of a house. Unless you have firm foundations, the house may prove shaky and be blown down in rough weather. Having a robust deed is very important for many SMSF strategies, including pensions, binding death benefit nominations and determinations of who eventually gets control of the fund on death, separation of a relationship and any other disputes.

Thus, it is important to ensure the fund’s governing rules provide a firm foundation for every SMSF. Note that an SMSF’s governing rules also require all prior deeds, rules and changes of trustee to be validly prepared, executed and, if necessary, stamped in compliance with prior variation powers, relevant consents and appropriate legal formalities. Compliance with all these formalities must have been satisified within the document trail otherwise the fund’s governing rules may be invalid and ineffective.

not receive any super contributions back simply because an employee has lost the employee’s own SMSF deed? (Deeds can exclude the presumption of resulting trust to minimise the risk of this happening.)

What if the deed that is lost was the establishing deed, but a subsequent deed is available? Presumably that subsequent deed would represent the governing rules of the SMSF and the fund would not fail, but that is not entirely clear or certain.

Also, would the outcome have been different if the trustee had made an application prospectively, rather than waiting for a disgruntled beneficiary to make an application? At paragraph 100 there is a suggestion that a different conclusion might have been reached had the trustee been more diligent and proactive in seeking judicial input.

A lost trust deed is a significant issue for an SMSF or a family trust. There are practical stop-gap measures available, such as drafting a deed update purporting to implement new governing rules, but there is no certainty such measures will definitively be effective. The greatest certainty is obtained via a court order, however, when applying for a court order, there is no guarantee the court will actually grant the order. For example, Re Barry McMahon Nominees Pty Ltd [2021] VSC 351 was a somewhat similar case that involved a trust with a lost deed. There, the court ordered that insufficient inquiry had occurred and the trustee should conduct additional searches and then file further evidence with the court.

Implications The implications of this decision are significant. Basically, they appear to be that if a deed is lost, unless there is clear and convincing evidence of the exact contents of the deed, all trust property might be transferred back to the person who transferred it to trust in the first place.

In the facts of this case, this outcome seems quite sensible. However, it poses many questions in the context of an SMSF. What if the contributor was an employer? Surely an employer should

Conclusion In short, a lost trust deed is not a mere procedural or administrative matter. It will cause risk and uncertainty for the life of the SMSF or trust. There can be tremendous merit in obtaining a tailored legal solution in these circumstances. Indeed, obtaining appropriate legal advice in a timely manner can minimise risk, cost and uncertainty; some, however, seek to defer the issue hoping the risks will go away and never surface.

QUARTER II 2022 41

INVESTING

A new impending investing vehicle

SMSFs will soon have access to a new structure for collective investments. Michael Hallinan details how these structures will operate.

MICHAEL HALLINAN is self-managed superannuation executive consultant at SuperCentral.

42 selfmanagedsuper

A new company-based structure will soon be available to undertake collective investment.

Currently most collective investment structures are trust-based structures, such as unit trusts.

While the new company-based structure, called corporate collective investment vehicles (CCIV), will have the same taxation treatment that currently applies to attribution managed investment schemes, it may have significant non-taxation features over trust-based structures as well.

The first noticeable feature is the companybased structure may have a far greater recognition and familiarity with foreign investors who are the intended consumers for an Australian cross-border funds management industry. The second feature is that a company-based structure may provide a solution, if not a far better solution, to the problem

regarding the difficulty of terminating uneconomic (managed) investment products. The deadweight cost to the funds management industry of having to maintain subscale investment products should not be underestimated, resulting from regulatory costs and, in particular, the IT costs associated with maintaining systems for subscale investment products.

While listed investment companies are a type of company-based investment structure, CCIVs will have greater flexibility in that they can be open ended or closed, they can be wholesale or retail, listed or unlisted, they can offer multiple investment products while having the same investor protections as currently apply to managed investment structures and have a flow-through tax treatment.

Mutual funds versus CCIVs CCIVs are often referred to as mutual funds in overseas jurisdictions.

A mutual fund is a term used to describe an investment vehicle that has the legal form of a company. The investors buy into the investment vehicle by acquiring shares or, more correctly, a particular class of shares, and they cash out their investment by selling the shares. In many countries, such as the United States, investment vehicles are structured as companies, while in Australia, New Zealand and the United Kingdom, investment vehicles have typically been structured as unit trusts.

By introducing mutual funds into Australia, the federal government hopes to encourage overseas investors to invest locally in Australian investment vehicles or to use Australian-based investment vehicles to invest in South-East Asian economies by allowing those investments to be made by means of mutual funds, with which they are familiar, rather than by unit trusts, which are a far less familiar structure.

In short, the government hopes to expand the Australian funds management industry by encouraging overseas investors to use the services of the local funds management industry whether to invest locally or to invest in South-East Asia.

Legislative background In late 2009, the Johnson report, “Australia as a Financial Centre: Building on our Strengths”, was released. The report recommended that policy changes be made to increase Australia’s cross-border trade in financial services and to improve the competitiveness and efficiency of the financial sector. In relation to the funds management segment of the financial services industry, it recommended the establishment of an Asian Region Funds Passport and also the introduction of a new collective investment vehicle, effectively referred to as a CCIV. The Asian Region Funds Passport regime was introduced in September 2018 with

the coming into force of Part 8A “Asia Region Funds” of the Corporations Act, enacted by the Corporations Amendment (Asia Region Funds Passport) Act 2018.

The CCIV regime will commence from 1 July 2022 when Part 8B of the Corporations Act comes into force. Part 8B was introduced by the Corporate Collective Investment Vehicle Framework and Other Measures Act 2022. Coincidentally, and completely irrelevantly, the retirement investment covenant provisions were also introduced by this act. Unfortunately, the technique employed in drafting Part 8B is that it is not a self-contained code for CCIVs and sub-funds, but contains a number of sections that modify non-Part 8B sections as those sections apply to CCIVs. However, those other non-Part 8B sections have not been modified to expressly apply to CCIVs or sub-funds. Consequently, there will be considerable page turning between Part 8B and the other parts of the Corporations Act.

Legal structure of CCIVs A CCIV is a company limited by shares that has been registered under the Corporations Act. It will have only one corporate director and that director must be a public company that holds an Australian financial services licence (AFSL) authorising the public company to manage and operate a CCIV. For a CCIV to be registered it must have at least one sub-fund and that sub-fund must have at least one member.

The name of a CCIV must include, at its end, Corporate Collective Investment Vehicle or CCIV. Each sub-fund of a CCIV will have its own Australian registered fund number (ARFN). Additionally, each sub-fund will, as a matter of commercial necessity rather than law, have its own superannuation product identification number (SPIN).

For each sub-fund, there will be a corresponding class of shares. Class A shares will be referrable to sub-fund A, Class B shares will be referrable to sub-fund B and so on. Each share

The attraction of CCIVs to superannuation funds may lie in their company-based structure and flowthrough taxation treatment of sub-fund distributions.

within a class must have the same dividend rights as the other shares of that class unless the constitution of the CCIV provides otherwise. The economic value of the share will be determined solely by the net value of the sub-fund to which the share is referrable. While an investor may hold any number of shares in various different sub-funds, there cannot be any crosssubsidisation or liability contamination between the various sub-funds.

A sub-fund can be considered as a separate/discrete pool of assets owned both legally and beneficially by the CCIV. For example, the CCIV may operate an investment pool restricted to Australian equities (sub-fund A to which A class shares are referrable), may operate an investment pool restricted to North American equities (sub-fund B to which B class shares are referrable).

Importantly, sub-funds are not trusts and an investor holding shares that are referable to a particular sub-fund does not have any legal or equitable proprietary interest in the Continued on next page

QUARTER II 2022 43

INVESTING

Continued from previous page

assets that constitute the sub-fund.

A CCIV can only operate through its sub-funds. It can only operate a business or commercial/investment activity if that business or activity is allocated to one and only one sub-fund. All shares or debentures issued by the CCIV must be allocated to sub-funds. The CCIV cannot issue a share or debenture unless the share or debenture is allocated to a subfund. In short, it cannot have any assets that are not allocated to a sub-fund.

A CCIV will elect to be either a retail CCIV or a wholesale CCIV. The distinction broadly corresponds to the present distinction between retail managed funds and wholesale managed funds. A retail CCIV will be subject to a more intense regulatory regime given the investors are retail clients. For a CCIV to qualify as a wholesale CCIV it must not have any retail investors. If a CCIV has one retail investor in one sub-fund, it will be a retail CCIV. Consequently, it is not possible for a CCIV to have some sub-funds that have retail investors while other sub-funds have only wholesale investors.

As a general statement, but a statement that is subject to various exceptions, normal rules applying to companies under the Corporations Act will apply to CCIVs. For example, CCIVs will be able to issue redeemable shares, however, those shares will be redeemable at the option of the shareholder, thereby mimicking a unitholder right to unilaterally exit an openended unit trust.

The CCIV itself will have no employees.

The directors and employees of the single corporate director will, under Part 8B of the Corporations Act, be able undertake certain activities as the agent of the CCIV, such as entering into contracts on behalf of the CCIV. In a similar manner to retail managed investment schemes, retail CCIVs must have a compliance plan and appoint a compliance plan auditor.

Distributions from a sub-fund to an

44 selfmanagedsuper

SMSFs will now have the opportunity of investing in CCIV subfunds in addition to or as an alternative to managed investment schemes and listed investment companies.

investor will be by way of dividends, whether they be income or capital or both.

A CCIV may reduce its share capital by means of a buy-back.

CCIVs and financial services The CCIV will not itself have to hold an AFSL as the corporate director of the CCIV is deemed for the purposes of chapter 7 of the Corporations Act to provide any financial services that are provided by the CCIV. However, the deeming does not apply to the issue of shares of the CCIV. It is the corporate director of the CCIV that must hold an appropriate AFSL that authorises the corporate director to provide the financial service of “operating the business and conducting the affairs of a CCIV”.

The offer document for shares in a subfund will be a product disclosure statement rather than a prospectus. The issuer of the offer document will be the CCIV and any dealing in shares of a sub-fund will be undertaken by the corporate director. The design and distribution obligations of Part 7.8A of the Corporations Act will apply to retail CCIVs, as well as the Australian Securities and Investments Commission’s product intervention powers.

How do they affect superannuation?

While one significant aspect of the CCIV regime is to attract offshore clients to the Australian funds management industry, superannuation funds will be able to invest in retail CCIVs and, if the super fund qualifies as a wholesale client, wholesale CCIVs. The attraction of CCIVs to superannuation funds may lie in their company-based structure and flowthrough taxation treatment of sub-fund distributions. The company-based structure of sub-funds may allow sub-funds that are subscale to be more readily and easily terminated compared to terminating a unit trust.

The flow-through taxation treatment of CCIVs will mirror the current taxation treatment of attribution managed investment trusts, which will make CCIVs a more attractive investment than listed investment companies.

The attribution method of taxation allows the CCIV sub-fund, and also attribution managed investment schemes, among other things to: • carry forward under and overestimates of tax amounts into the financial year in which the under or overestimate is identified without adverse tax consequences, • be treated as fixed entitlement entities – this is important as the investors are treated as having a fixed entitlement to income and capital and the trust or sub-fund has to satisfy less onerous conditions to carry forward and deduct tax losses and it enables imputation credits to flow to investors, and • allow investors, in certain circumstances, both upward and downward adjustments to the cost base of their holdings to eliminate double taxation that may otherwise arise.

To conclude, SMSFs will now have the opportunity of investing in CCIV subfunds in addition to or as an alternative to managed investment schemes and listed investment companies.

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COMPLIANCE

Required competencies SMSF practitioners are required to adhere to five competency standards. Grant Abbott details what this compulsory obligation involves.

GRANT ABBOTT is non-legal senior consultant at Abbott & Mourly.

To provide advice on SMSFs, there are five competency standards laid out in the financial services training package that can be found at www.training.gov.au, a joint initiative of the commonwealth and state governments. These are base competency standards and apply to all SMSF professionals.

There is no moving away from these standards and they exist to support the industry and provide confidence and respect from clients and other financial services professionals that an SMSF professional is of the highest standard.

But I continue to be surprised at issues and errors that come across my desk at Abbott & Mourly. We are not talking about administration mistakes, but failure to understand the law, regulations and even know the fundamentals of the trust deed. The fund’s trust deed is actually part of the superannuation laws and not knowing it means potential litigation.

There are no ifs or buts: all SMSF professionals need to know these to a level of being “consciously competent”. If you don’t, you can be sued for any losses or damages the fund experiences. Cam & Bear Pty Ltd v McGoldrick [2018] NSWCA 110 is a good example where an auditor was sued for losses on an underlying investment in an SMSF. Unless you can show conscious competence under cross-examination, then it is time to rethink your commitment to SMSFs.

Warning to SMSF professionals If you have been following my articles in selfmanagedsuper, you will know: a. The commissioner of taxation states that a trustee of an SMSF must produce an investment strategy and regularly review it. b. The Australian Securities and Investments Commission (ASIC) has stated in ASIC INFO

46 selfmanagedsuper

c.

d.

e.

f.

g.

216 that accountants can prepare and advise the trustee on an investment strategy. They are exempt from the licensing rules in the Corporations Act 2001 when it comes to investment strategies, but importantly cannot advise a trustee on specific investments.

The commissioner of taxation has published the following for SMSF trustees: “Broad investment ranges between 0 to 100 per cent in a broad range of assets do not reflect proper consideration in satisfying the investment strategy requirements. Your strategy must articulate how you plan to invest your super in order to meet your retirement goals.”

SMSF administrators and accountants who have prepared an investment strategy for their client with 0 to 100 per cent broad ranges for classes of assets have breached section 52B(2)(f) of the Superannuation Industry (Supervision) (SIS) Act 1993. This is considered a personal breach as was demonstrated in Australian Prudential Regulation Authority v Holloway [2000] FCA 579 where the regulator at the time took action against the accountant personally rather than his corporate entity.

Now here is the warning. If there is no investment strategy for the fund, the trustee can recover against the administrator, accountant and the auditor of the fund for any losses on investments pursuant to section 218 of the SIS Act. With the current equity market outlook moving to the downside, expect some actions by trustees against administrators.

And don’t expect to use the defence of contributory negligence as this is a statutory claim under the SIS Act backed by the Commonwealth Crimes Act.

SMSF advice standards So how you can show your competence? As I noted above, there are five detailed competency standards – which you may or may not have read. Read these carefully and assess objectively how many of these you display in your SMSF

Table 1: FNSSMS603 – Apply legislative and operational requirements to advising in self-managed superannuation funds Element

Performance criteria

Elements describe the essential outcomes

Performance criteria describe the performance needed to demonstrate achievement of the element

1. Establish knowledge of client regarding SMSFs

1.1 Advise client on features, structures and operations of an SMSF 1.2 Inform client of roles played by trustee, specialist advisers and regulators 1.3 I nform client of process to appoint trustees and explain trustee duties, responsibilities and liabilities 1.4 A dvise client of key issues and associated risks to be considered when evaluating SMSF applications 1.5 Advise client of steps required to establish an SMSF 1.6 Explain to client process of winding up an SMSF

2. Advise client on relevant legislative requirements

2.1 Identify sources of legislative information appropriate to an SMSF 2.2 Advise client on legislative requirements that apply to an SMSF 2.3 Advise client of role of principal regulator in managing an SMSF 2.4 Inform client of ongoing legislative requirements to maintain a compliant SMSF 2.5 Inform client of consequences of an SMSF becoming non-compliant

3. Advise client on relevant operational requirements

3.1 Identify sources of operational information appropriate to SMSFs 3.2 Advise on operational requirements that apply to client 3.3 Inform client regarding operation of trust deeds and ongoing deed amendment 3.4 A dvise client of requirements for establishing investment strategy, considering investment restrictions for an SMSF 3.5 A dvise client of application of Superannuation Industry (Supervision) Act preservation rules on fund monies

4. Identify and explain implications for contributions to client

4.1 Advise client on regulations regarding eligibility to contribute to an SMSF 4.2 Advise client on contribution rules, including in specie contributions of business real property 4.3 Advise client on allocation of contributions to individual member accounts 4.4 Advise client to seek advice for higher level, specialist and/or comprehensive advice if required

5. Identify and explain implications for benefits to client

5.1 Explain requirements for accessing assets in SMSFs for payments of benefits to client 5.2 Explain key features, characteristics and risks of different types of SMSF income streams to client 5.3 Explain process of setting up income stream from an SMSF to client 5.4 Explain calculation and operation of member accounts in both accumulation and pension phases to client 5.5 Inform client of treatment of death benefits, including lump sum and pension issues Continued on next page

QUARTER II 2022 47

COMPLIANCE

Continued from previous page

knowledge, evidence and advice.

And this is not the full standard, just one page out of five-plus pages. There are four more pages that determine your competency.

Questions to test your SMSF competency Let me ask you a couple of questions and provide your answer: 1. Can an accountant act as the director of a client’s SMSF corporate trustee provided they have a director identification number?

2. Can a tax-effective testamentary trust be directly created by the trustee of an SMSF on the death of a member rather than going through the will?

There is no moving away from these standards and they exist to support the industry and provide confidence and respect from clients and other financial services professionals that an SMSF professional is of the highest standard.

Answers 1. Accountant director of an SMSF

From a practical point of view, it’s probably not a great idea for an accountant, lawyer or financial planner to act as the corporate trustee director of an SMSF. They can, however, act as a director of a client or friend’s SMSF. However, there are caveats.

First and foremost, the constitution of the SMSF corporate trustee must allow it.

Secondly, the accountant must hold the member’s enduring power of attorney – see section 17A(3)(b)(ii) of the SIS Act. And for confirmation, the commissioner of taxation stated in SMSFR 2010/2: Example 1 20. Andrew works for a large international group of companies. He and his wife, Jane, are trustees and members of their SMSF. From 1 February 2009, Andrew is transferred to an overseas company for an indefinite period of time. In accordance with the relevant state legislation, Andrew and his wife each execute an enduring power of attorney in favour of their friend and retired accountant, Trevor. In addition, Andrew and Jane both resign as trustees of their SMSF and appoint Trevor as the trustee.

The appointment of Trevor as trustee is in accordance with the terms of the trust 48 selfmanagedsuper

deed. Other than the fact that Andrew and Jane are not trustees of the SMSF, the superannuation fund satisfies the other requirements of the definition of an SMSF in subsection 17A(1).

21. Trevor is a legal personal representative of both of the members, Andrew and Jane, by virtue of holding an enduring power of attorney in respect of each of them.

In addition, Trevor is now the trustee of the SMSF in place of both Andrew and Jane. Once appointed as trustee, Trevor is subject to civil and criminal penalties in the event that he breaches his duties.

Provided that the enduring power of attorney remains valid during the period Trevor is the trustee and given that the other requirements of subparagraph 17A(3) (b)(ii) are satisfied, the superannuation fund continues to satisfy the definition of an SMSF in subsection 17A(1), notwithstanding that Andrew and Jane are no longer trustees.

2. SMSF testamentary trust

The next question is an important one, but so many estate planning lawyers get it wrong. Can a testamentary trust be directly created by the trustee of an SMSF on the

death of a member rather than going through the will?

I remember writing on this some time ago and had a number of lawyers saying this was absolutely impossible as testamentary trusts can only be established under a will.

But a testamentary trust is not limited to a will. A testamentary trust is a trust established on the death of a person, including a member of an SMSF, insured or employee as well as a testator. From a legal perspective, section 102AG(2)(c)(v) of the Income Tax Assessment Act 1936 provides that a minor beneficiary of a trust created from the superannuation benefits of a member of a super fund is to be taxed under ordinary marginal tax rates and not penalty tax rates.

In order to do so, the super benefit must be paid to a dependant, such as a spouse, adult or minor child, a person who has an interdependency relationship with the member or is a financial dependant of the member. This allows the trustee to pay the benefit to the dependant pursuant to section 62 of the SIS Act – the sole purpose test. This can be optional for the dependant or mandated through an SMSF will. I have yet to see a binding death benefit nomination (BDBN) that caters for this strategic option.The importance of this testamentary trust is that it is not subject to a family provisions claim or contested will compared to a testamentary trust in a will – except perhaps in New South Wales, the only state with the concept of ‘notional estate’. So here is a great question: If a lawyer directs super via a BDBN into the deceased member’s estate and there is a family provisions claim, can any losses from what would have been paid to the dependant or dependants be recovered from the lawyer personally and/or their legal firm?

Conclusion In the next issue I will cover other SMSF competency questions and will show you how to make a claim against a lawyer or adviser who has recommended super to be transferred to an estate that ends up being contested.

STRATEGY

The pension toolkit Practitioners need to consider many elements when providing advice related to pension strategies. Tim Miller details the options available and their implications with regard to income streams.

TIM MILLER is education manager at SuperGuardian.

In issue 35 of this magazine, in an article titled “When more than one is better”, I identified multiple pensions could be commenced to isolate contributions or benefit components for estate planning purposes and that pro-rata requirements should be considered when determining the use of such strategies.

This is just one of a number of strategies advisers need in their pension toolkits when discussing how best to handle pensions in a post-super reform environment. With the onset of non-work-related contributions up to age 75 coming into effect from 1 July, now is a great opportunity to look at other key considerations for your pension clients.

Partial commutations versus withdrawals Lump sum benefits, in the form of a partial commutation, do not count towards the minimum pension requirement and can be an in-specie payment, unlike pension payments, which must be in cash.

If a member wants to take a benefit that exceeds their minimum pension requirement, there may be circumstances where it might be more appropriate to treat the benefit as a lump sum rather than a pension. If an amount is not to be treated as a pension payment, the member must notify the fund trustees of their intention to take the benefit as a superannuation lump sum so this can be reported against their transfer balance account (TBA) within the appropriate timeframe. As partial commutations are a debit to the TBA, they provide future transfer balance cap (TBC) space for the member.

Therefore, consideration should be given to how withdrawals are treated each year, especially in light of the government’s recent decision to extend the 50 per cent minimum pension drawdown discount for 2022/23.

For an SMSF the allocation of payments as a lump sum or a pension and whether to take it from a pension interest or an accumulation interest can impact the tax paid by the fund.

Withdrawal options There are alternatives for how any amount above the minimum pension can be accounted for by SMSF trustees, subject to whether the member has an additional accumulation interest or not.

Lump sum withdrawal from accumulation account If available, the excess amount may be withdrawn from an accumulation interest. Withdrawing from an accumulation interest does not reduce the personal TBC as this relates only to amounts held in a retirement-phase pension interest. However, it does reduce the amount of taxable component of the fund, meaning more of the income, including capital gains, will ultimately be exempt from tax.

Drawing down from the accumulation portion of the fund will generally increase the exempt income percentage for the year as determined by an actuary.

The higher the percentage, the lower the income tax for the SMSF.

Lump sum withdrawal from pension account While the above option is only available where accumulation interests exist, members may also choose to withdraw the excess over their minimum pension requirement as a partial commutation lump sum from their retirement-phase pension account(s) to free up some of their personal TBC space.

Additional space within this cap can enable future contributions or rollovers from other funds Continued on next page

QUARTER II 2022 49

STRATEGY

If a member wants to take a benefit that exceeds their minimum pension requirement, there may be circumstances where it might be more appropriate to treat the benefit as a lump sum rather than a pension.

Continued from previous page

to be included in the tax-exempt pension environment. This can be handy in light of the contribution changes and the possibility of downsizer contributions at a later stage in life.

A commutation creating a debit to the TBA can therefore be of future benefit to the SMSF. It is not a requirement to take the minimum before taking a lump sum, as long as the minimum is taken over the course of the year.

Treating excess payments as pension drawdowns Leaving any amount above the minimum as a pension payment, where an accumulation account exists, means the proportion of the fund in retirement phase is likely to be reducing relative to the accumulation-phase balance, unless contributions are still being made. This will have a flow-on effect to the actuary percentage and tax calculation.

Additionally, treating any withdrawal above the minimum as a pension payment rather than a commutation from a retirementphase pension means you don’t have the opportunity to create room in the TBA that

50 selfmanagedsuper

may be of use in the future. This may not be an issue for low member balances.

Death of a pensioner It is conceivable that where benefits are drawn from is likely to have an impact on those beneficiaries the member intends to leave their superannuation interests to upon their death, more so than on the member themselves.

Withdrawing monies from an interest with a high taxed component versus those with higher tax-free components can be beneficial if interests are to be distributed to non-tax dependants, such as adult children.

However, as a significant proportion of death benefits is traditionally paid to a spouse, the bigger issue may be appreciating the difference between autoreversionary pensions and the use of trustee discretion regarding death benefits that provides for a new death benefit income stream to commence, as each has different reporting, payment and strategic outcomes.

Existing pension versus new pension A great deal of focus is given to the issue of paying pensions to a surviving spouse and the concept of automatically reverting it to them

versus trustees having discretion as to how the death benefit is paid, which would result in the original pension(s) ceasing and a new one(s) commencing.

Traditionally the issue revolved around the tax exemption afforded to funds paying a pension and the consequence of the pension ceasing. This was addressed with the provision that the exempt pension income deduction exists following the death of the pension up until the time the death benefit is paid so long as the death benefit is paid as soon as practicable.

The issues created since the introduction of the TBC are those of timing, reporting and valuations, as well as convenience.

TBA reporting Reversionary pensions are afforded a 12-month TBA amnesty, for want of a better term, whereby the reversionary beneficiary has 12 months from the date of death until the pension will appear as a credit in their TBA. This provides a fund ample time to adjust

existing pensions so as not to create an excess where the combined value of the deceased’s benefit and the surviving spouse’s exceeds their personal TBC. The choices available within that 12-month period would be for the surviving spouse to commute their own pension back to accumulation, providing an opportunity to retain the money in the super system, or commute part of the reversionary pension, which would require the money to be taken out of the fund as a lump sum, or both.

Reversionary pensions provide valuation certainty for the amount credited at that time. It is the value at the date of death.

A significant benefit of this 12-month amnesty is that effectively the fund is generating exempt income on both the deceased’s and surviving spouse’s pensions.

Death benefit income streams, where the trustee uses their discretion to commence a new pension following the death of the member, must be reported based on the value on the date it is commenced, which is subject to when the trustee determines to commence it.

While this approach still gives the trustees and surviving spouse time to consider what actions are necessary in the event the new pension would create an excess TBA position, any decision must be made as soon as practicable and there is no way of having certainty on the value of the new pension at a future date.

The question therefore is whether trustee discretion in an SMSF is a good thing.

with the possibility of failing to meet the pension standards if the pension isn’t paid to the reversionary spouse due to trustee oversight. This would result in the fund losing its exempt income status.

The ATO has gone to some extent to address this by providing relief that stipulates while the pension is deemed to have stopped at the start of the year for exempt pension income purposes, the fund won’t be in breach of the payment standards if the pension is paid correctly the following year.

If a pension is discretionary, the pension calculation provides a completely different outcome. Usually when a pension ceases there is an obligation to pay a pro-rata pension. This obligation does not apply when the reason for the commutation is death. So in the event of a member dying during a financial year having not paid any pension, it does not impact the fund, that is, the exemption is still available.

If then the trustee is determined to pay the pension to the spouse, that income stream would be calculated based on the spouse’s age and would be subject to the pro-rata rules. A new pension commenced on or after 1 June would not require a minimum to be paid. In the event the member dies late in the year, as above, it may not be practical for the pension to be commenced in the current year, but the fund would still receive the income exemption despite no pension being paid at all. Quite a different outcome.

Minimum pension obligation

TSB and contributions

One relevant matter when discussing reversionary versus discretionary pensions is the minimum pension obligation.

If a pension automatically reverts to the spouse on the death of the member, then the fund has an obligation to pay the pension for the entire year as calculated at the previous 1 July.

If, for example, the intention was to pay the pension on an annual basis and the member dies towards the end of the financial year, then the fund could be faced

Another consideration for reversionary versus discretionary pensions is a member’s total superannuation balance (TSB) and their capacity to make contributions to a fund.

From 1 July, more individuals will be able to make non-concessional contributions to super given the removal of the work test for individuals up to the age of 75, however, their capacity will be limited by their TSB at the preceding 30 June.

This is where the reversionary pension 12-month amnesty may be problematic.

For an SMSF the allocation of payments as a lump sum or a pension and whether to take it from a pension interest or an accumulation interest can impact the tax paid by the fund.

While nothing shows on the TBA, the entitlement has transferred and as such the value of the reversionary pension will count towards the TSB. If the combined value of the member interest and the deceased’s interest exceeds the general TBC, currently $1.7 million, then the surviving member is unable to contribute. However, if the trustee has not yet determined to commence to pay the benefit, the member will not yet be in receipt of the deceased’s proceeds and their balance will be lower. This could bring into play the use of recontributions, which could provide better tax outcomes for any non-dependent beneficiaries.

When contemplating pension strategies there are numerous matters to be taken into consideration. Is the client better off with one pension or multiple pensions?

Reversionary pensions offer peace of mind, but may not necessarily be the answer to everyone’s situation. How will clients deal with excess lump sum withdrawals?

There are many strategies available for account-based pensions; the key is determining what is right for your client.

QUARTER II 2022 51

STRATEGY

The importance of regular planning reviews

Multiple superannuation legislation changes have occurred over the past few years. Scott Hay-Bartlem illustrates how these changes and other evolving factors make regular reviews of estate plans a must.

SCOTT HAY-BARTLEM is a partner at Cooper Grace Ward Lawyers.

52 selfmanagedsuper

Many people talk about the lessons they have learned over the past few years. One important lesson in the SMSF ecosystem is the importance of not just creating a robust SMSF estate plan, but also of reviewing it.

That leads to the question of how often should an estate plan be reviewed. The simple answer, of course, is “it depends”. This article will discuss some triggers that can help guide advisers and trustees with regard to this decision.

The outcome of a review is not always wholesale changes. Some reviews do not result in much, but other times quite extensive changes are necessary.

The failure to review as necessary has many possible consequences, including the wrong beneficiaries benefiting, unnecessary disputes and extra costs, and all at a difficult time.

Law changes In the SMSF ecosystem, the rate of law changes has

The failure to review as necessary has many possible consequences, including the wrong beneficiaries benefiting, unnecessary disputes and extra costs, and all at a difficult time.

been astronomical and we are likely to see more in the future.

Law changes can be quite extensive. For example, we have seen the Simpler Super changes of 2007 and the transfer balance cap changes of 2017. These both had significant flow-on effects to SMSF estate planning.

Any estate planning that involves superannuation really must be reviewed after 1 July 2017. There are several reasons for this.

As a result of the 2017 changes, any SMSF with more than $1.6 million in a pension for a member will have changed.

One very common scenario is SMSFs that only had a pension account for a member now also have an accumulation account. For example, Liz started an account-based pension in 2015 that was reversionary to her husband, Phillip. At 30 June 2017, the balance in Liz’s pension was $2 million, so on 1 July 2017, she was no longer able to have a single pension and instead had to have a pension and also an accumulation account. While her pre-1 July 2017 strategy of a pension that is reversionary to Phillip worked to send all of her superannuation to him, now that

she also has an accumulation interest, we also need to take the additional step of putting in place a binding death benefit nomination to Phillip for the accumulation interest.

Another estate planning implication from the 2017 changes is when the first person in a couple passes away we can no longer always simply pay a death benefit as a pension to the survivor. If a benefit cannot be paid as a pension, then it must be paid as a lump sum. This means we are seeing more money leave the superannuation system in this scenario. For example, Liz’s $2 million SMSF balance probably cannot all be paid to Phillip any more as a pension, and it is likely some must leave the superannuation system.

In light of this development, where should those funds go? If there is a significant amount that is going to leave the superannuation system on Liz’s death, do we want the funds to end up in Phillip’s name? What might he do with them and will that cause tax issues for him due to the increase in his income?

One consideration is whether the excess superannuation can be directed into the estate of the deceased member to form part of a testamentary trust. This may have benefits for income splitting with children or grandchildren, or protection from future spouses. It will be important to make sure the testamentary trust is properly worded so as not to trigger death benefits tax if the surviving spouse will be a principal beneficiary.

A further consequence of the 2017 changes was that some people withdrew some or all of the excess over their transfer balance cap from the superannuation system. For example, Liz may have set up a family trust for the excess of her superannuation over her transfer balance cap. This means Liz’s estate plan still needs to consider her pension in the SMSF and also how she now passes on control of her family trust after her death.

Finally, court decisions such as Re Marsella; Marsella v Wareham (No 2) [2019] VSC 65 (death benefit payment

processes) and McIntosh v McIntosh [2014] QSC 99 (conflicts) have also affected the steps we should take at the planning stage to minimise their impact. Failure to take these court decisions into account can lead to good SMSF estate planning not working out as intended.

Asset changes There are many life situations that result in a significant change to asset holdings.

These can occur in many different ways and should be monitored for the impact on SMSF estate planning.

With the significant cost of and increased reliance on different types of aged care, money may be withdrawn from the superannuation environment to fund those arrangements.

Any return from the aged-care funding forms part of the estate of the person when they die. This can result in a rebalancing between the superannuation and other estate assets and distorts outcomes where the plan is to send retirement savings to one beneficiary or group of beneficiaries, and then the estate to another or others.

For example, if Liz intends her husband to receive her superannuation assets when she dies, with her estate being divided between her four adult children, that plan will be thwarted if a significant amount is withdrawn from the SMSF to pay for aged care as it will be returned to her estate when she dies. This could result in Phillip receiving far less than was intended and a significant amount more going to her four children.

By the time aged care has been considered, the person in question may have lost capacity, making it too late to change existing arrangements.

Whether attorneys can change binding death benefit nominations and similar documents is a discussion for another day. It is therefore very important when preparing an estate plan to consider this possibility and include adjustments in case superannuation forms part of the estate.

Another issue that has a similar Continued on next page

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STRATEGY

Continued from previous page

impact is where money is withdrawn from an SMSF shortly before death. The taxation consequences of superannuation benefits being withdrawn before death can be significantly different to paying a death benefit after death. For example, superannuation death benefits being directed toward adult children rather than to a spouse can have vastly different tax consequences if it is paid as a death benefit after death rather than a member benefit before death. A good estate plan should take into account the fact superannuation may be withdrawn before death and the potential rebalancing that results.

Change in family circumstances Family relationships take many different forms and families can change in many and often unexpected ways. Changes in family circumstances are triggers for reviewing SMSF estate plans.

Entering or leaving de facto relationships, along with marriage and divorce, are obvious warning signs that SMSF estate plans could be out of date.

Many think a marriage ceremony is the trigger for review, but in modern Australia a de facto spouse has most of the same rights and a de facto relationship often starts much earlier than most realise.

Harnessing the discretion in death benefit payments, particularly with regard to SMSFs, is a powerful tool and often a major choice is between having them paid out via the estate or being distributed directly to the beneficiaries. The best answer could change significantly with the estrangement of a family member or with marriages, divorces or financial issues among family members. It is important with superannuation and SMSFs particularly to ensure assets are not distributed through estates where there is a risk of an estate challenge (subject to the notional estate provisions in New South Wales).

This must be balanced against the downside of distributing superannuation directly to beneficiaries as it exposes

54 selfmanagedsuper

Entering or leaving de facto relationships, along with marriage and divorce, are obvious warning signs that SMSF estate plans could be out of date.

the inheritance to risks resulting from business and marriage breakdowns and the like. There are situations where paying superannuation into an estate and using testamentary trusts to protect the inheritance is the better alternative.

A common strategy is for superannuation to be directed equally between adult children after the death of both parents using a binding death benefit nomination. But what happens if an adult child with children of their own dies before the parents? Under most documents, the

result is the surviving children receive all the superannuation equally, meaning the grandchildren miss out altogether. Where an adult child dies before their parents, SMSF estate plans must be reviewed to ensure the grandchildren’s share is directed back into the estate and the grandchildren inherit under the will should that be the intended outcome.

For example, if Liz’s son, Charles, dies before her, a binding death benefit nomination between her four children equally results in Margaret, Andrew and Edward receiving all her superannuation and Charles’s two sons receiving nothing.

Instead, the binding death benefit nomination must require the payment of Charles’s share to Liz’s estate, where her will leaves the superannuation between Charles’s two sons.

Conclusion There are many issues when implementing SMSF estate plans and these only seem to be increasing. On top of all of those issues it is really important for advisers to stay on top of changes in client circumstances so there can be an informed discussion of what should/could/must change as their situations evolve.

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STRATEGY

Beware the ECPI implications The presence of exempt current pension income within an SMSF can hold other tax consequences for the fund. Mark Ellem examines these scenarios.

One of the significant benefits of starting a retirementphase pension is the tax-free status of the income associated with the pension, referred to as exempt current pension income or ECPI. While the rules for how an SMSF can calculate and claim ECPI have changed from the 2022 income year, an SMSF that has ECPI needs to be aware of the effect a claim for this pension income exemption may have on fund income tax deductions.

MARK ELLEM is head of education at Accurium.

When deductions must be apportioned Where an SMSF claims ECPI, the expenses it incurs in deriving this type of income are not deductible.

Many fund expenses will be incurred in deriving both assessable and exempt income and consequently must be apportioned so only the portion relating to the derivation of assessable income is claimed as a tax deduction.

Some fund expenses, particularly those that have specific income tax provisions, can be claimed in full, despite a portion of the fund’s income being treated as exempt. The ATO sets out in its Taxation Ruling (TR) 93/17 the income tax deductions available to superannuation funds, including the methods to apportion expenses between deductible and non-deductible, where the fund has derived exempt income.

ECPI will also have an effect on any broughtforward tax loss. A brought-forward tax loss must be first reduced by net ECPI before being applied against fund assessable income.

Which expenses to apportion?

Expenses claimed under the general deduction section 8-1 of the Income Tax Assessment Act 1997 (ITAA) are required to be apportioned. Where there is a specific provision in the ITAA, reference must be made to the specific provision to ascertain if there is

56 selfmanagedsuper

a requirement to apportion the specific deduction where the fund derives exempt income.

Deductible fund expenses can be categorised as follows in relation to whether they need to be apportioned where the fund derives exempt income (see Table 1).

Common SMSF expenses can be classified as in Table 2.

Approach to apportioning When claiming general expenses, under ITAA section 8-1, that have been incurred partly in gaining assessable income and partly in gaining exempt income, you can again refer to TR 93/17 for guidance on apportioning expenses. This type of situation can arise when an SMSF has a member or members with both retirement-phase interests and non-retirement-phase interests.

Paragraph 7 of TR 93/17 states: The correct method for apportioning expenditure between assessable income and non-assessable income depends on the particular circumstances of the case. If there is a single outlay in respect of a thing or service, only part of which is used for gaining or producing assessable income, then the following principles apply: 1. If a distinct and severable part of the thing or service is devoted to gaining or producing assessable income and part is not, the expenditure can be apportioned according to the ratio of those parts, and 2. If an outlay serves both objects indifferently, another method must be used to apportion the expenditure which gives a fair and reasonable assessment of the extent to which it relates to assessable income.

In relation to expenditure of an indifferent nature, the ruling provides two apportionment methods.

1. Apportionment for expenses incurred in deriving investment income only: Expenditure x (assessable investment income/ total investment income).

From a practical perspective, this is commonly referred to as the actuarial method and effectively

Table 1 Apportioned

Not apportioned

Section 8-1 general expenses

Section 25-5 tax-related expense

Division 40 capital allowance (depreciation)

Section 295-460 insurance premiums

Division 43 deduction for capital works

Section 295-470 future service liability deduction Section 70B (1936 act) loss on traditional securities (also refer ATO ID 2014/26)

Table 2 Section 8-1 general expenses

Section 25-5 tax-related expenses

Accounting and administration fees

Tax agent fee

Audit fees

Actuarial fee for ECPI tax certificate

Bank charges

ATO SMSF levy

Investment costs and management fees

Tax advice fee

Cost to amend SMSF trust deed (updating) ASIC annual return fee

Legal fees (complying with income tax obligations)

Table 3 ($5000 x (($11,494 + $17,100 + $200,000 + $1,239,000) - $8046))) ($11,494 + $17,100 + $200,000 +$1,239,000) = $4973 apportions the total expense by first deducting the actuary’s ECPI percentage from 100 per cent and applying the result to the total amount of the deductible expenditure. For example, if the ECPI percentage is 70 per cent and the fund incurred total investment expenses of $200, the portion of the total deductible expense that can be claimed is $60, being 30 per cent (100 per cent less 70 per cent) of $200.

2. The income ratio method for apportionment of expenses that are

general in nature: Expense amount x (assessable income/ total income).

Assessable income, for the purpose of the above formulae, includes all contributions to the fund (assessable and non-assessable) and rollovers (refer to paragraphs 9 & 9A of TR 93/17).

Example

The following example demonstrates that simply utilising the actuary ECPI percentage

to claim such general expenses will result in an underclaimed tax deduction.

A fund was notified by the actuary its ECPI is 70 per cent and has: • $3000 of investment expenses, • $5000 of general expenses, • $17,100 of assessable contributions, • $200,000 of non-concessional contributions, • $1,239,000 rollover into the fund, and • $11,494 of assessable interest income.

Claim for ECPI will be $8046 (70% x $11,494).

Claim for investment expenses will be $900 applying the actuarial method: ((100% - 70%) x $3000).

Claim for general expenses will be $4973, using the income ratio method in Table 3.

If you applied the actuarial method to the $5000 of general expenses, the deduction would be only $1500. An underclaim of expenses may not concern the ATO, but the SMSF client may not be too pleased.

Obviously, where an SMSF does not have any non-assessable contributions or rollovers in an income year, the effective deductible portion applicable to expenses claimed under the ITAA section 8-1 general deduction provision will be the same under both the actuarial and income ratio method.

Periods of mixed interest plus period of deemed segregation For an SMSF that claims ECPI under both the segregated and proportionate method in the same income year, this presents a challenge when apportioning expenses in order to claim an income tax deduction.

This would apply where the SMSF does not have disregarded small fund assets and does not make the choice for assets held during a period of deemed segregation not to be treated as segregated current pension assets.

When apportioning expenses, the basic principle to apply is that any method used is fair and reasonable. The following approaches to apportioning expenses, Continued on next page

QUARTER II 2022 57

STRATEGY

Continued from previous page

where an SMSF claims ECPI under both methods, can be considered: Expense relates to asset during period not deemed segregated (an investment expense): • Expense x (100% - ECPI%) – the actuarial method.

Expense relates to asset solely to deemed segregated period (investment expense): • Expense not deductible Expense relates to asset during both unsegregated and deemed segregated periods (investment expense): • Expense x (100% - ECPI%) – this is actually not appropriate as it only applies to the unsegregated period. Actuaries may include on the ECPI certificate an expense percentage that can be used to apportion expenses that relate to assets (investment expenses) for periods when the asset was deemed segregated and other periods the asset was an unsegregated asset.

Expense not related to particular asset or income type (general expense): • Income ratio method from TR 93/17.

Example

The Friendly Family Super Fund is an SMSF. It starts the 2022 income year with two members, one in retirement phase and the other not. The non-retirement-phase member commences a retirement-phase pension on all of their benefits in the SMSF in October 2021. Consequently, from that time the SMSF consists wholly of retirement-phase interests. However, at the start of February 2022, the fund admits four members who roll over their benefits into the SMSF. These benefits remain in accumulation, that is, nonretirement-phase interests.

The SMSF does not have disregarded small fund assets and has not made the choice to treat assets held during the period of deemed segregation not as segregated current pension assets. Consequently, it will claim ECPI using both the segregated and proportionate method for the 2022 income year. The fund has acquired the relevant actuarial certificate to cover the periods of unsegrgeated assets, which 58 selfmanagedsuper

Table 4 $2320 x [($6500 + 0 + $956,800 + $153,345) – $122,595] ($6500 + $0 + $956,800 + $153,345) = $2065 Note: ECPI claim calculation is [(($47,054 + $59,237) x 71.07%) + $47,054] = $122,595 includes an ECPI percentage of 71.07 per cent and a deductible percentage to apply to expenses that can’t be attributed to solely producing assessable or exempt income of 22.048 per cent.

In additon to the assessable income for each period, as outlined above, during 2021/22 the fund has received total assessable contributions of $6500 and total rollovers of $956,800.

The fund has incurred expenses of which some relate to income earned from investments and some relate to the fund as a whole. Let us consider how those expenses are apportioned.

Depreciation of $15,650: related to income from investment assets and covers entire income year: • deductible per division 40 of the ITAA 1997 and requires apportionment where there is derived exempt income, • relates to fund asset, being the rental property, and • covers both periods of unsegregated assets and deemed segregation (the entire income year).

Use actuarial provided deductible portion of 22.048 per cent that has been calculated taking into consideration the whole income year.

• $15,650 x 22.048% = $3450 If an ECPI percentage of 71.07 per cent was used to apportion the expense, this would result in an amount of $4528 being claimed, which is greater than the above amount of $3450. This would be an incorrect (over) claim for depreciation as the 71.07 per cent only applies to the unsegregated periods and does not take into account the period of deemed segregation. When the period of deemed segregation is taken into consideration,

this increases the ECPI percentage and conversely decreases the deductible proportion of the expense.

Accounting fees of $2320: Not related to any income from fund assets plus covers entire income year.Apply income ratio method (see Table 4).

Rental property expenses of $1200: related to income from investments and covers deemed segregated period only.

Deductible portion = $0 – incurred during period of deemed segregated, all incurred in earning exempt income, and non-deductible.

Rental property expenses of $2600: related to income from investments and covers both unsegregated periods.

Deductible portion – apply actuarial method using ECPI per cent applying for that period. $2600 x (100% - 71.07%) = $752.

Rental property expenses of $2950: relates to income from investments and covers entire income year.

Deductible portion – apply actuarial provided deductible portion of $22.048 per cent. $2950 x 22.048% = $650.

Review and understand your SMSF admin platform It is the responsibility of the preparer to determine whether this proportion is fair and reasonable for each relevant fund expense. This will include understanding how the SMSF administration platform treats expenses when an SMSF has ECPI, how expense accounts should be set up in the platform to ensure apportioning is only applied to those expenses where it is required, and where apportionment is required, the relevant apportioning approach is applied.

We are delighted to announce our new conference, designed specifically to develop your practice and explore business opportunities. Join us for a practical, informative and thought-provoking program that has been created to give you tools and ideas to grow and maximise your client list; develop your practice including your own personal development.

In this one-day intensive event we bring you tax and superannuation technical specialists; regulators; business opportunities and solutions – all with outstanding networking opportunities.

Seats will be limited so we encourage you to book your place as soon as our registrations open – stay tuned!

Save the date LOCATION

Sofitel on Collins, Melbourne

DATE

17 August 2022

TIMES

9:00am - 5:30pm (Conference) 5:30pm - 7:30pm (Cocktail party)

Tickets on sale soon!

T: (03) 8851 4555 | E: conference@taxandsuperaustralia.com.au

SUPER EVENTS

SMSF ASSOCIATION NATIONAL CONFERENCE 2022

The SMSF Association National Conference 2022 returned to a faceto-face format for the first time in two years. Around 900 delegates travelled to Adelaide to physically reconnect with their industry peers.

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1: Meg Heffron (Heffron). 2: Peter Burgess (SMSF Association). 3: John Maroney (SMSF Association). 4: Julie Dolan (KPMG). 5: Dylan Parker and James Norton (The Paper Pilots). 6: Belinda Aisbett (Super Sphere). 7: Deborah Kent (Integra Financial Services) and Louise Biti (Aged Care Steps). 8: Irene Guiamatsia (Investment Trends). 9: Bryce Figot and Daniel Butler (both DBA Lawyers). 10: Tim Miller (SuperGuardian).

11: Marisa Broome (FPA), Phil Anderson (AFA), Simon Grant (CAANZ), Vicki Stylianou (IPA) and John Maroney (SMSF Association). 12: Jemma Sanderson (Cooper Partners). 13: Graeme Colley (SuperConcepts). 14: Andrew Lowe (Challenger). 15: Emma Rosenzweig (ATO). 16: Bryan Ashenden (BT Financial Group).

QUARTER II 2022

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LAST WORD

JULIE DOLAN STUDIES THE IMPACT THE NOTIONAL ESTATE CONCEPT CAN HAVE ON SUPERANNUATION DEATH BENEFITS.

JULIE DOLAN is a partner and enterprise head of SMSFs and estate planning at KPMG.

62 selfmanagedsuper

New South Wales is the only state in Australia that allows for notional estates.

The Succession Act 2006 (NSW) contains the rules relating to family provision claims.

This type of claim is an application to the Supreme Court of NSW by an ‘eligible person’ to ‘claw back’ specific assets into the estate.

This may occur where a deceased person left no estate, the estate was insufficient to properly provide for the eligible person or provision ought not be made entirely out of the estate because there are other entitled people or special circumstances exist. The court can make a family provision order in relation to a deceased person’s estate if it is satisfied the deceased did not make adequate provision for an eligible person’s proper maintenance, education or advancement of life.

Superannuation can be included as notional property, as even though not directly owned by the deceased person, they exercised a level of control or it could have formed part of the deceased person’s estate had they exercised a power to deal with it before their death. A notional estate order extinguishes the property rights of the owner who held the property prior to the making of the order.

There is also a transfer requirement test.

For the property to be subject to a notional estate order, there must have been a property transaction where the asset was transferred to someone without full consideration.

Another qualification is where the property is not eligible to be held in the estate but is still effectively controlled by the deceased.

This category of asset arises because of the deceased’s omission or failure to act resulting in it not already being included in the actual estate.

Therefore, a notional estate claim can include superannuation death benefits and attached insurance policies that have a binding death benefit nomination (BDBN), as the deceased could have chosen to nominate the executor or administrator of the estate, thereby assigning the benefits to the deceased estate. It also can include jointly held property and assets in family trusts where the deceased was in a position of control over the distribution of capital. There are specific time limits for a claim dependent on the

intent of the deceased when the transfer was made and the degree of moral responsibility the deceased had towards the claimant.

Benz v Armstrong (2022) NSWSC 534 is a recent decision made by the NSW Supreme Court that dealt with a notional estate and the clawback of superannuation death benefits that were subject to a valid BDBN. Dr Benz passed away leaving his second wife, Erlita, and six children to his first marriage. There were three different claims of provision made by three of his six children. The defendant to each proceeding was Erlita, who was also executor/ trustee of his estate. Pursuant to the will, Erlita was to benefit from most of his assets, including his superannuation balance of over $12 million.

The super was to pass to Erlita via a valid BDBN to which she paid out the benefits to herself shortly after the family provision claims were made and before mediation was scheduled. The residue of the estate was to be divided equally among his six children. There was very little residue to divide, which Erlita acknowledged.

One of the issues that was considered by Justice Ward was whether the provision for the three plaintiffs was adequate for their proper maintenance, education or advancement of life based on the history of the family and the deceased’s testamentary intention. Also considered was whether the relevant property transactions, being the in-specie transfer of shares to satisfy the superannuation death benefit payments, were a notional asset to the estate, that is, was there a failure by Dr Benz to revoke the BDBN prior to his death and put in place a new one in favour of the executor of his estate?

The plaintiffs submitted that by omitting to revoke his nomination and/or give a replacement nomination, the deceased brought himself within the provisions of sections 75 and 76(2)(a) of the Succession Act. Justice Ward concluded the deceased’s failure to revoke his BDBN and put in place a replacement nomination was in fact a transaction within the meaning of section 76(2)(a) of the act.

Therefore, the superannuation was to form part of the notional estate available for distribution based on the family provision orders.

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