Did you miss the live events for SMSF Professionals Day? No worries, on-demand is now available!
selfmanagedsuper subscribers use discount code ‘SMS’ for special rate $365 for a limited time only. Not a subscriber? It’s free: https://smsmagazine.com.au/subscribe
Investing | 20
Opportunities arising from AI.
Investing | 24
Assessing diversified index funds.
Compliance | 28
Areas of ATO focus.
Strategy | 32
The importance of contribution timing.
Compliance | 36
Obvious flaws in the proposed $3 million cap.
Strategy | 39
Maximising SMSF tax benefits from risk cover.
Compliance | 42
Details of the draft NALE legislation.
Strategy | 44
Managing legacy pensions.
Compliance | 50
How the planned Division 296 tax will operate.
Strategy | 53
The advantages of using an SMSF testamentary trust.
Compliance | 56
Cost-of-living pressure considerations.
Cover story | 12
Dividend imputation system changes | 16
SMSF impacts.
What’s on | 3
News | 4
News in brief | 5
SMSFA | 7
CPA | 8
IFPA | 9
IPA | 10
Regulation round-up | 11
Super events | 60
Last word | 62
Recent policy announcements would indicate the SMSF sector is in for the fight of its life during the term of the Albanese government, however long that might be. To this end, sources have actually told me there is a feeling in Canberra SMSFs have no friends in the corridors of power.
I accept the situation is one the sector must deal with, but a warning should be sent to the people currently in power that whacking people just for the sake of whacking them comes with a pretty hefty price.
In my previous editorial for this publication, I discussed the egregious nature of the proposed additional 15 per cent tax on total super balances above $3 million. This of course is just one battlefront for SMSFs.
A second has been the non-arm’s-length expenditure provisions, with a draft bill having been tabled in parliament to legislate the final operation of these rules.
These two developments have dominated industry discussion over the past six months at least and have had the effect, designed or otherwise, of steering attention away from what could be one of the most alarming initiatives the government is looking to implement – a change to the dividend imputation system applying to Australian listed companies.
No doubt we all remember the ALP’s attempt to scrap franking dividend refunds as a policy during the 2019 federal election – one that turned out to be an abject failure resulting in three more years on the opposition benches.
Well it appears Labor is still looking to change the way franking credits work in this country, but is going about it in a more piecemeal manner this time around.
It is looking to outlaw the use of franked dividends for off-market share buybacks and to
restrict their use when dividends are declared as a result of capital-raising activities.
Given the first attempt at amending the dividend imputation system was seen as a direct attack on SMSFs, the conclusion can be drawn these subsequent actions have been designed to ostensibly do the same thing.
If that’s the case, my response is go your hardest. After all we all know the ALP has to provide some payback to the industry funds who now effectively bankroll its election campaigns. But I would advise being careful animosity does not lead to poor outcomes for everyone and not just SMSFs.
Consider this: yes it is irrefutable a change to the franking credit system will hurt SMSFs, but the policy goes a lot further than that.
It is well recognised a large motivation for the home market bias of Australian investors stems from the dividend imputation system. Take any part of this element away and it could result in both individuals and organisations looking for better returns elsewhere and the exiting of monies from the Australian Securities Exchange. And we all know what happens to share prices when positions are sold down. They plummet.
Of course it will see SMSFs take a hit, but it also means industry funds will suffer a decline in investment performance and I’m certain this is not an intended consequence from this measure.
A parliamentary committee hearing conducted on the subject has recommended the proposal regarding franking on dividends resulting from capital raisings be reassessed, so there is reason for some optimism.
However, the ongoing episode perhaps proves animosity has the ability to cloud judgment and should be forever parked as driver of government policy.
Editor Darin Tyson-Chan darin.tyson-chan@bmarkmedia.com.au
Senior journalist
Jason Spits
Journalist
Todd Wills
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
AJRM Design Services
SMSF Trustee Empowerment Day
2023
Inquiries: Cynthia O’Young (02) 8973 3317 or email events@bmarkmedia.com.au
QLD
31 August 2023
Hilton Surfers Paradise Hotel
6 Orchard Avenue, Surfers
Paradise
NSW
5 September 2023
Sydney Masonic Centre 66 Goulburn Street, Sydney
VIC
7 September 2023
RACV City Club
501 Bourke Street, Melbourne
On demand
11 September 2023
SMSF Association
Inquiries: events@smsfassociation.com
Technical Summit 2023
QLD
26–27 July 2023
The Star Gold Coast
1 Casino Drive, Broadbeach
Accurium
Inquiries: 1800 203 123 or email enquiries@accurium.com.au
SMSF Compliance Day
QLD
23 August 2023
Hotel Grand Chancellor Brisbane
23 Leichhardt Street, Spring Hill
To have an upcoming event featured on the What’s On page, please contact darin.tyson-chan@bmarkmedia.com.au.
25 August 2023
Sofitel Gold Coast
81 Surfers Paradise Parade, Broadbeach
VIC
28 August 2023
Rivers Edge Events
18–38 Siddeley Street, Melbourne
NSW
30 August 2023
Skye Suites Parramatta
30 Hunter Street, Parramatta
1 September 2023
Rydges Norwest Sydney
1 Columbia Court, Baulkham Hills
DBA Lawyers
Inquiries: dba@dbanetwork.com.au
SMSF Online Updates
4 August 2023
2.00pm–3.30pm AEST
8 September 2023
12.00pm–1.30pm AEST
6 October 2023
12.00pm–1.30pm AEST
Institute of Financial Professionals Australia
Inquiries: 1800 203 123 or email info@ifpa.com.au
SMSF and member incapacity
22 August 2023
12.30pm–1.30pm AEST Webinar
SMSF and property developments
5 September 2023
12.00pm–1.00pm AEST Webinar
Superannuation Quarterly Update
22 August 2023
12.30pm–1.30pm AEST Webinar
Super Sphere
Inquiries: (03) 9827 5177 or email info@supersphere.com.au
How to audit an SMSF for 30 June
SA
8 August 2023
Mayfair Hotel
45 King William Street, Adelaide
VIC
11 August 2023
Crown Promenade Melbourne
8 Whiteman Street, Southbank
QLD
15 August 2023
Hyatt Regency Brisbane
33 Burnett Lane, Brisbane
NSW
23 August 2023
Sheraton Grand Sydney Hyde Park
161 Elizabeth Street, Sydney
WA
31 August 2023
Duxton Hotel Perth
1 St Georges Terrace, Perth
Institute of Public Accountants
Inquiries: Liz Vella (07) 3034 0903 or email qlddivn@publicaccountants.org.au
SMSF pension planning toolkit
8 June 2022
12.30pm-1.30pm AEST Webinar
Heffron
Inquiries:
1300 Heffron
Super Intensive Day 2023
NSW
29 August 2023
Rydges World Square 389 Pitt Street, Sydney
The Auditors Institute
Inquiries: (02) 8315 7796
Melissa Caddick – A Case Study
25 July 2023
1.00pm–2.00pm AEST Webinar
NALI
1 August 2023
1.00pm–2.00pm AEST Webinar
Auditing Crypto and NFTs
22 August 2023
1.00pm–2.00pm AEST Webinar
SMSFs, Holistic Estate Planning and BDBNs
5 September 2023
1.00pm–2.00pm AEST Webinar
SuperConcepts
Inquiries: 1300 023 170
Virtual SMSF Specialist Course
10–12 October 2023
10.00am–2.00pm AEDT
17–19 October 2022
10.00am–2.00pm AEDT
The latest sector research has identified the specific sense of control for which individuals are searching when they decide to establish an SMSF.
“What they mean [when referring to control] is they want to be able to pick exactly which route they will take to [their retirement] destination, whatever the destination is that they’ve set their mind to. So they want to be in the driver’s seat and pick the route,” Investment Trends head of research Dr Irene Guiamatsia revealed at the release of the “Vanguard/Investment Trends 2023 Self Managed Super Fund Report”.
“So they want to pick the investments, whether it’s an ETF (exchange-traded fund) or a managed fund, they want to be able to also opine on which ETF or managed fund is in their portfolio, is really what SMSF investors mean by desire for control.”
She took the opportunity to point out the
sense of control SMSF trustees were seeking did not translate into seeing them make constant revisions to their fund portfolios.
“When we actually observed the behaviour of SMSF investors, what we did notice is that they don’t actually rebalance [their portfolios] that often. They don’t trade so actively,” she noted.
“So yes [they want to be] in the driver’s seat, but perhaps [they’re not] really driving too much at this stage.”
Apart from the desire to have more control over their investments, she said the report found the belief they have the ability to achieve better returns, 37 per cent, and they can make better investment decisions, 32 per cent, than public offer super funds as the other two primary factors motivating people to set up an SMSF.
The report analysed responses of 2290 SMSF members who participated in an online survey conducted across February and March. It marks the 18th edition of the study.
The issue of SMSFs using reserves has become less of a concern for the ATO with regard to both newer strategies involving them as well as any pre-existing ones established under previous compliance rules.
“We have seen a decline, which is great, in the amount of reserves in SMSFs and probably because a few of them have now paid out some of those legacy pensions that were supporting those reserves,” ATO SMSF trustee experience director Kellie Grant told selfmanagedsuper Grant revealed a positive
sign has been the fact regulator fears the reserves would be used more as a mechanism to manage or even avoid total super balance and transfer balance cap issues have not eventuated.
To this end, she acknowledged the ATO has been monitoring the use of reserves closely since 2017 and has not been able to identify any worrying trends.
According to Grant, the current situation with the use of reserves falls into line with the regulator’s attitude on the subject.
“As you know our view is that an SMSF doesn’t really need to have a reserve unless it’s
supporting one of those legacy pensions,” she said.
She also took the opportunity to reiterate the circumstances where the ATO does not consider a reserve has actually been used.
“With respect to those
SMSFs that use a strategy where individuals make a contribution in one financial year and then allocate it to a member in the next – we don’t really see that as being the use of a reserve as such,” she noted.
Since this strategy is seen as employing a suspense account rather than a reserve, she confirmed there are no associated compliance actions required.
“I did want to take the opportunity to point out that people don’t need to report because we are still seeing some trustees report those sort of suspense accounts as a reserve in the return when they really don’t need to,” she said.
The ATO has released a draft taxation determination (TD) detailing how non-arm’s-length income (NALI) and capital gains tax (CGT) provisions interact to determine the amount of statutory income that will be taxed at penalty rates as a result of non-commercial transactions.
Draft TD 2023/D1 references section 295.550 of the Income Tax Assessment Act (ITAA) to identify what is NALI and non-arm’s-length expenditure (NALE), using both of these definitions to determine the statutory amount impacted by NALI.
In Appendix 1 of the determination, the regulator stated: “An amount of statutory income for the purposes of subsection 295-550(1) can include a part of the net capital gain calculated in accordance with the method statement in [ITAA] subsection 102-5(1) [which defines net capital gains].
“That is, where a capital gain arises as a result of a non-arm’s-length dealing, the NALI is determined by reference to the amount of the non-arm’s-length capital gain, being the capital proceeds less the cost base arising from the scheme in which the parties were not dealing at arm’s length.”
Referencing section 295-550(1)(b) and (c) of the act, it applied the same methodology to losses or expenditure, noting if they were non-existent or less than what the fund was expected to incur from arm’s-length dealings, these amounts would be considered NALE.
The financial adviser levy will increase to more than $3200 for the 2023 financial year, taking it past
the level the industry had previously complained was too high and unsustainable.
The increased levy has been set at $3217 per adviser and passes the figure that would have been applied during 2021 of $3138 per adviser, had the impost not been frozen at $1142 per adviser by the then superannuation, financial services and the digital economy minister Jane Hume.
The levy figure was released by Australian Securities and Investments Commission (ASIC) in the latest Cost Recovery Implementation Statement (CRIS) for 2022/23, which states licensees will continue to pay a $1500 levy and the total estimated cost recovery amount from the financial advice sector would be $55.52 million drawn from 2655 licensees and 16,019 advisers.
In the CRIS, ASIC noted the cost of regulating the advice sector had varied little from 2021/22 to 2022/23, with its costs decreasing from $56.7 million to $55.5 million.
The SMSF Auditors Association of Australia has changed its name to the Auditors Institute as part of its effort to provide support for auditing professionals operating outside the SMSF sector.
The new name took effect in July and is the result of a survey among the membership base of the professional association that indicated it supported the change to drive growth and increase its presence and influence as a peak representative body for auditors.
“The rebranding reflects our commitment to inclusivity, innovation and excellence of the auditing profession. We remain dedicated to supporting our members and providing them with the necessary resources, insights and guidance to achieve those goals,” the
Auditors Institute noted.
Two electronic service address (ESA) providers will merge from the start of October requiring SMSFs using either group for SuperStream rollover purposes to update their details with the ATO.
The regulator informed the SMSF community ClickSuper ESA would merge with Wrkr ESA and from 1 October the ClickSuper ESA will be decommissioned and no longer accept messages.
“SMSFs that currently use the ClickSuper ESA will need to update their ESA with us. If your SMSF doesn’t have an active ESA recorded with the ATO, it will be unable to process contributions and rollovers electronically,” the ATO warned.
“Trustees will also need to advise their employer of the ESA change so the SMSF can continue to receive employer contributions.”
The ATO added ESA details can be updated via its online services for business portal, by a registered agent or over the phone and SMSFs had no other options but to use an active ESA for SuperStream when conducting a rollover.
The overwhelming majority of SMSF auditors believed their existing skill set would exempt them from having to sit an exam to gain Au
AMP will sell its administration and software business, SuperConcepts, to a private management group led by a former CountPlus senior executive for $8 million in cash.
The research showed 80 per cent of auditors servicing SMSF clients thought they had adequate experience, allowing them to avoid the competency exam associated with the new compulsory ASIC.
The deal is expected to be completed by the third quarter of this year with around 500 SuperConcepts employees transferring out of AMP as part of the sale, which will also see the installation of a new management team backed by private equity firm Pemba Capital Partners.
access schemes, emphasising the implementation of stricter scrutiny and severe penalties for those caught violating the rules.
ATO SMSF auditor and portfolio director Kellie Grant outlined two common scenarios the regulator has noticed in regards to trustees accessing their super early.
“Firstly, new registrants will enter the system purely to illegally access their super, often at the direction of promoters who will charge high fees for their services. And once that money is taken from their SMSF bank accounts, the fund is abandoned and never lodges a return,” she said.
million was a good idea.
The results reflect greater concern about the new tax from the SMSF sector, with separate Investment Trends data showing 44 per cent of the general superannuation population suggesting its implementation is a positive step.
Of the 46 per cent of people who identified the policy as a bad idea, 47 per cent said it was either somewhat likely or very likely to affect them personally.
The new management team will be headed by former CountPlus chief executive Matthew Rowe, who will become managing director of SuperConcepts, and will include Brad Ackermann as chief operating officer and Andrew Row as executive director of client services.
The overwhelming majority of SMSF auditors believed their existing skill set would exempt them from having to sit an exam to gain Au
The research showed 80 per cent of auditors servicing SMSF clients thought they had adequate experience, allowing them to avoid the competency exam associated with the new compulsory ASIC.
In their new roles, Ackermann and Row will return to SuperConcepts where Ackermann was previously chief technology officer and a developer of the firm’s software platform, SuperMate, while Row was previously a joint managing director of Cavendish Superannuation, which was subsequently purchased by SuperConcepts.
Outgoing SuperConcepts chief executive Grant Christensen said the firm had a long history in the sector and “this transaction supports the future growth of the business, with the new management team having a clear focus on continuing to improve outcomes for our clients”.
The ATO has issued a stern warning to SMSF trustees and participants engaging in early superannuation
“And secondly, illegal early access happens with our existing trustee population unfortunately accessing their super too early. They may stop lodging to avoid detection and then have a contravention reported to us.”
Grant noted the consequences for illegally accessing superannuation early can be harsh and the regulator is stepping up its actions to ensure compliance among scheme promoters and participants.
The latest sector research has shown nearly half of SMSF members believe the proposed additional 15 per cent tax on total super balances above $3 million is a bad idea.
The “Vanguard/Investment Trends 2023 Self Managed Super Fund Report” revealed 46 per cent of trustees surveyed indicated it was a bad idea, while another 12 per cent were unsure about the merits of the proposed policy and wanted to be provided with more detail on the measure.
Another 18 per cent of SMSF members said their attitude was neutral toward the policy, while 24 per cent thought imposing an additional tax on retirement savings balances above $3
The Australian Securities and Investments Commission (ASIC) has taken action against two individuals for allegedly providing dishonest advice when encouraging clients to transfer their existing superannuation funds to SMSFs.
In the first instance, the regulator banned Brisbane-based financial adviser Stephen Garry Vick for five years from providing financial services due to the provision of defective advice statements, conflicts of interest in his business structure and acceptance of conflicted remuneration.
In a separate matter, Ashley Vincent Arandez, of Broadbeach, Queensland, has been arrested and charged with three counts of dishonest conduct, eight counts of dealing with proceeds of crime and one count of carrying on a financial services business without holding an Australian financial services licence.
An ASIC investigation found that between September 2017 and April 2021, Arandez allegedly deceived clients by promoting and operating a financial services business, advising them to transfer their superannuation funds into SMSFs and invest in business ventures he controlled, and dishonestly misrepresenting the nature of the investments.
It’s an interesting phenomenon – financial crises prompt people to set up SMSFs. It happened post the global financial crisis in 2008 and, more recently, with the COVID-19 pandemic, although this time there was an interesting twist – a good percentage were gen X or even millennials. No longer are SMSFs the preserve of the well-heeled nearing or in retirement, with many younger Australians increasingly focused on their retirement savings.
ATO data bears this out. At 31 March 2023, 13.5 per cent of the 1.1 million SMSF members were aged 44 or younger and around 40 per cent of the SMSFs being established annually are by individuals in this age bracket. As I said when commenting on those numbers, it’s a healthy sign for the SMSF sector and the broader community because it means the narrative around the benefits of investment flexibility, control and higher levels of engagement with your superannuation savings is reaching people at a younger age and well before retirement.
Going hand in glove with this growing cohort of younger SMSF members is evidence from the latest Investment Trends “2023 SMSF Adviser Report” indicating the sector is proving a profitable exercise for advisers, with 40 per cent of the 185 respondents to the report saying these clients have increased their practice revenue.
As Investment Trends head of research
Dr Irene Guiamatsia said in an interview with selfmanagedsuper: “It’s pleasing to see advised SMSFs appreciate the value delivered and be amenable to paying more for it. The challenge for advisers is to demonstrate value to the much larger pool of unadvised trustees who acknowledge gaps but remain reluctant to seek advice.”
It’s a perfect storm. At the very time government, regulators and the community are demanding higher professional standards of their advisers, the market is saying there is a commercial imperative for doing so. Just as importantly, more practitioners are responding by obtaining SMSF competencies, with educational provider Kaplan Professional noting the SMSF specialisation is one of its fastest-growing courses. Programs range from an Introduction to SMSF to its Master of Financial Planning with an SMSF specialist advisor (SSA) designation.
Enrolments to its SMSF elective subject, FPE020 SMSF Regulation and Taxation, are up 30 per cent, with Kaplan chief executive Brian Knight on record
as saying enrolment numbers in each of its six study periods show it is the most popular elective. “The subject is built in partnership with the SMSF Association and successful completion provides eligibility to apply for the SMSF Specialist Advisor (SSA) designation,” Knight explained.
“Financial advisers are wanting to complete the elective subject as part of the Master of Financial Planning, so they can achieve a master’s degree and the SSA designation simultaneously. They are also completing it as a single stand-alone elective subject in great numbers to further specialise and gain more recognition.”
In my opinion, this doesn’t simply reflect a growing interest in SMSFs. Advisers are increasingly appreciating the importance of providing superannuation advice because it’s a conversation more younger clients want to have, irrespective of whether they are a member of an SMSF or Australian Prudential Regulation Authority-regulated fund. Certainly, it’s not about setting up an SMSF for every client that walks through the door. Instead, it’s about having the competencies to determine whether an SMSF is appropriate for a client. Sometimes it’s even necessary to talk them out of setting one up.
There is another factor at play. There has been a sharp decline in the number of advisers and accountants holding a limited licence. To this end, in the 2023 financial year alone the number of accountants holding a limited licence dropped by 75 to 621. So, at the very time the SMSF sector is growing at a steady clip, the number of advice professionals has been declining.
This shortage is being exacerbated by younger individuals establishing SMSFs. Although to my knowledge there is no hard data saying younger people are more likely to seek advice, it seems logical many would. Juggling young families, careers and social lives makes them time poor, so getting advice on running their SMSF would seem a logical step.
At the very least, all the evidence suggests the demand for SMSF advice can only grow.
Let me make one final point. The Quality of Advice Review made many good recommendations, most of which the association supports. But we believe there was a major oversight – the role of accountants in giving SMSF advice. Our advocacy for appropriately qualified accountants to be able to provide some form of limited SMSF advice has not wavered, and we will continue to push this barrow in Canberra and industry forums.
PETER BURGESS
The federal government’s implementation of recommendations from Michelle Levy’s Quality of Advice Review brings positive news for SMSF members. These reforms prioritise the removal of unnecessary red tape with the potential to streamline processes, ultimately benefiting SMSF trustees.
The changes are aimed at improving financial advice regulations. Importantly, this will contribute to a more efficient and cost-effective environment for people managing their own super funds.
standardised consumer consent requirements for insurance commissions enhance transparency and protection, ensuring trustees are fully informed.
RICHARD WEBBThe government has prioritised removing regulatory red tape that adds to the cost of advice without benefiting consumers. SMSF trustees, already struggling to obtain good advice, will welcome these changes.
The elimination of superfluous and potentially detrimental steps in the provision of advice will streamline the adviser’s best interest duty. This includes safe harbour provisions, which were originally designed to protect financial advisers. These changes will allow financial advisers to better focus on client-centred advice, allowing trustees to see how to better meet their fund’s objectives and concentrate on managing their members’ retirement savings.
The replacement of statements of advice (SOA) with a more fit-for-purpose advice record is a muchneeded change. SOAs are often lengthy and complex documents, making them less accessible and userfriendly. With the introduction of a more practical advice record, trustees are expected to benefit from clearer and concise advice. This will enable them to spend time discussing the recommendations provided by financial advisers with their adviser, ensuring better understanding of the advice provided.
A number of other measures have also been prioritised to reduce the burden of paperwork required from financial advisers and simplify processes for SMSF trustees. One such measure is the consolidation of ongoing fee renewal and consent requirements into a single form, eliminating the need for a fee disclosure statement. Additionally, there is to be greater flexibility in meeting financial services guide requirements. Standardised consumer consent requirements in respect of wholesale and sophisticated clients will bring clarity and consistency to the financial product landscape. Further, simplification and removal of certain exemptions to the ban on conflicted remuneration stands to benefit trustees through consistency and clarity. Lastly, the
In addition to these immediate steps, the government has announced longer-term plans that align with Levy's recommendations in full. These plans involve extensive consultation with industry and consumer stakeholders to explore the expansion of advice provided by other institutions, including Australian Prudential Regulation Authority-regulated superannuation funds. The key areas to be addressed include broadening the definition of personal advice, removing the general advice warning, allowing non-relevant providers to offer personal advice, introducing a good advice duty and amending the design and distribution obligations. The consultation process aims to finalise the implementation details for a number of recommendations. This includes the replacement for SOAs and having the adviser’s best interest duty replaced with a true fiduciary duty and review of the financial adviser code of ethics. It also includes expanding access to affordable retirement advice. The government intends to evaluate these proposals through trials involving various advice models, such as digital advice, while considering practical policy design and implementation. Consumer protection expectations will also be addressed.
The introduction of a duty to provide ‘good’ advice, rather than solely focusing on a best financial interest duty, is particularly significant for trustees. This requirement, applicable to all interactions between financial professionals and their clients, will have an impact on those providing retail financial services. The concept of good advice entails wholly or partly personalised advice that, at the time it is given, is suitable for the intended purpose. This takes into account the client’s needs or the potential usefulness of the advice from the provider’s perspective. Overall, this shift towards a good advice duty holds the potential to enhance the quality of all advice provided.
The implementation of recommendations from the Quality of Advice Review brings potentially positive changes. However, for SMSF trustees to maximise the benefit, the government will have to consider the full suite of recommendations and think differently about who can provide financial advice and how that advice is provided. Innovative thinking is needed while ensuring consistent consumer protections are maintained.
is financial planning and superannuation policy adviser at CPA Australia.With all the superannuation policy measures announced this year, it’s questionable how much thought was given to ensuring those measures are fair and equitable among all members of all types of super funds.
The first example is the non-arm’s-length expenditure (NALE) rules for superannuation funds. In late January, Treasury released its consultation paper, which considers options to amend the non-arm’slength income (NALI) provisions that apply to super funds. Following this consultation, the government released draft legislation, which is consistent with the 2023/24 federal budget announcement, to amend the NALI provisions by exempting large Australian Prudential Regulation Authority (APRA)-regulated funds from the NALE provisions for both general and specific expenses. That is, none of their income will be considered NALI even if the fund’s administrative or investment-related expenditure is lower than it would have been in an arm’s-length situation.This is no doubt a major win for APRA superannuation funds. However, SMSFs and small APRA funds were not so lucky. These funds will still be subject to the NALE provisions as the draft legislation contains amendments that will limit the income taxable as NALE at twice the shortfall amount (that is, the difference between the amount of the general expense that should have been incurred on arm’slength terms and the amount of the general expense that was actually charged to the fund). This means small funds will need to ensure all their expenses are at market rates or pay extra tax.
The proposal as it stands will result in an uneven playing field between APRA funds and SMSFs and does not promote tax neutrality across the superannuation sector.
The extra 15 per cent tax on earnings on superannuation balances above $3 million is another example of how large APRA funds have been given preferential treatment on the basis of the alleged complexity involved for large public offer funds to comply with this measure. The government’s view is the extra 15 per cent tax proposal treats individuals equally in applying a tax on large balances, regardless of the type of super fund of which they are members, and is the easiest to administer under existing reporting systems and will keep compliance
costs low.
The government has also stated the alternative approach of reporting actual taxable earnings would require significant changes to the reporting of APRA funds that would come at a cost to all their members, not just those with high balances. Even if true, simplicity of reporting should not come before fairness. This simplistic approach of applying an extra 15 per cent tax on earnings or increases in total superannuation balances (TSB) over $3 million (including unrealised gains) favours APRA funds as it relieves them from determining and reporting the actual earnings and the correct tax outcomes for their members, which could easily be in the millions of dollars.
Funds such as SMSFs, which can already identify a member’s TSB and can calculate actual earnings for each member of a fund, should be given the option to apply the extra 15 per cent tax to actual taxable income/earnings above $3 million. Conversely, large APRA funds that cannot easily work out actual earnings for members could rely on an alternative method, such as the formula-based approach proposed by Treasury. Provided the outcome delivers on the policy goal, then having two options as solutions for large and small funds should be permitted.
We already have different approaches for large and small funds, such as transfer balance account reporting, as reporting and timing requirements vary between SMSFs and APRA funds, so having an alternative approach for the extra 15 per cent tax proposal would be no different.
In my opinion, it’s clear these two examples both benefit large APRA funds due to the purported administrative issues they would face to comply with these measures. It’s understandable large and small funds operate differently due to their size, however, coming up with a one-size-fits-all approach to all funds will not always work across the industry.
With the superannuation sector worth $3.5 trillion at the end of March, and SMSFs representing around a quarter of total super assets, it’s hard not to think such policy positions are not a direct attack on SMSFs. The issue isn’t about paying extra tax, rather it’s about paying tax fairly. Fairness should trump inconvenience.
Despite a lot of opposition, the federal government has decided to adhere to its experienced pathway for financial advisers election promise. The Institute of Public Accountants (IPA) has been, and continues to be, opposed to this approach.
However, we accept the flexibility the legislation provides in terms of acknowledging advisers may come from different backgrounds, countries or sectors.
We appreciate and support the policy objective of trying to get more advisers into the sector and trying to encourage those who left to return to the industry, though we support a different pathway for achieving this, of which experience is one component.
Mandatory and ongoing continuing professional development (CPD) is a given and we believe this shouldn’t be an issue for professional advisers. The IPA has mandatory CPD requirements around ethics and professional standards, as well as two other mandatory categories based on technical skills and professional management, that is, interpersonal-type skills.
Existing advisers – experienced pathway
Since the proposal will proceed, the IPA believes certain parameters need to be included to make it consistent with the policy intention transitioning the financial advice sector into a profession. We have worked with other professional associations to develop a way forward, which is outlined below.
Relevant experience:They can demonstrate 10 years of relevant licensed experience where they have provided personal advice to retail clients. This would be over the period from 1 January 2004 to 1 January 2019.
Clean record: Further consultation may be required to define what constitutes a ‘clean record’. The IPA applies a ‘fit and proper person’ test for our members, which is broader, widely understood and accepted. This could also be used to inform the clean record requirement. It could
include:
• no disciplinary actions recorded on the Financial Advisers Register (FAR),
• never been suspended or banned from being licensed for any period of time,
• no material complaint with the Australian Financial Complaints Authority (AFCA) resulting in a client suffering financial detriment, and
• no disciplinary action taken by a professional association of which the adviser is or was a member.
Proof: The adviser should provide proof of having met the requirements by way of a statutory declaration. It is essential to ensure accountability and transparency as far as possible if the experienced pathway is to be adopted.
Accordingly, there should be appropriate penalties for providing a false declaration that could include disqualification from registration for a prescribed period of time, including a permanent banning order.
Sunset clause: The government did not accept the proposal of including a sunset clause (we suggested the end date of 1 January 2032).
This would strike the right equitable balance between advisers who have undertaken study and complied with the regulatory requirements, and those who haven’t.
Any adviser who wishes to continue to practice after this date would need to meet the education requirements for existing advisers. Again, this would strike the right equitable balance.
After so much pain and anguish in trying to transition the industry into a profession, the government has decided to put aside the essential requirement of an appropriate qualification and instead rely on experience.
The IPA believes experience should be treated as one component of professionalism.
In time, we will see if the experienced pathway is sufficient to lure back all the advisers who have left the industry.
In addition to the normal 1 July indexation changes to rates and thresholds, the following changes apply from 1 July 2023:
• super guarantee (SG) increase – the compulsory SG rate increases to 11 per cent of ordinary times earnings paid from 1 July 2023,
• age pension age – age pension age has been incrementally increasing from age 65 to 67. This increase will be fully phased in from 1 July 2023, with age 67 being the minimum age pension age for new applicants. Service pension age for veterans remains at age 60,
• minimum drawdown relief – the 2023 financial year is the last year for the 50 per cent drawdown relief that was provided to accountbased pensions during the COVID period. From 1 July 2023 the standard minimum drawdowns must be drawn each financial year.
From 1 July 2023, SMSFs must report quarterly on events that impact members’ transfer balance accounts.
The transfer balance account report must be lodged within 28 days from the quarter end.
If the SMSF trustees are reporting 2022/23 events annually with their SMSF annual return, they will need to report all events for that year by 28 October 2023.
SMSFs are required to process rollovers electronically using the SuperStream system.
But due to difficulties with finding an electronic service address provider, the ATO offered temporary relief to continue lodging paper rollovers but only where approval was sought from the ATO.
This relief ended on 30 June. From 1 July all rollovers, with no exceptions, need to be processed electronically
This class order sets out competency standards and knowledge areas of law that are required for SMSF auditors in addition to the legislated obligations.
It has been decided this class order is no longer required and it was repealed from 21 April 2023.
The ATO published this alert to highlight concerns with SMSF trustees investing in a special purpose vehicle that undertakes property development
as a way of diverting the profits of the property development to an SMSF.
The ATO view is these dealings may create nonarm’s-length income due to a lack of commerciality. Trustees may wish to obtain a private binding ruling if participating in these types of arrangements.
Law Administration Practice Statement (PSLA) 2023/1
One of the powers held by the ATO is the ability to issue rectification directions to SMSF trustees when the fund is found to be non-compliant.
This practice statement provides guidance to ATO staff on whether to issue a rectification direction.
ATO staff are given directions to consider specific factors of each case, including:
• any financial detriment that might arise as a result of complying with the direction,
• the nature and seriousness of the breach, and
• the trustee’s behaviour, circumstances and compliance history
Legislation has been introduced into parliament to increase flexibility for the use of the FHSSS. These changes include:
• allowing an individual to amend or revoke an application that has been submitted to apply for a release of super benefits, and
• the timeframe to request a release authority would be extended from 14 days to 90 days after entering into a contract to buy or build a home.
Amendments by the ATO to administration processes mean that when the final annual return is lodged for an SMSF that has closed, the Australian business number of the fund will not be cancelled until 28 days after the processing of a tax refund. This allows trustees to roll over any money received after lodgement, such as a tax refund, to another superannuation fund.
The form for SMSF trustees to voluntarily disclose non-rectified regulatory conventions has been amended to require the signature of at least one trustee or director of a corporate trustee. Trustees should ensure they use the current form as older versions will not be accepted.
Non-arm’s-length expenditure has been an issue on the table between government and industry for some years, with little movement until the start of this year. In the space of four months a new model was devised, revised and turned into a draft law and Jason Spits examines whether the industry takes what’s on offer or presses for more.
In the world of superannuation, the end of the financial year not only draws a line under what has passed, but also is a reminder of changes to come from the first day of the new year. These typically include changes to various caps, rates and thresholds, but the start of the 2024 financial year also includes the commencement of a compliance regime that has not been policed for five income years – the application of certain non-arm's-length expenditure (NALE) provisions and the associated non-arm'slength income (NALI) penalties.
From 1 July 2023, Practical Compliance Guideline (PCG) 2020/5, under which the ATO stated it would not act against some NALE breaches, no longer applies and the regulator will begin taking action against SMSFs and small Australian Prudential Regulation Authority (APRA)-regulated funds (SAF) in the event they incur general expenses on a non-commercial basis.
The key issue with the NALE rules is every SMSF has expenses, of both a general and specific nature, and since the issue of NALE first came to light in 2019, the question has been how to apply the NALE provisions and what financial disincentives will apply when they are breached.
The initial position of government was a nexus would exist between NALE and the ordinary and/or statutory income of a fund impacted by the transaction in question, triggering the NALI provisions and a penalty tax levied at the highest marginal tax rate or 45 per cent. However, when applied to general expenses the approach had the potential to taint all fund income as NALI – a scenario that caused a great deal of industry consternation.
The situation was further complicated in February this year when the government instead suggested the NALE penalty in regards to general expenses would be five times the difference between the
discounted expense and the market value of the expense in question. While some movement on the issue was welcomed, many were quick to point out this would result is a five times 45 per cent tax, or 225 per cent, and was significantly disproportionate to the particular transgression.
Following industry consultation, three months later in the federal budget the penalty tax to be applied for general expenses was reduced to two times the discounted amount of the expense. This is the position the government has included in the draft NALE legislation, for which consultation closed on 7 July. (See breakout box: What’s in the draft NALE bill?)
The question now to be asked is should the industry accept the two-times factor as the best it can expect from the NALE rules governing general expenses or continue to push for the complete removal of the entire NALE regime.
SMSF Association chief executive Peter Burgess says the two-times factor put forward by the government is not what the SMSF sector was hoping for and it would prefer to see the entire NALE system repealed (see breakout box: Rolling back the clock), but concedes the current status is a large step forward.
“The 2019 changes are no longer needed and the mischief that led to the non-arm’s-length arrangements has been addressed and it still remains a mystery as to why we need to have provisions relating to NALI and NALE,” Burgess explains.
“Despite this, the draft legislation has broken the nexus to all the income of a fund, which would have been a very harsh outcome if it had been maintained.”
Institute of Financial Professionals Australia head of superannuation and financial services Natasha Panagis also
sees the two-times factor in the draft legislation as a better outcome than the five-times factor first presented, but would also prefer a repeal of the NALE provisions and a return to pre-2019 rules.
“What we have is better than the fivetimes model presented earlier this year, but it is not ideal and not required because the superannuation system has rules in place to deal with non-arm’s-length arrangements,” Panagis says.
“The ATO has the rectification powers and tools at hand so there is no need to even adopt the two-times model to deal with NALE.”
Yet, looking at the progression from a position where the entire income of a fund would be taxed at penalty rates to the two-times model presented in the draft legislation it would appear the government, while aware of the super sector’s concerns, will not be taking NALE off the table.
“Scrapping the NALE provisions is not going to happen,” SuperConcepts SMSF technical and strategic solutions executive manager Phil La Greca notes.
“The government is more likely to scrap related-party transactions before NALE, and that is unlikely to occur.
“At the end of the day the government had to resolve the matter and we can see its thinking in the draft bill which contains the two-times factor first presented in the budget.
“The two-times factor is a reasonable basis for NALE compared with the fivetimes factor and is a behaviour-change penalty that recognises the government is out of pocket when NALE occurs within a fund.”
While settling on the NALE model put forward in the draft bill may be as good as it gets for now, Chartered Accountants
Continued on next page
“The 2019 changes are no longer needed and the mischief that led to the non-arm’s-length arrangements has been addressed and it still remains a mystery as to why we need to have provisions relating to NALI and NALE.”
Peter Burgess, SMSFA
Continued from previous page
Australia and New Zealand (CAANZ) superannuation leader Tony Negline points out it will create distortions in the super sector depending on who conducts a transaction and where that transaction is carried out. As such, CAANZ has supports the call for a repeal of the entire NALI regime.
“Distortion number one takes place such that if you carry out a transaction in a certain way you will have a certain tax outcome. If within the fund you carry out a transaction in a certain way that may or may not be at arm’s length, you will end up with a different tax outcome, which doesn't make a lot of sense to me,” Negline says.
“Distortion number two arises from whether you execute that transaction through an APRA-regulated fund or through an SMSF because any similar NALE transactions will create distortions or inconsistencies between those two environments and the law around this should be entity neutral.”
The exclusion of APRA-regulated funds from the draft NALE bill is also of concern for IFPA, with Panagis labelling it as preferential treatment due to the supposed complexity of applying the provisions to these larger funds.
“The reasons for the exemption, according to the explanatory memorandum to the draft bill, is that APRA funds will only enter into non-arm'slength arrangements that provide general services because their primary intention would be to reduce costs and pass those on to their members rather than gaining a tax benefit,” she suggests.
“We completely disagree with that fact because superannuation fund trustees are required to act in the best financial interests of their members. Smaller funds such as SMSFs and SAFs are also required to act under that interest and reduce cost
savings to their members so it's completely unfair this consideration is being applied only to APRA-regulated funds.”
Coming back to his preferred view of what should happen to NALE, Burgess indicates the SMSF Association does not have problems with APRA-regulated funds being exempted from the NALE provisions, but wants it to apply to all superannuation funds.
“The argument is these provisions around general expenses should apply to SMSFs because the trustees are in a better position to influence and control the arrangements more so than members in large funds,” he says.
“We accept that but also note the general expense shortfall amounts are quite small and ask why a member of an APRA-regulated fund can benefit from a discounted fee negotiated with a related entity while members in an SMSF can’t.
“It is concerning that we seem to have inconsistencies here and the government is happy to treat funds differently when it comes to some parts of the law.”
While the exemption for APRA-regulated funds may be a question of fairness, the lack of information on key practical and operational matters also contributes to the view the draft bill is only half a solution, with the absence of benchmark general expense costs being a leading concern.
La Greca notes the SMSF sector has raised the need for benchmark general expense costs and while the draft bill recognises what those general expenses will typically be, the onus is on the ATO to provide that information to the sector.
“We are potentially looking at the use of benchmarks, which the ATO could draw from tax returns, applying an average or median cost for use by the industry which would act as a safe harbour guideline, which we have in other areas related to
expenses,” he explains.
“However, this leads to the question of who is going to ask whether a NALE figure is consistent with a benchmark. Will it be the tax agent or the fund auditors, who are complaining already about all the extra things they are being asked to do? But having something to measure against is the biggest stumbling block in making this work.”
Smarter SMSF technical and education manager Tim Miller also sees the need for the SMSF sector to have some guidance as to what will be a fair general expense, but it may also highlight the irrelevance of the NALE regime.
“Costs across the industry will vary for different services and which one will be right? None of them, but none of them will be wrong either because they are what people are charging and what is fair and reasonable is going to be different in everybody's eyes,” Miller points out.
“Yet when you start to put a value on things such as general fund expenses, you start to table the real impact. Then the reason for introducing the provisions in the first place has to be questioned.
“Many general expenses for an SMSF are typically low and have minimal impact on a fund’s income and so it seems like we have been chasing shadows because we are not really talking about people trying to abuse their contribution caps, which was supposedly the whole concept behind NALE.”
Miller adds the draft NALE bill also includes no scope for rectification or makegood provisions compared to other parts of the tax regime, but does not believe the industry effort to date has been wasted.
“I hate to say any consultation was a waste of time because if you don't
Continued on next page
“What we have is better than the five-times model presented earlier this year, but it is not ideal and not required because the superannuation system has rules in place to deal with non-arm’slength arrangements.” Natasha Panagis, IFPA
Continued from previous page
have that period, you don't have the opportunity to push the same narrative and we saw that with the five-times factor where the industry questioned how Treasury came up with that,” he acknowledges.
Panagis also sees the draft bill as a step in the right direction, but not the destination and notes the industry has only dealt with general expenses and not NALE related to specific expenses.
“We are still in limbo in terms of what will apply to specific expenses because at the moment they will be subject to the normal NALI rules, which means a 45 per cent tax rate instead of one treatment for both sets of expenses,” she acknowledges.
“This seems odd given we have been talking about non-arm's-length arrangements for years, but only landed on the expenditure side for general expenses. The specific expenses have not been ignored, but there's been no move
on that from the government side.”
Negline believes the SMSF sector has to date received a fair hearing even if it has not received its preferred outcome and will push forward towards that goal.
“The government gave some ground and listened in part and we accept that, but the SMSF sector still feels its model is regulatory overreach and there is a better way forward. We have stated that in submissions and will continue to meet with Treasury and prosecute the case for the repeal of NALE,” he says.
After more than four years of waiting, the superannuation sector has been given an insight into how the government will apply the NALE provisions by releasing on 20 June a draft bill: Treasury Laws Amendment (Measures for Consultation) Bill 2023: Non-arm’s Length Expense Rules for Superannuation Funds, which states how it plans to enact those rules via amendments to the Income Tax Assessment Act 1997. These amendments include:
• limiting the application of the NALE rules to SMSFs and small APRA funds (that is, excluding APRA-regulated funds from the general expense provisions),
• making a distinction between the specific
Is it possible to live in a NALE and NALI-free world? Yes it is, according to a collection of industry associations that have put forward a case for repealing the entirety of the NALI regime and using existing tax and superannuation law to tackle non-arm’s-length arrangements within superannuation.
The argument, which forms part of a joint submission made by CPA Australia, Chartered Accountants Australia and New Zealand, the Institute of Public Accountants, the SMSF Association and
and general expenses of the fund for the purposes of NALE,
• limiting the amount of income taxable due to a NALE general expense breach as twice the difference between the amount that would have been charged as an arm’slength expense and the amount actually charged to the fund,
• limiting the potential income of the fund that can be taxed under the provisions to the fund’s taxable income less contributions and related deductions, and
• exempting expenses that were incurred or might have been expected to be incurred before the 2019 income year.
The explanatory memorandum to the
draft bill adds a general expense is one not related to gaining or producing income from a particular asset of the fund and may include actuarial costs, audit, accountant, trustee and investment adviser fees, administrative costs to manage the fund and costs to comply with the regulatory obligations of the fund. At the same time, the explanatory memorandum notes a specific expense “will be any other expense” and “the existing treatment [of a 45 per cent tax expense] will continue to apply” with the amount to be taxed being the amount of income derived from the scheme where the SMSF was not dealing at arm’s length.
the Tax Institute in regards to the draft NALE legislation, calls for a repeal of the 2019 NALE amendments to section 295-550 of the Income Tax Assessment Act 1997
This would be possible because the issue that led to the amendments, zero interest loans from related parties for limited recourse borrowing arrangements, has been addressed by Practical Compliance Guideline 2016/5, which introduced safe harbour parameters for related-party loans.
As such, the government could use the existing provisions of the Superannuation Industry (Supervision) (SIS) Act, namely section 109, which already prohibits trustees from engaging in transactions with any party unless they are conducted on arm’s-length terms, to address NALE.
At the same time, any expense shortfall amount as a result of undercharging or non-charging could be treated as a contribution in accordance with ATO Taxation Ruling 2010/1.
“When you start to put a value on things such as general fund expenses, you start to table the real impact. Then the reason for introducing the provisions in the first place has to be questioned.”
Tim Miller, Smarter SMSF
Labor’s latest move to amend the imputation credits system has reignited fervent discussion within the financial services industry. Todd Wills dives into the debate surrounding the proposal, examining the potential consequences and impacts as it makes its way through the Senate.
In the constantly evolving world of fiscal policy, it appears changes to the franking credit regime are back on the bargaining table. Within four months of assuming office, Assistant Treasurer and Financial Services Minister Stephen Jones announced the government had introduced draft legislation seeking to amend the Income Tax Assessment Act to potentially render dividends distributed under certain conditions, unfrankable.
The proposal has taken many by surprise as the Albanese government had given multiple assurances prior to the last federal election it wouldn’t be touching the system. However, the tax reform policy involving franking credits appears to have been resurrected, albeit in a less substantial form, from the proposal Labor put forward during the 2019 election campaign.
The Treasury Laws Amendment (2023 Measures No 1) Bill 2023, presently under review in the Senate, introduces two noteworthy measures that will reshape the utilisation of franking credits in the corporate realm. The first measure, Schedule 4, aims to align the tax treatment of off-market share buybacks by listed public companies with on-market share buybacks.
The second measure, Schedule 5, seeks to restrict the franking of certain distributions funded through capital raisings that fall outside a regular or typical dividend cycle. These proposed amendments hold the potential to redefine how franking credits are employed in the corporate landscape in Australia. Given the ALP’s turbulent relationship with franking credits, it’s only natural to question its decision to pursue this course. Jones has framed both measures as ‘minor’ adjustments aimed at enhancing the integrity and fairness of the imputation credits system. During the bill’s second reading in the House of Representatives, he argued off-market share buybacks essentially result in a budget subsidy that assists companies in acquiring their own shares at discounted prices. He contends such arrangements are effectively subsidised by Australian taxpayers.
Regarding Schedule 5, he argues its purpose is to prevent companies from raising capital without a genuine commercial purpose and using that capital to finance special franked dividends. He asserts such actions exploit a tax loophole, which the
amendment aims to address.
While both of these measures are new, it is worth noting the genesis of this proposal originated on the opposite side of the Australian political spectrum. The policy aims to address a specific integrity issue brought to light in ATO Taxpayer Alert (TA) 2015/2.
The ‘mischief’ alluded to in the alert concerned certain companies manipulating the franking credit system and using arrangements that may be in contravention of taxation anti-avoidance laws. The TA cited examples of large corporations who engaged in fully underwritten capital raisings and swiftly distributed the raised funds as
franked dividends to their shareholders.
However, back in 2015 this policy was never formally implemented.
Now the current proposal has faced significant resistance from various sectors within the financial services industry. The amendment is currently undergoing thorough examination by the Senate and was subsequently referred to the Economics Legislation Committee, which handed down its report in May.
While Schedule 4 received considerable community and industry support, and was recommended to be passed without amendments, the committee noted industry concerns have prompted the need for substantial revisions to address the provisions of Schedule 5.
The bulk of the criticism surrounding the new initiative revolves around the belief it transcends the original scope of TA 2015/2 in a number of key ways and ventures into territory beyond the specific issues it originally intended to solve. This is the view of SMSF Association chief executive Peter Burgess, who argues the proposals are overly broad and should be refined to specifically target instances of illegal corporate behaviour.
“The ATO was very clear in delivering a message to the marketplace as to the kind of behaviour it thought was unacceptable. We haven’t seen that type of behaviour since then and the taxpayer alert back in 2015 seems to have dealt with that behaviour,” Burgess says.
“The concern we have with these particular amendments is they go much further than the behaviour the taxpayer alert was intending to target and it’s also a concern many others in the industry have raised. These amendments will unintentionally capture many genuine practices that have nothing to do with tax avoidance and manipulating the franking credit system.”
In response to a question posed by Liberal Senator Andrew Bragg, Treasury conceded the point made by Burgess that “the ATO has not observed taxpayers engaging in this behaviour in any significant way” and suggested the majority of both public and private companies have been complying with the TA since its
Continued on next page
“These amendments will unintentionally capture many genuine practices that have nothing to do with tax avoidance and manipulating the franking credit system.”
Peter Burgess, SMSF Association
Continued from previous page
announcement.
Treasury further argued since the majority of companies were already in compliance with the existing rules, they would not be affected by the specific legislation under consideration.
Throughout the submissions to the Senate, the phrase unintended consequences emerged as a recurring theme, reflecting the industry’s apprehensions about the purported far-reaching effects anticipated from the proposal. From the retail mum and dad investor, to small and medium-sized companies, and the Australian economy itself, the proposal has been heeded as a game changer at multiple levels.
Wilson Asset Management chief financial officer Jesse Hamilton for instance warns restricting the ability of corporate entities to use franking credits may have much wider implications for the tax system.
“Schedule 5, in my opinion, is potentially more damaging than what could have been proposed in 2019. In 2019, you had an issue of inequity where different people at different stages in their life, and depending on where they had their super, were treated differently with Labor’s proposal. And I think the Australian public saw the inequity in that approach,” Hamilton notes.
“This piece of legislation is more worrying, because it has, in my opinion, wider impacts to the franking system. It’s targeting the source and going after companies and their ability to pay a franked dividend, which I see having longer-term structural problems for the Australian economy and Australian investors.
“If we start tinkering with the system, lots of unintended consequences start to fall out from that. Starting to put limitations on companies will mean that if they can’t pay franked dividends, then the whole incentive system changes. Companies are incentivised to pay tax in Australia and if companies can’t distribute that franking credit and the tax paid down to shareholders, I think it’s logical to assume that they might look to either minimise or defer that tax.”
Many of the concerns about the unintended
consequences of Schedule 5 arise from how it will be interpreted and applied in practice. Critics have lamented that Treasury appears to have overlooked those impacts when drafting key criteria contained within the bill.
In their Senate submission, Listed Investment Companies and Trusts Association (LICAT) chief executive Ian Irvine and chairman Angus Gluskie acknowledged the legitimate intention of the measure while expressing concerns about its lack of clarity in execution.
“The proposed legislation as drafted would appear to inadvertently catch many thousands of situations of legitimate company operation and could accordingly delay or significantly discourage the normal processes of capital raising, investment and economic growth within Australia. That is, the legislation does not sufficiently distinguish between acceptable activities and the mischief it properly seeks to address,” LICAT’s submission states.
As numerous commentators point out, this represents one of the core shortcomings of the current bill. The proposed provisions lack clarity in determining which dividends can be classified as frankable or unfrankable in relation to capital raising, creating significant ambiguity for the industry.
The inclusion of the ‘established practice’ test is one example. This provision stipulates dividends paid by a company to shareholders would be classified as unfrankable if they deviate from the company’s regular dividend distribution cycle.
Institute of Public Accountants technical policy general manager Tony Greco points out the potential hurdles the inclusion of Schedule 5 and the accompanying established practice test could impose on new, small to medium-sized and growing companies.
“The way the amendment was drafted covers too many ordinary transactions. Many companies that don’t have a normal dividend pattern could fall foul of these provisions. Start-up companies, for example, haven’t paid a dividend in the past and they don’t generally have a normal dividend history,” Greco acknowledges.
“There are also private companies, where as part of their succession planning they may want to bring in new shareholders, but they also want to reward the old shareholders.
And then you’ve also got listed entities who may use dividend reinvestment plans who could potentially get caught up in this as well.
“So you are going to penalise those sorts of entities that want to engage in a dividend and sometimes they have to raise capital to be in a position to reward their shareholders who took the risk to invest in these entities.”
Introducing another criterion, the ‘purpose and effect’ test requires a capital raising primarily serves the purpose of funding a distribution or a portion thereof.
Institute of Financial Professionals Australia (IFPA) senior tax specialist Frank Drenth expresses concerns about the problematic
Continued on next page
“Starting to put limitations on companies will mean that if they can’t pay franked dividends, then the whole incentive system changes.”
Jesse Hamilton, Wilson Asset Management
nature of the test’s details.
“It’s sort of a sudden-death rule. Even if a small part of a distribution is funded by capital raising, the whole of the distribution becomes unfranked, which is troubling. It’s a disproportionate penalty that’s being implemented because of some subjects of judgment that someone is making,” Drenth observes.
“The other problem with the legislation is the fact it’s self-executionary and doesn’t require the commissioner to make a finding, so we’ve got this self-assessment regime. The shareholder thinks it’s a franked dividend and they have to look at all the transactions throughout the company and determine whether the distribution is caught by this.
“How are you supposed to find out enough about the intentions of the company in making the distribution? That just can’t work in practice.”
Beyond the purported effects on companies and individual shareholders, Burgess reveals members of SMSFs are more likely to notice an impact as they often use franking credits as an income strategy and substantial source of revenue.
“Franking credits are very attractive to superannuation members and in particular self-managed superannuation fund members in the pension phase who are not paying any tax. It’s a very important source of income in retirement and it’s very effective for superannuation funds because they only pay a maximum tax rate of 15 per cent,” he explains.
“And if they’ve got members in the pension phase, they’re not paying any tax. So
the refund of franking credits enables funds to firstly reduce their tax if they were paying tax, and if they’re not paying any tax, to bolster the income retirement of members.”
To support this view he cited a University of Adelaide study performed in conjunction with the SMSF Association earlier this year that showed SMSF members in the pension phase exhibit a strong inclination towards investing heavily in Australian equities. He suggests SMSF members may need to re-evaluate their investment strategies if Schedule 5 is implemented as it currently stands if the benefit of receiving franking credits plays a part in their Australian equities bias.
“To the extent these SMSF members have investments in small to medium-sized private companies, they may need to begin to reassess what impact this amendment could potentially have on the income that the fund will receive, particularly for those funds that have members in the pension phase,” he advises.
“Funds may hold in their portfolio some small to medium-sized private companies, which don’t have a track record of paying regular dividends and are reinvesting to grow. These types of investments are going to potentially become riskier with the implementation of these amendments.
“So there may need to be some assessment made on what is the likely impact on the fund’s income and we believe that’s another unintended consequence. We don’t think these amendments should be discriminating against those types of companies.”
Some have questioned whether the measure is worth the potential pitfalls as Senate
forward estimates reveal the government is likely to generate $10 million a year from the initiative.
“It’s interesting the measure kind of goes under the radar because it’s only got a $10 million forward estimate per revenue generator. So it feels like it’s a non-issue. It doesn’t feel like much versus Schedule 4, which was put forward as part of the budget process in October last year at $550 million,” Hamilton reveals.
Drenth too questions the merit of implementing a measure that extends far beyond the intended resolution of the original issue and believes the risks outweigh the benefits.
“There’s nothing inherently bad about paying your dividends out and franking credits to shareholders. I would say you should be able manage your capital however you desire. You should be able to capital raise and you should be able to borrow,” he notes.
“There’s a feeling policymakers have had for the last 30 years where they recognise there’s a flow through from the companies to the individual shareholders, but they don’t want too much to flow through.
“So if that’s seen as a mischief, then that mischief is still there. I would argue it’s not a mischief at all. Is $10 million a year really worth upending the capital markets in this way? I wouldn’t think so.
“Schedule 5 should really be abandoned altogether. For $10 million a year, it doesn’t seem worth it to create all of this uncertainty.”
Currently the exact form of the measure remains uncertain and its fate in parliament is yet to be determined. No doubt the eyes of the financial services industry will be keenly observing this process, eager to see how the process plays out.
“The way the amendment was drafted covers too many ordinary transactions. Many companies that don’t have a normal dividend pattern could fall foul of these provisions.”
Tony Greco, Institute of Public Accountants
Natural language processing tools, like ChatGPT, have created global interest, not just in their capacity to disrupt a wide range of industries, but also in their investment potential.
In fact, we believe the recent acceleration of artificial intelligence (AI) applications has been behind the recovery in the Nasdaq to the extent that it is positively impacting earnings expectations for companies that operate as enablers of AI.
High-performance computing is one of our investing areas of interest. It’s an area that is being driven by increased advances in AI and one in which we are most heavily invested.
Through the first five months of 2023, the total return for the Nasdaq was over 30 per cent. That was its third biggest start to a calendar year since its inception in 1985. It has also outperformed all other major United States indices over that timeframe.
One of the main sub-sectors where we have observed AI driving potential earnings power is the semiconductor industry. The PHLX
Semiconductor Sector, which measures the performance of the 30 largest US companies involved in the semiconductor industry on the Nasdaq, was up by 38 per cent over the first five months of this year.
Companies in this index are the organisations that are going to effectively provide the computing power needed to process AI applications. Consumers might interact with a type of AI watching Netflix, or ordering food at a quick service restaurant, or driving a luxury vehicle, but we don’t know which of those AI applications is necessarily going to be better than any others. But what we do know is that for all those applications, the computing power behind the scenes requires the semiconductor companies. And that is why we focus on investing in these companies, which are the enablers of AI.
Over a period of 50 years the semiconductor market has gone through three broad eras, starting with mainframes, moving into the second with personal computers and the internet, and then the third, the mobility era of smartphones.
The semiconductor market has grown from a
Continued on next page
The development of artificial intelligence is not only significantly changing our lives, but also the investment landscape. Kieran Moore notes the companies offering the most attractive opportunities in this new world we are facing.
Continued from previous page
nascent industry in the 1970s to one worth close to US$500 billion in value today.
We believe there is a significant structural tailwind behind the semiconductor industry and it is about to move into its fourth, or AI, era, which will double the size of the semiconductor market again, taking it from a US$500 billion industry to a US$1 trillion industry (see Chart 1). What’s so exciting about this is that it’s not going to happen over the next 50 years, but over the next 10. Over the next decade, AI is going to massively accelerate the demand for semiconductors globally.
There are a number of layers to the industries and sectors that will be supporting this fourth era as outlined in the pyramid diagram.
There are those providing the tools. ASML is a good example. It is a
company that designs and manufactures essential tools, such as the lithography machine used in chip manufacturing. It is listed in the Netherlands. Then there are the companies that produce the semiconductors. We call these the foundries and they include Taiwan Semiconductor Manufacturing Company (TSMC), Samsung and Intel.
In fact, TSMC is a good example of a foundry company. It is based in Taiwan, which is a critical part of the global technology supply chain.
It obviously has some geopolitical risk given the relationship between the US and China, however, it is building a manufacturing plant in Arizona, which is due to go online next year. That should reduce some of the geopolitical risk associated with manufacturing semiconductors in Taiwan by diversifying its manufacturing footprint.
The foundries use the tools to build the semiconductors, which are designed by
companies like Nvidia and AMD and then sold to the big data centre players like Microsoft, Amazon and Meta (Facebook).
There have been major players in each of the different eras of semiconductor development. In the personal computer era, companies like Intel were the dominant players. For the mobility era there was Apple and Qualcomm, which is a semiconductor company supplying chips used in smartphones. When we look forward to the potential hero company of the fourth era, or the AI era, we think Nvidia is in the box seat to become the champion. Its recent performance has been strong and we believe it has contributed to the Nasdaq’s overall performance in recent months.
Nvidia was co-founded in 1993 by chief executive Jensen Huang. It invented the graphic processing unit (GPU) in 1999,
Continued on next page
which allows for parallel processing and accelerated computing.
In the past, computers would process tasks in a linear, sequential and straightforward manner. A company like Intel, for example, would deploy a central processing unit (CPU) into a computer to process a task. If somebody wanted a piece of information, they would send a request to a computer and it would process that in a fairly straightforward linear way.
However, linear processing isn’t sufficient to be able to deliver the computing power needed for AI applications. For companies like McDonald’s, Netflix or Mercedes to deploy a version of AI to their customers, or adopt it within their business practices, computers need to be able to use parallel processing.
Computers effectively need to find a way of operating at a different level. Parallel processing involves taking a traditional CPU application and combining it with a GPU to enable computers to process far more complex tasks simultaneously and in real time. Via this combination of CPUs and GPUs, the way humans and computers interact to process information and solve problems is transformed.
The increasing number of AI applications created by companies is going to necessitate an increasing number of data centres to host those applications and also to effectively retrofit existing data centres with the ability to use parallel processing or accelerated computing. It is in the data centre where these AI applications will be processed and so they need to be AI ready, meaning they will require parallel processing chips, that is, GPU and CPU together.
In a recent earnings call, Huang estimated around US$1 trillion has been spent on data centres over the past four or five years. However, most of these data centres haven’t yet adopted this parallel processing ability, with our estimates suggesting just 14 per cent of these data centres currently use it.
So those data centres, which have recently been developed with that US$1 trillion spend, now need to adopt this accelerated computing technology. We expect that to get to about 45 per cent of data centres by 2030, which is a huge opportunity for Nvidia. Huang has said it is already seeing large global orders for its chips to effectively retool existing data centres.
While it does have some competition, Nvidia is streets ahead of its closest competitor, AMD, in terms of its ability
to take meaningful market share. We believe the market share for Nvidia in the accelerated computing market is in the 70 per cent to 80 per cent range.
The chips designed by Nvidia are some of the fastest on the planet and it has also combined these chips with a software stack to be able to offer a complete solution for data centres. The Nvidia solution is effectively a one-stop shop to facilitate optimal computing power for data centres. Importantly, it can also do it at a lower total cost of ownership compared to its peers.
We are definitely bullish on Nvidia and can see a world where it gets to almost $30 a share in earnings by 2030. That would be almost a tenfold increase from the $3.30 it reported for the 2023 fiscal year. Note it’s not just the existing data centres that need to be retooled, but any new data centres being built will also need to encompass the ability to perform accelerated computing.
AI will massively transform the way humans and computers interact and process information. It will change the way we, as consumers, ultimately live our lives. But what is equally important in this new era of AI is computing infrastructure behind the scenes to facilitate this growth and advancement in AI.
We believe there is a significant structural tailwind behind the semiconductor industry and it is about to move into its fourth, or AI, era, which will double the size of the semiconductor market again.
Investing in managed funds tracking one index is fairly straightforward, but assessing an offering covering a diverse number of indices is a lot more complex. Stephen Flegg outlines 10 factors that can help individuals select an appropriate diversified index fund for their circumstances.
In recent years, the growing popularity of index investing has gained momentum and index funds have experienced an exceptional increase in assets under management. This growth has pushed down fees for investors, while also commodifying single asset class index-tracking strategies.
In contrast, differences among diversified passive funds have been proliferating due to the growing number of them being offered to investors and the absence of any industry standards around how they should be managed.
When individuals invest passively in a single asset class, there are typically a small number of commonly accepted indices from which to choose – for example, the S&P/ASX 300 Index for Australian shares. These indices operate under a transparent set of rules, known as an index methodology, which investment managers can closely track. Single asset class index portfolios have therefore become highly standardised, with competition largely revolving around fees.
Diversified index funds show few signs of
Continued on next page
Continued from previous page
standardisation because there are no accepted standards or rules governing things such as:
• the asset classes diversified portfolios should invest in,
• the size of allocations to each asset class,
• the specific indices that should be selected for each asset class,
• how foreign exchange exposures should be managed,
• risk profile definitions, that is, what one manager considers a balanced fund, another may classify as a growth fund,
• growth/defensive classification of asset classes, and
• how environmental, social and governance (ESG) issues should be addressed.
To help navigate this complexity, here are 10 important things to consider when choosing a diversified index fund.
Unlike single asset class passive funds, which have the sole objective of tracking a specified benchmark as closely as possible, investment objectives across diversified index funds can vary greatly. They may cater for a certain type of investor or express a distinct investment philosophy.
These objectives play a pivotal role in guiding the portfolio construction of diversified portfolios and are a key underlying cause of portfolio and performance differences.
Not all diversified index funds invest in the same asset classes and the inclusion or exclusion of certain asset classes varies significantly. This variability is greatest in infrastructure, property, emerging market equities, small company equities, cash and high-yield credit asset classes. The asset classes held by portfolios is often influenced by the scale of the fund, how cost effectively they can access certain asset classes and what other products the fund manager offers to investors.
As Nobel laureate Harry Markowitz famously said, diversification is “the only free lunch in investing”. It enhances riskadjusted returns by reducing risk without compromising performance. However, being well diversified goes beyond just asset classes and can be further maximised using characteristics such as security, geography, industry and currency wherever appropriate.
Variation in asset allocation between diversified index funds is the most significant contributor to performance differentials. Investors must therefore carefully evaluate whether a fund is appropriately diversified and offers robust portfolio construction. Investors must also determine the level of growth asset exposure suitable for their financial circumstances. There’s currently no widely accepted standard for defining risk profiles or how to classify growth and defensive assets. Investors should be mindful of these details when considering a fund and avoid drawing too many conclusions merely from a fund’s label or marketing.
After share market movements, currency exposures typically represent the second largest source of absolute risk in a diversified index fund. So currency hedging practices, which vary widely between managers, can drive performance differences. Individuals
must be confident any fund in which they invest includes a well-considered currency hedging policy that aligns with their investment objectives, manages risks appropriately and achieves low transaction costs.
Selecting the appropriate underlying index for each asset class to track can be complex. While the largest traditional asset classes, such as Australian and global shares and fixed income, have common underlying indices, there’s much more choice across asset classes like property and infrastructure. Investors should ask the following questions when choosing a fund:
• Is the index broadly diversified and able to provide a comprehensive representation of the asset class?
• Is the index commonly used by other investors and stakeholders, such as regulators? Being accepted by more stakeholders is often a sign of an index’s quality.
• Are there actively traded futures contracts for the index? This is important to facilitate efficient trading and rebalancing.
• Can the index be effectively tracked without compromising on liquidity? This requires evaluation of the liquidity profile of the underlying securities.
• Do the rules governing the index promote the long-term interests of investors?
• Are the index provider’s fees and costs fair and competitive?
Efficient rebalancing is crucial for diversified portfolios to maintain their asset class targets and meet investment objectives. Poorly executed rebalancing can lead to unintended tracking error and high transaction costs, which can negatively impact investor returns. Effective rebalancing demands a specialist team, a clear implementation strategy and
Continued on next page
It is critical investors understand deviations in performance can occur and to be aware of the underlying causes.
access to a range of instruments such as futures, forwards and swaps. The ability to directly cross trade with other investors can further enhance rebalancing efficiency and reduce costs.
Diversified index funds invest in trust vehicles, direct holdings of physical securities and derivatives such as futures and swaps. The choice of underlying structures and asset type is important as it can meaningfully affect transaction costs, tax impacts and risk management outcomes.
8.ESG
ESG issues matter to active and passive investors alike. The degree to which funds incorporate ESG considerations into their investment decisions and risk management practices can vary significantly. Some funds may screen out certain types of securities or engage with companies to improve their performance on ESG matters. Investors should carefully consider a fund’s ESG policies and approach before investing to ensure alignment with their own values, beliefs and priorities.
Diversified index funds vary significantly in the size of their assets under management, from just a few million dollars to tens of billions of dollars. Larger funds generally boast advantages such as greater cost efficiencies, specialised resources, access to more sophisticated systems and efficient bespoke internal structures, that is, dedicated mandates. For example, the North Index funds have a total portfolio size in excess of $14 billion. This allows for a highly cost-efficient operation and provides the funds access to dedicated resources including ESG specialists, risk analysts, trading teams, tax experts and
dedicated asset class portfolio managers. Their size also means the funds can access a diverse set of asset classes and have dedicated mandates in each.
As the passive investing industry has grown to trillions of dollars under management, it has evolved considerably. The methodology for tracking asset class indices has become increasingly sophisticated and various index replication methods have emerged, including physical replication, synthetic replication and hybrid approaches. While these different approaches usually yield similar results, there are certain situations where investment outcomes can vary measurably. Put another way, while the returns might look the same the risks can be very different.
The North Index funds primarily employ a physical replication approach. This offers benefits such as access to franking credits for Australian shares and lower counterparty risk. However, the portfolios do replicate some small exposures synthetically via futures, typically for rebalancing purposes. This hybrid approach reduces transaction costs while maintaining the benefits of
physical replication.
Not all diversified index funds are created equal. Investors should make sure the diversified fund is aligned to their needs and suitable for their circumstances. Equally important is selecting a manager with the expertise, experience and resources to successfully navigate these issues.
Efficient rebalancing is crucial for diversified portfolios to maintain their asset class targets and meet investment objectives. Poorly executed rebalancing can lead to unintended tracking error and high transaction costs, which can negatively impact investor returns.
AS part of SMSF Professionals Day 2023 –Strategies for Success, Mark Ellem spoke exclusively to ATO SMSF trustee risk and strategy director Kellie Grant about the compliance areas the regulator is targeting and those still causing concern. The following is an extract from this discussion.
Mark Ellem (ME): What are the ATO’s concerns when it comes to super strategies and what raises your interest in respect of super strategies?
Kellie Grant (KG): We have a particular focus on
reviewing strategies or arrangements that result in an inappropriate channelling of income into an SMSF to take advantage of the concessionally taxed environment. These schemes often involve the application of the non-arm’s-length income (NALI) tax provisions and sometimes Part IVA antiavoidance provisions.
These strategies typically involve group structures and related-party dealings.
An example of where these arrangements
Continued on next page
sometimes play out is in the property development space. While an SMSF is not prohibited from investing directly or indirectly in property development, these ventures can involve complex arrangements that can lead to inadvertent breaches of the super laws and serious contraventions.
We strongly recommend trustees read our SMSF Regulator’s Bulletin (SMSFRB) 2020/1, our recently released Taxpayer Alert (TA) 2023/2 and seek independent professional advice before commencing a property development venture or apply to the ATO for advice.
ME: What other types of strategies concern you?
KG: Our Super Scheme Smart web content, soon to be rebranded as Schemes Targeting SMSFs, also outlines some other types of actions we are concerned about. These involve:
Life interest schemes: These involve an SMSF member or other related entity granting legal life interest over commercial property to their fund in order to divert rental income, enabling it to be taxed at a lower rate without full ownership of the property ever transferring to the fund.
Dividend-stripping schemes: The activity here involves stripping profits from a company in a tax-free form by using an SMSF in pension phase. The SMSF will acquire the shares in a related private company usually at less than market value. The company often has significant previously taxed accumulated profits which then get distributed to the fund as franked dividends, the credits for which are then fully refunded to the fund. Personal services income streams: This is where an individual, with an SMSF often in pension phase, diverts income earned from personal services to the SMSF so it is concessionally taxed or treated as exempt from tax. The individual usually does this by having the client they perform services for remit the consideration to a third-party company or trust that then distributes this income to the fund purportedly as an
investment return to the fund in that entity. Sometimes the return of income to the SMSF occurs via a chain of entities. The arrangement and our concerns are outlined in TA 2016/6.
Section 66 schemes: These are schemes set up to avoid the related-party rules regarding asset acquisitions. We are concerned when we come across arrangements involving a number of parties who have entered into agreements which effectively enable their respective SMSFs to indirectly acquire assets like unlisted shares in private companies the parties in question control.
Limited resource borrowing arrangements (LRBA): We are also worried about LRBAs and intra-group lending arrangements that are not on arm’slength terms because they do not meet the requirements of commercially similar products. Often the interest charged is too low and the repayments on the loan aren’t regular or are on generous repayment terms. These inflate SMSF balances and result in significant profits flowing to the fund. Advisers should read our taxation determination and practical compliance guide on safe harbour LRBA terms for SMSFs to help their clients avoid any NALI consequences.
Note: The ATO’s new web content called Schemes Targeting SMSFs has gone live. You can access it via ato.gov.au and search using quick code QC 49657.
ME: Is the ATO still concerned about reserves being used as a strategy to avoid caps?
KG: Yes, we are still concerned about reserves being used to circumvent caps like the total super balance and transfer balance cap measures introduced back on 1 July 2017.
Following the introduction of those elements, we published our SMSF Regulator’s Bulletin SMSFRB 2018/1
– The use of reserves by self-managed superannuation funds, which provides our view on when we would expect an SMSF to have a reserve.
The material makes it clear there are very limited circumstances under which we would expect a SMSF to hold a reserve and they must be used for a specific legitimate purpose. Basically, the only situation where we would expect an SMSF to have a reserve is when it is paying a member one of the legacy pensions.
We have been monitoring the use of reserves by SMSFs since the 2017 measures came into effect and we’ve noticed a
Continued on next page
“We are now seeing more voluntary disclosures in relation to SMSFs losing crypto assets through scams, theft or fraudsters hacking into their accounts.” Kellie Grant, ATO
Continued from previous page
decrease in their numbers over the last five years, which is expected as some of the funds paying defined benefit pensions have now wound up.
We continue to monitor the use of reserves with particular focus on any SMSFs reporting a new reserve and the limited use for them. We will closely scrutinise such arrangements and consider the potential application of the sole purpose test under section 62 of the Superannuation Industry (Supervision) (SIS) Act and Part IVA of the Income Tax Assessment Act 1936 (ITAA).
ME: What’s the ATO’s view on a withdrawal and recontribution strategy where the is to move a taxable component to a tax-free component for the member or move benefits from one member of a couple to the other member of the couple to equalise balances and ultimately maximise the fund’s claim for exempt current pension income?
KG: Ultimately, we would need to consider the facts of each case to determine whether there are any issues, such as contravening any tax or super laws, or triggering the antiavoidance provisions of Part IVA.
A key consideration is whether there has been a legitimate payment of a super benefit and subsequent contribution. Reliance on journal entries or other strategies that attempt to change the components of a super interest without actually making any transactions will not be effective and may attract the operation of ITAA Part IVA.
Other factors that may be considered when looking at whether a particular arrangement attracts the Part IVA provisions may include the purpose and circumstances of the recontribution, whether it forms part of an overall retirement income plan, the type and number of amounts withdrawn and recontributed, the resulting tax position and benefit gained by employing the strategy.
Clients can always request a private ruling if they want formal advice on the tax consequences, including the application of Part IVA, to a particular arrangement. They can also request SMSF-specific advice on the application of the super laws.
Trustees should also seek professional advice when considering whether a particular strategy complies with the super and tax laws.
ME: Does the ATO have an update on the issue of SMSFs with a single-asset investment strategy?
KG: Just before I answer this question, I might just remind everyone of the background to this one. So, in August 2019 we sent letters to around 17,000 trustees who we believed were at risk of failing to meet the diversification requirements when formulating and reviewing their investment strategy. This is because 98 per cent of these trustees had a concentration risk in their fund having invested solely in property using an LRBA.
The purpose of the letter was to
remind the trustees of these SMSFs that in formulating their investment strategy, they must comply with the requirements of SIS regulation 4.09. This requires them to have considered diversification and the risks associated from a lack of diversification. The letter was sent to trustees to raise their awareness of their legal obligations and to update their investment strategy if necessary. At around the same time we also updated the content on our website to provide more guidance on what factors the trustee should consider when formulating and reviewing their investment strategy.
To this end, we confirmed that while an SMSF trustee has the ability to choose to invest all of their retirement savings in one asset or asset class such as property, they should be aware this will be bring increased risks such as risks of return, market volatility and liquidity, and that these can be minimised if they diversify by investing in a variety of assets.
They would also need to document in their investment strategy that they had considered the risks associated with a lack of diversification and how a singleasset investment would meet the fund’s investment objectives given the likely return on the investment and the fund’s cash-flow requirements. The trustee’s auditor will then be able to verify compliance with the provision.
Since we sent the letters, we have seen a
Continued on next page
“While an SMSF is not prohibited from investing directly or indirectly in property development, these ventures can involve complex arrangements that can lead to inadvertent breaches of the super laws and serious contraventions.”
Kellie Grant, ATO
Continued from previous page decrease in the number of regulation 4.09 contraventions that have been reported to us via auditor contravention reports (ACR). So, this would indicate auditors are seeing more compliant investment strategies. I have also received feedback from auditors that trustees are now putting more thought into their investment strategies and hopefully more thought into whether their investments are meeting their retirement objectives.
ME: Do you see many funds invest solely in crypto assets?
KG: No, our annual stats for the year ended 30 June 2021 show that only 1.3 per cent of the overall population of SMSFs for that income year held crypto assets, with the average holding being around $65,000. However, although only a small percentage of funds held crypto during the 2021 income year, this was a 122 per cent increase from the 2020 income year where 0.6 per cent of funds held crypto assets, with the average investment being $33,000.
So, while investments in crypto assets by SMSFs are increasing, those funds that hold these assets still form a small percentage of the overall sector population.
However, we are beginning to see some concerning trends in crypto investments through ACRs and voluntary disclosure reporting.
In the 2021/22 financial year the types of voluntary disclosures we received involved separation of fund asset contraventions, where wallets were not in the fund’s name, and market valuation issues. Along with section 62 breaches of the SIS Act, these were also the most commonly reported breaches identified in ACRs.
However, in the 2022/23 income year to date, we are now seeing more voluntary disclosures in relation to SMSFs losing crypto assets through scams, theft or fraudsters hacking into their accounts. Further, we are seeing loss of crypto assets
via collapsed platforms, lost passwords and therefore accounts become locked.
Approximately 70 per cent of the voluntary disclosures are being received for funds for which the youngest fund member is in the 30 to 49 age category.
So, we stress trustees need to be mindful of these risks when considering making investments in crypto assets and should seek professional advice before doing so.
ME: Is there anything else you would like to update us on?
KG: Yes there is. I’d also like to use the opportunity to mention we recently updated our SMSF rollovers web content following consultation with industry stakeholders. The aim of the updates was to provide more detail around how a trustee needs to prepare themselves for making a rollover via superstream.
I should point out the rollover relief we commenced in March last year also ends on 30 June. This means trustees can no longer call the ATO to ask for an extension where they are experiencing difficulties in finding a SMSF messaging provider that
provides rollover services for SMSF to SMSF and SMSF to Australian Prudential Regulation Authority fund transactions. They will now be required to use SuperStream or their auditor will need to report a SIS regulation 6.17 contravention in the ACR where appropriate. The auditor should provide reasons as to why the trustee could not comply with the SuperStream requirements in the free text as we will still take into account reasons provided when determining the application of any penalties.
I also want to finally mention later this year we will release our third and final life-cycle publication on running a SMSF. We have received positive feedback from industry on the usefulness of these publications for both SMSF professionals and their clients and recommend you provide all new and existing trustees with these publications.
The full interview has been made available to attendees of SMSF Professionals Day 2023 and can be accessed via the on-demand option for the event.
Superannuation contribution strategies have become complicated from the outset of deciding to contribute, qualifying for a particular contribution and whether it is possible to claim a tax concession from the amount allocated to the fund. Whether a contribution can be made at all may be ringfenced by the client’s total super balance (TSB), the member’s age and who made the contribution.
The general rules about contributions are governed by five overriding principles:
• the amount the person has in super as determined by their TSB,
• the amount that will be made as a contribution,
• qualifying factors for making the contribution,
• the timing and order in which contributions are made to super, and
• whether the contributor is going to claim a tax
deduction.
Strategies to maximise the contribution and any tax concession involved can be complex and interwoven. Making one type of contribution now may limit the ability to make other types of contributions in future. Also, depending on how the contribution is made, for example, via cash or an in-specie transfer of personal assets, may impact on the individual’s tax outcomes external to the superannuation fund.
Contributing to a super fund can be tricky in the first place and Taxation Ruling 2010/1 is the ATO’s opinion on when a contribution has actually been made. With contributions made in cash or by
Continued on next page
Timing is often the key factor in determining the success of contribution strategies and the tax advantages they can yield for SMSF members, writes Graeme Colley.
electronic funds transfer or cheque, they are acknowledged as to having been made when they are received by the super fund. In the particular case of a cheque, the contribution is recognised upon receipt but the cheque must be cashed as soon as possible after the event.
In contrast, contributions made in specie carry with them unique features based on the transfer of ownership of the asset to the fund and the specific asset’s market value at the time the transfer takes place. Timing is important here as the fund is considered to have received the contribution when the parties to the arrangement have a legally signed agreement, in the case of shares, or on settlement of the sale/purchase when real estate is involved. If contributions are made towards the end of a financial year, the fund may not actually receive the contribution until the new financial year. The key here is to ensure the transaction has been completed prior to 30 June.
The downsizer contribution from the sale of a person’s main residence owned for at least 10 years has become a very popular concession. It is very useful for anyone with relatively large amounts in super who is prevented by their TSB from making nonconcessional contributions to the fund.
Under the downsizer concession up to $300,000 for each member of a couple can be contributed to super within 90 days of the property settlement. It is available on a once-only basis without a maximum age limit or any of the limits imposed by the TSB, which is $1.9 million for the 2024 financial year. The minimum qualifying age for downsizer was reduced from age 60 to age 55 from 1 January 2023, which is another positive sign about the potential longevity about the concession.
From a strategy point of view the reduction in the minimum age needs to be considered in conjunction with other contribution strategies. A person or
members of a couple who qualify for the downsizer contribution when they are 55 may find they may be better off to make non-concessional contributions to super in place of downsizer contributions.
The decision to make the downsizer contribution will depend on the individual’s circumstances and their intention to purchase another main residence which will be owned for at least 10 years. In that situation it may be better to claim the downsizer when the other main residence is purchased so that in the interim the client is able to make concessional and nonconcessional contributions to super. If the downsizer contribution is made too early it is added to the person’s TSB and may restrict other types of contributions being made nearer to retirement.
Another strategy with downsizer contributions is created by the 90-day period after settlement of the sale of the main residence. A client who sells their main residence within 90 days of the end of the financial year, say after 1 April, may find it beneficial to make the downsizer contribution early in the new financial year. This may be worthwhile for someone close to one of the various TSB thresholds to maximise their catch-up concessional contributions or bring-forward nonconcessional contributions.
The timing of when an individual uses the downsizer contribution may also depend on legislative risk associated with the downsizer and whether it will be impacted by any future changes to superannuation policy. If the adviser or client feels nervous about the longevity of the downsizer concession, then it may be better to take the opportunity now if their TSB is over the current threshold. On current indications, due to the popularity of the downsizer contribution it would seem to have an enduring quality from a retirement policy perspective.
The recontribution strategy is a longstanding and well-worn one that
continues to be valuable if a member’s death benefit will be paid to surviving adult children.
The aim of the recontribution strategy is to convert a taxable component of a person’s pension or accumulation benefit into a tax-free component. This is done by withdrawing a lump sum and recontributing it back to the fund as a non-concessional contribution. It adds to or creates a tax-free component to the member’s accumulation-phase benefit.
There are a number of versions of the recontribution strategy and which is applicable depends on whether the member has an accumulation-phase amount and a pension or pensions which have various taxable and tax-free components. Successful execution of the strategy relies on the member meeting a condition of release, usually retirement for superannuation purposes attaining age 65, allowing their benefit to be withdrawn from the fund.
The recontribution strategy can also be used in conjunction with a transitionto-retirement income stream (TRIS). In that situation the member recontributes the Continued on next page
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.
Continued from previous page
amount withdrawn via the TRIS as a nonconcessional contribution.
The recontribution strategy has become part of client conversations this year with the possible introduction of the $3 million cap and the extra 15 per cent tax, which includes unrealised capital gains. Whether the proposal will make it into the law is still debatable. However, in an attempt to counter the impact of the extra tax, the recontribution strategy can provide some advantages where one member of a couple is in excess of their TSB and the other member is well below their TSB. This involves withdrawing up to $330,000 from the member who is in excess of their TSB and gifting it to the other member for them to make a non-concessional contribution, which would potentially allow access to the bring-forward rule. In some cases it may also be possible to use the catch-up concessional contributions if they have a TSB of up to $500,000.
In some circumstances you may wonder whether it is beneficial to use a recontribution strategy. For example, it may be just as easy for a pensioner with a considerable amount in superannuation to draw a lump sum or series of lump sums tax-free over time and gift them to the adult children. That way, the children would receive a tax-free gift from the parent without any worries about its taxable and tax- free components. However, maybe retaining the benefit in super and using the recontribution strategy has to do with the parent or parents’ control over the superannuation money and the fear of it running out prior to their death.
Contribution reserving strategies are useful for concessional contributions in a financial year where a client may have a significant amount of income, for example, from a taxable capital gains tax (CGT) event, large business income or a taxable employment termination payment. SMSFs are the better vehicle for use of a reserving strategy as it is available to all of these types of funds
providing there are no limitations imposed by the fund’s trust deed. There are a very limited number of Australian Prudential Regulation Authority-regulated funds that provide access to the strategy.
The reserving strategy involves the use Superannuation Industry (Supervision) (SIS) regulation 7.08, which allows a fund to allocate contributions received in respect of a member during a certain month to be allocated within 28 days after the end of that month or such longer period as is reasonable. In practice, the reserving strategy works only for contributions made in June of a financial year and allocated to the member’s account by 28 July of the next financial year. To be successful, the strategy requires use of a contribution holding account, which should be authorised by the fund’s trust deed and allocating the amount to the member’s accumulation account later.
As a general rule, the contribution reserving strategy allows a member to make a personal contribution in excess of the concessional contributions cap in a financial year and claim a tax deduction for the amount contributed. The amount within the member’s concessional contribution cap is allocated to their accumulation account and any excess is allocated to a contribution holding account. The amount allocated to the
holding account is then credited to the member’s accumulation account in the next financial year by 28 July and counted against their concessional contributions cap in that financial year.
While this strategy is mainly used for concessional contributions, SIS regulation 7.08 dictates it can apply to non-concessional contributions as well. In most cases all personal contributions made in June would technically be received by the fund as non-concessional contributions until the member has lodged a section 290-170 notice of intent under the Income Tax Assessment Act to claim a personal tax deduction, which is required to be acknowledged.
The contribution reserving strategy can be extremely useful for members who have a TSB of no more than $500,000 and may be able to make catch-up concessional contributions in combination with the reserving strategy.
The abolition of the work test for personal non-concessional contributions between ages 67 and 75 has also opened up the ability of individuals who qualify to transfer cash and assets as in-specie contributions to super. The work test still applies for personal contributions claimed as a tax deduction made by individuals aged between 67 and 75. In many cases it has allowed members to top up their balances in the fund and at the same time commence pensions which fully use the member’s transfer balance cap.
This article has covered just some of the potential strategies available to anyone contributing to superannuation. Other strategies can include the timing of the small business CGT concessions, death benefit strategies and even qualifying for the government’s co-contribution. When used in combination they can maximise the amount a person is able to contribute to superannuation and optimise the use of the available tax concessions.
The recontribution strategy is a longstanding and wellworn one that continues to be valuable if a member’s death benefit will be paid to surviving adult children.
Buy tickets
Get ready to gear up for the 2022-23 tax season with Accurium’s SMSF Compliance Day. This event is designed to equip you with the knowledge and skills necessary to efficiently and effectively assist your clients during this tax season. Discover the latest updates, understand current risks, and explore considerations for audit preparation. With a practitioner-oriented approach, our Head of Education Mark Ellem has curated a comprehensive agenda that includes opportunities for interactive Q&A, and real-life case studies to address your compliance queries.
Can’t attend in person? Register for our online event
Find out more
6 CPD hours
The proposed new tax on total super balances above $3 million has been met with significant SMSF community trepidation. Peter Burgess details some of the alarming aspects of the measure already identified and why the government must consider changing its position on the matter.
It was the Spanish-born American philosopher George Santayana who famously said: “Those who cannot learn from history are doomed to repeat it.” In 1996, a 15 per cent surcharge levy on superannuation contributions when earnings exceeded $85,000 a year was implemented. It was abolished less than a decade later, the consensus being that it cost more to build and run than it had raised in revenue.
Nearly three decades later, a fresh superannuation tax is on the drawing board, this time a proposal to introduce a $3 million cap on super balances above which earnings will be taxed at a higher rate. Although this proposal will not be introduced until 2025, assuming it becomes law, it is sending palpable waves of consternation through the SMSF community.
At first glance, this might seem an overreaction. After all, it’s more than two years and a federal election away and, according to Treasury’s estimates, will only affect 80,000. But dig a little deeper, as the SMSF Association has done, and the likelihood of the law of unintended consequences being triggered becomes increasingly apparent.
It’s not just any unintended consequences. This proposal is ill-advised on many levels.
For starters, think complexity. Another cap will further complicate a system that already has contribution caps and caps on the amount that can be transferred to the pension phase. This amounts to cap upon cap.
Numerous inquiries into superannuation, the
Continued on next page
Continued from previous page
Retirement Income Review was the latest, have called for its simplification; yet it seems every government initiative adds more complexity. And the cost of change and complexity is high as it undermines confidence in super. Every time the goal posts are moved, fund members ponder what next. Our feedback to this change is that people are feeling increasingly vulnerable, and not just those immediately affected.
The proposed cap is often mentioned in the same breath as significantly large superannuation balances. This is misleading. Large super balances are a legacy issue, a product of historical policy settings by successive governments. The current policy framework strictly limits amounts that can be contributed into super. Consequently, the days of individuals accumulating significant wealth in super are over.
The transfer balance cap operates to strictly limit the amount of capital that can be used to start a retirement income stream or pension. The associated tax concessions on retirement pensions are therefore tightly constrained. And, with the introduction of the fair and sustainable superannuation reforms, member benefits relating to a deceased member must be compulsorily paid out of the retirement savings system. So, over time, these large balances will be expelled from the super system.
The decision not to index the $3 million cap simply compounds the uncertainty. For those entering the workforce today it’s estimated about 500,000 super balances will breach the cap, of which about onethird are now under age 30. So, today’s 80,000 is set to grow exponentially. Remember, too, that a $3 million cap will be worth about $1 million in 30 years. It will inevitably lead to confusion and uncertainty about future retirement planning strategies, with increasing numbers turning to other tax-favoured structures that may be subject to lower levels of regulatory oversight.
The proposed model actively promotes simplicity over equity – a dangerous and concerning precedent. Positioning in this manner is counter to both vertical and horizontal equity taxation principles. And, when the various distortions that will arise and the exceptions that will need to be addressed are factored in, the outcome is far from simple or equitable.
For example, to ensure the proposed calculation of earnings does not overstate the amount of earnings that will be subject to this new tax, numerous adjustments will need to be made to the definition of ‘contributions’ and ‘withdrawals’, and various amounts will need to be excluded from an individual’s total super balance (TSB).
The adjustments that have been identified so far include:
• limited recourse borrowing arrangements (LRBA) – certain amounts included in a member’s TSB will need to be excluded for the purposes of the proposed model,
• disability benefits – insurance proceeds will need to be excluded from the calculation of a member’s TSB,
• death benefits – a deceased member’s interest will need to be excluded,
• excess contribution withdrawals,
Division 293 assessments, contribution splitting amounts and family law settlements will need to be excluded from the definition of a ‘withdrawal’, and
• small business capital gains tax concessions and applicable fund earnings associated with an overseas transfer will need to be included in the definition of a ‘contribution’ for the purposes of the proposed model.
What is also disconcerting about this proposal is how it is designed. Put bluntly, it’s a measure that appears to have been designed to benefit large Australian Prudential Regulation Authority (APRA)regulated funds, with about 75 per cent, or 60,000, of the initial 80,000 affected being SMSF members. The lack of equity and resulting unintended consequences arising from the proposal are driven by a desire to placate the large APRA funds.
For example, SMSF members with balances exceeding $3 million should not be required to pay tax on unrealised gains simply because some APRA funds may find it difficult to report the taxable income attributed to fund members. This is a clear case of the tail wagging the dog. Given the significance of the impact on members of SMSFs, and the distortions already arising, any model must be considered in an SMSF context.
Yet the government’s “Better Targeted Superannuation Concessions” consultation paper dismisses the option of calculating this new tax on actual earnings. We believe this issue, in the interests of fairness, can and should be resolved. To this end, our submission in response to the consultation paper proposes an alternative way of calculating earnings based on a member’s actual taxable earnings. Our submission recognises that, in situations where this information is not available or the fund chooses not to report this information, a default notional earning rate would apply. In our view this is the simplest and most equitable way of introducing the proposed $3 million threshold. Importantly, our alternative
The proposed model actively promotes simplicity over equity – a dangerous and concerning precedent. Positioning in this manner is counter to both vertical and horizontal equity taxation principles.
Continued from previous page
approach would avoid tax being imposed on unrealised gains.
The impact of taxing unrealised gains should not be underestimated. In our opinion, it has the potential to be the most lethal of the unintended consequences. Under the proposed model, SMSFs with farming or business premises within the fund may encounter significant liquidity pressures.
In this regard, farming is the standout as it is a cyclical industry where bumper seasons are followed by lean years when flooding, bushfires, plagues and drought can exact a heavy toll. It is not just Mother Nature. Global commodity prices and the Australian dollar play a major role in determining farming income.
What this means is a farmer may receive no income in a financial year but still face a higher tax bill due to an increase in the value of their farm. Changes in property values do not automatically correlate to increases in either leasing or farm income. Put simply, the market forces driving rural property prices differ to those driving yield or income. Broadly, yield is driven by
the use, size, quality and location of the property asset. Income is determined by commodity prices and the dollar.
Property values can be influenced by increased buying activity (larger operators seeking scale), land treatment, such as soil enrichment for crop or pasture, improved or additional water assets, such as upgrades to irrigation, dams and tanks, new fencing, or land remediation to address salinity, wind, soil and water erosion.
So, there is a real disconnect between income generated and the value of the property. In difficult years where little or no income is derived, this can have an impact on their ability to pay wages and superannuation contributions for themselves. Reduced contributions, or the cessation of contributions, will therefore impact the fund’s liquidity which could be further exacerbated by additional future tax liabilities levied upon the fund’s increase in the paper value of the underlying property.
If trustees are forced to sell the property, the taxation impacts are multiplied as capital gains tax will be triggered. The family may not be able to acquire the property personally, which could result in the loss of the property and/or their family farming business. Furthermore, it may not be an opportune time to sell, which could have a further detrimental impact on the fund. Members should not be forced into a fire sale scenario to fund the payment of this arbitrary tax.
Similar issues arise for small business owners. Typically, the family home and personal assets are at risk due to debt securities, director guarantees and trade or supply agreements. For both farmers and small business owners the key point is this – the level of wealth inside the fund at a point in time is not indicative of the individual’s personal wealth or liquidity outside of the superannuation system.
There are two other points worth pondering. The public consultation phase in response to the objective of
superannuation consultation paper has closed and we have still not progressed to an exposure draft. It was a reform that had everyone in the industry in agreement, at least in principle, when it was recommended as part of the Murray review in 2014 (yes, 2014).
We would argue no substantive change to super should occur before we have that objective. Yet the “Better Targeted Superannuation Concessions” consultation paper proposes a significant policy shift and a fundamental change in taxation policy and concepts without considering the broader retirement income system or the impacts on it.
The Retirement Income Review examined the essential pillars and components of the retirement income system of which superannuation is only one part. Other essential components include home ownership and aged care. Significant policy changes must be considered under a legislated objective and consideration of the impacts within the broader retirement income system is paramount. There is no evidence of this happening with the proposed $3 million cap.
The government has announced a 2025 kick-off. Yet despite this lengthy period, there has been limited consultation to allow sufficient time to properly consider the impacts and identify the unintended consequences arising from this model. Indeed, we have seen new concerns arise daily through engagement with our members, stakeholders and other industry groups.
The consultation paper process has the appearance of a tick-the-box exercise that risks detrimental outcomes for the many individuals affected. We urge government to take a careful and considered approach to any policy reform. A rush to legislate could have lasting negative impacts. The superannuation system is one that is already laden with complexity and red tape. What is being proposed will only add to the mire.
The consultation paper process has the appearance of a tick-the-box exercise that risks detrimental outcomes for the many individuals affected. We urge government to take a careful and considered approach to any policy reform.
It’s the time of year we now start to reconcile transactions that have occurred in the previous financial year for the purposes of preparing and lodging the annual return where, among other things, one objective is to reduce the tax liability of the SMSF. When a death or disability benefit is paid, and insurance is held within the fund, there are opportunities to help reduce the tax liability of the fund, both in the present and in the future too. Transfer balance cap, ECPI and the $3m cap Prior to 1 July 2017, the most common death benefit strategy for a spousal fund was for the surviving spouse to receive a pension from the deceased and to continue to receive a pension for themselves, if they were eligible. This maximised the tax effectiveness of the fund as the income on the assets was subject to the exempt current pension income (ECPI) deduction.
The nature of the transfer balance cap requires us to consider whether this strategy is appropriate as an individual can place no more than their personal transfer balance cap ($1.9 million for any pension commenced after 1 July 2023) within the retirement phase. As it is, in the instance where a member receives a death benefit pension from their spouse, their own pension may be required to be commuted back to accumulation, or alternatively they may choose to take money out of the superannuation system or if they hadn’t already commenced
a pension, they may just leave the benefit in accumulation. Any action that results in more benefits being held in the accumulation phase means less of the fund income is considered ECPI.
Further, with the government’s announcement to impose a 15 per cent tax liability on the earnings attributable to a member’s total superannuation balance above $3 million from 1 July 2025, there is no doubt those impacted the most by this measure in the future will be individuals who never had $3 million until a life-changing event occurred, and not generally a good one.
In light of this announcement and as part of clients’ needs to undertake appropriate estate planning, we should once again be asking the question about the role insurance can play in an SMSF. It may be counterintuitive to consider something that will result in an increase in a member’s benefit, however, its presence in a fund does avail the fund to tax deductions, which can alleviate the fund’s tax liability, which could go some way towards minimising the impact of a higher personal tax liability if the new measure proceeds.
Regardless of future measures, in the event a fund has received and paid out insurance proceeds, we should be asking ourselves whether the SMSF should contemplate claiming a future service period deduction when a benefit is paid prior to age 65.
Continued on next page
Risk insurance is often held within an SMSF for the associated tax breaks. Tim Miller looks at the different methods of maximising a tax benefit when a payment from life or disability cover is received.Continued from previous page
As alluded to above, the deduction opportunities do not exist solely for funds paying death benefits but also for one paying a benefit when a member is incapacitated or terminally ill. While these deductions will provide a tax benefit for a fund, we still must ask whether a member will commence a disability income stream or consider taking a disability or terminal illness lump sum. Given commencing an income stream will affect their personal transfer balance cap, often at an earlier age, retaining insurance proceeds to pay an income stream may not be the go-to strategy and it could also push individuals above $3 million in the future.
Having crossed over from the end of the financial year, there is an opportunity, in a year a death or disability-based benefit is paid, to contemplate whether the fund claims the standard premium-based deduction or one under section 295-470 Complying funds – deduction for future liability to pay benefits of the Income Tax Assessment Act (ITAA)
Importantly, the ATO confirms via Interpretative Decision 2015/17 that the decision to claim under ITAA section
295-470 is not required prior to the event occurring, meaning a fund can claim the standard premium-based deduction in each year prior to the year the event triggering payment occurs and then make the election to claim against the benefit payment when appropriate. So how does the deduction work?
ITAA section 295-470 allows a fund to claim a deduction on payment of:
a) a superannuation death benefit, or
b) a terminal illness benefit, or
c) a disability superannuation benefit, or
d) a temporary incapacity income stream.
The payment of a), b) or c) must be as a consequence of termination of a member’s employment and is eligible whether a benefit is paid as a lump sum or taken as a pension.
The formula for calculating the deductions as follows:
The benefit amount is the lump sum or the purchase price of the pension or the total of the amounts paid during the income year in the instance of a temporary incapacity income stream.
Future service days is the number of days from the date of termination to the member’s last retirement day (age 65).
Total service days is the sum of future service days plus the member’s eligible service period to the day of termination.
Losses created by this deduction can be carried forward. This is the significance of the action for SMSFs as the deduction may not have a great impact in the year it is claimed, but may provide an ongoing benefit for the accumulation interests of the fund.
Section 295-465 of the ITAA allows an SMSF to claim a deduction for death and disability insurance premiums where the policy is held within the superannuation fund. To be entitled to claim a deduction under section 295-470, the fund must make an election under section 295-465(4) not to deduct amounts based on the
premiums paid, but rather to claim on the future liability to pay benefits.
The election applies to all future years unless otherwise determined by the commissioner of taxation. Therefore, if a fund elects, in the year of paying a benefit, to claim for future liability and not for premiums paid, it cannot in future years claim insurance premiums for other members of the fund.
This requirement makes the future liability deduction more attractive to an SMSF as the deduction attributable to individual member premiums will in most instances be less significant.
Of course, with a deduction that provides the tax savings the way this one can, there are often drawbacks that need to be considered.
A superannuation death benefit paid to a non-dependant is taxable at 15 per cent plus the Medicare levy to the extent of the taxable component at the time of payment. If a deduction is claimed by a fund under either section 295-465 or 295-470, an untaxed element must be calculated as per the formula below. The untaxed element will be taxed at 30 per cent plus the Medicare levy.
Amount of Superannuation Lump Sum x Service Days/Service Days + Days to Retirement.
There are two other points worth pondering.
The taxed element in the fund is the amount derived from the above calculation less any tax-free component of the superannuation lump sum; the amount cannot be less than zero. The balance is the element untaxed.
It’s important to highlight the untaxed element will apply even when the fund claims the premium-based deduction, so where a benefit is paid to a non-dependant, there is no disadvantage by claiming the larger benefit-based deduction.
These calculations highlight the potential
Continued on next page
Any action that results in more benefits being held in the accumulation phase means less of the fund income is considered ECPI.
Continued from previous page
of the deduction. It is important when undertaking these calculations to use actual days.
Stefan is aged 47 and has an 18-year service period. He dies shortly after turning 47, leaving a wife and a 20-yearold non-dependent daughter. He has a superannuation fund balance of $500,000 comprising a $300,000 taxable and $200,000 tax-free component, and also holds an insurance policy valued at $900,000.
Stefan’s wife, Marie, is self-employed, makes deductible contributions to their SMSF and has a balance of $300,000.
The fund has previously claimed a deduction for the insurance premiums paid so elects not to do so, but rather to claim a deduction for the future liability to pay benefits.
The fund had taxable income of $50,000 consisting of contributions, realised capital gains and other income.
In the first year the SMSF creates a carried-forward loss of $639,265 that can be
offset against future contributions, gains and income.
In this example the payment of $1.4 million to Marie is tax-free as she is a dependant. Ultimately she can take it as a lump sum or a death benefit income stream. If she elects to take it as an income stream, the SMSF would be entitled to an ECPI deduction on the income generated on the $1.4 million, which would lessen the appeal of the deduction, and is used prior to applying the ECPI percentage.
Let’s assume Stefan and his wife have divorced so he wants to leave his superannuation proceeds to his daughter who is over 18 and not financially dependent. The same amount is calculated as above, $689,265.
In addition to this, the death benefit payment to the non-dependent daughter requires the calculation of the taxed and untaxed element:
Element taxed in the fund
$1,400,000 x 6753 / 13,302
Element taxed
$710,735 - $200,000 (tax free) = $510,735
Element taxed
$510,735 x 17% = $86,825
Element untaxed
$1,400,000 – $710,735 = $689,265
Element untaxed
$689,265 x 32% = $220,565
Total tax on death benefit
$220,565 + $86,825 = $307,390
Stefan’s daughter will receive an after-tax death benefit of $1,092,610, but will have the deduction of $689,265 to offset against the future income of the fund.
There is no doubt the deduction is more attractive for a death benefit payment to a dependant.
The nature of the transfer balance cap means the death or disablement of a member will not automatically result in a fund paying pension, but may lead to more lump sums being paid or more money being retained in accumulation.
Funds paying death or disability benefits to members and/or beneficiaries while continuing to generate a taxable income should consider the pros and cons of claiming a future liability to pay benefits deduction subject to meeting the applicable conditions. With the likelihood of a personal tax liability for those with high balances in the future, saving tax in the fund could provide some relief.
It’s important to highlight the untaxed element will apply even when the fund claims the premium-based deduction, so where a benefit is paid to a non-dependant, there is no disadvantage by claiming the larger benefit-based deduction.
On 19 June, Treasury released Exposure Draft Treasury Laws Amendment (Measures for Consultation) Bill 2023: Non-arm’s Length Expense Rules for Superannuation Funds together with Exposure Draft Explanatory Materials.
The bill and explanatory materials (EM) provide guidance on changes to the non-arm’s-length expenditure (NALE) provisions introduced in section 295-559(1)(b) and (c) of the Income Tax Assessment Act 1997 (ITAA) with effect from 1 July 2018.
The NALE changes in mid-2018 Paragraphs (b) and (c) of ITAA section 295-550(1) result in the ordinary and statutory income of a superannuation fund being taxed at 45 per cent if the parties to a scheme were not dealing with each other at arm’s length and one or more of the following applies:
(b) in gaining or producing the income, the entity incurs a loss, outgoing or expenditure of an amount that is less than the amount of a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm’s length in relation to the scheme,
(c) in gaining or producing the income, the entity does not incur a loss, outgoing or expenditure that the entity might have been expected to incur if those parties had been dealing with each other at arm’s length in relation to the scheme.
Thus, broadly, where the parties are not dealing at arm’s length and a lower or nil expense is
incurred, all the ordinary and statutory income of a superannuation fund for that financial year will be taxed at 45 per cent. In other words, NALE results in having the non-arm’s-length income (NALI) provisions apply.
NALE currently applies to all superannuation funds, both Australian Prudential Regulation Authority (APRA)-regulated funds and SMSFs. Note, however, the ATO provided an administrative solution by way of its Practical Compliance Guideline (PCG) 2020/5 where it did not apply its compliance resources for the 2019 to 2023 financial years to enforce NALE relating to general expenditure.
NALE relating to specific expenses relating to particular assets was not covered by PCG 2020/5 and therefore can result in a NALI penalty from 1 July 2018.
The NALE bill proposes a cap on the amount of income that will constitute NALI from a non-arm’slength scheme involving a lower or nil general fund expense. This cap is in the form of a twotimes multiple of the amount of the lower general expense for an SMSF or a small APRA fund. The example below outlines how this cap is to apply. The proposed changes do not apply to expenses relating to specific assets or income sources. The difference between a specific and a general expense is discussed below.
Continued on next page
Continued from previous page
Example applying a two-times multiple:
If an SMSF trustee uses a member’s brother’s accounting firm’s services, which would usually cost $5000 under an arm’slength relationship but is not charged any fee, this is considered NALE as the parties were not dealing at arm’s length. Therefore, the tax payable would be calculated as follows:
• 2 x $5000 = $10,000 NALE
• $10,000 x 45% = $4500 tax payable by the fund.
Note where the product of two-times NALE formula is greater than the fund’s actual taxable income, an upper cap will be the fund’s taxable income for the financial year excluding any assessable contributions or any deductions against assessable contributions.
Referring to the above example of the SMSF member’s brother’s firm providing accounting services valued at $5000 for free, where the amount of NALI penalty under a multiple of two is $10,000 but the fund’s actual taxable income is only $6000, the upper cap would result in $6000 of actual taxable income being taxed at 45 per cent rather than $10,000 of notional NALI.
The two-times multiple in the NALE bill will not apply to a loss, outgoing or expenditure of capital or of a capital nature. This is a new development as previously
NALE was focused on a general expense, whether of a revenue or capital character.
Advisers will therefore have to apply their tax skills to determine whether NALE will be capped by the two-times multiple if the NALE is not on the capital account. Thus, a general expense of a revenue nature should qualify for the two-times cap, but a capital expense of a general nature will not. While a capital expense of a general nature may not be common, the cost of certain equipment or software needed to administer the fund may fall into this category.
The NALE EM states:
1.5 Any [NALE] will be either a specific expense or a general expense. A general expense will be an expense that is not related to gaining or producing income from a particular asset of the fund. A specific expense will be any other expense.
1.6 For specific expenses the existing treatment will continue to apply, and the amount of income that will be taxed as [NALI] will be the amount of income derived from the scheme in which the parties were not dealing at arm’s length.
Example 1.4 of the NALE EM is relevant to SMSFs using the services of related members and parties as the example, among other matters, states: [Sam is a related party of an SMSF, whose assets include a rental property.]
… Sam is a licensed builder and blocks time out of their work calendar to conduct renovations on the rental property worth $3000 for which they charge nothing. The renovations were an expense incurred in deriving income from a particular asset, the asset being the rental property. The renovations are a specific [NALE].
Thus, given the lower $3000 specific expense, the net rental income from the SMSF’s rental property in example 1.4 is
taxed at 45 per cent. The example gives no guidance on whether the property is tainted for life or just in relation to that particular financial year. However, the ATO’s Law Companion Ruling (LCR) 2021/2 suggests Sam’s work taints the property for the remainder of its life.
In example 9 in LCR 2021/2, Trang, a plumber, renovated the kitchen and bathroom of her SMSF’s rental property, which exposed the net rental income and future capital gain forever to NALI.
Note there is no express discretion for the tax commissioner to disregard honest or inadvertent oversights.
The NALI bill proposes to exclude contributions assessable under division 295-C of the ITAA from NALI. Note under current legislation, general expenditure NALE results in assessable contributions being taxed as NALI at 45 per cent.
Pre-1 July 2018 expenditure to be exempt
The NALE bill proposes expenditure incurred prior to 1 July 2018 will be exempt from NALI. Note under current legislation, NALE can apply retroactively.
APRA funds exempt from NALE APRA-regulated funds will be exempted from NALE in relation to both general and specific expenses.
Many SMSF trustees are unaware of the breadth of these provisions and advisers should ensure there is ongoing education and monitoring for both NALI and NALE risks in their client base.
In particular, specific NALI remains a risk given it exposes all future ordinary and statutory income from a particular asset to a 45 per cent tax rate, including a future net capital gain on disposal of the asset.
A number of professional bodies representing both APRA-regulated funds and SMSFs requested a more proportionate treatment for NALI and the ability to rectify honest and inadvertent oversights.
Many SMSF trustees are unaware of the breadth of these provisions and advisers should ensure there is ongoing education and monitoring for both NALI and NALE risks in their client base.
Legacy pensions continue to be a burden for SMSF trustees. Jemma Sanderson examines the rules governing these income streams and some strategies to address some of their associated compliance issues.
Prior to the 2006 budget and the Simpler Super regime, we had reasonable benefit limits (RBL) and Centrelink assets test exempt (ATE) pensions. These provisions resulted in many taxpayers structuring their pension accounts so that they optimised their position from an RBL or ATE perspective.
In an SMSF, these types of pensions were available, however, they were discontinued for new pensions early in calendar year 2005. The pensions in Table 1 were those that were available in an SMSF prior to this time.
One of the main features of these types of income streams was the fact they were unable to be commuted, unless the commutation was to then commence a new pension that satisfied the requirements of the pension accounts in Table 1, or of a pension account that was similarly restricted.
In the lead-up to 30 June 2007, many members restructured a lifetime or life expectancy/term pension to a market-linked pension (MLP), however, they were still subject to the MLP rules regarding commutation restrictions. However, where the pension originally had an ATE, such a restructure didn’t necessarily occur as it would have resulted in the loss of the ATE. For some members, where a pension originally had a 100 per cent ATE, this had a substantial benefit to them from a Centrelink age pension perspective and therefore they would keep such a pension intact.
Fast-forward to the transfer balance cap (TBC) regime, where these accounts are capped defined benefit income streams (CDBIS) as defined by section 294-130 of the Income Tax Assessment Act 1997 (ITAA). The TBC treatment of a CDBIS depended on whether it was a lifetime product whereby a ‘special value’ is determined to calculate the amount of a transfer balance credit.
1. Special value of lifetime products – section 294120(2) of the ITAA provides a formula for the special value of a lifetime product:
Annual entitlement x 16
The annual entitlement is the annual pension amount over the 12 months from either 1 July 2017 or the date of commencement of the income stream (if subsequent to 1 July 2017, which wouldn’t be any such pension in an SMSF).
2. Special value of life expectancy products/MLPs – section 294-120(3) of the ITAA provides a formula for the special value of a life expectancy product or an MLP/annuity:
The annual entitlement is the annual pension amount over the 12 months from either 1 July 2017 or the date of commencement of the income stream (if subsequent to 1 July 2017, which wouldn’t be any such pension in an SMSF).
Given the way MLPs work, whereby the income is based on a remaining term and pension valuation factor contained in Superannuation Industry (Supervision) (SIS) Regulation Schedule 6, in most cases the operation of the formula in ITAA section 294-120(3) resulted in a higher special value for the MLP than the capital value that is actually supporting that income stream in the member’s account.
To reiterate, one of the considerations with a legacy pension is they are non-commutable, meaning the recipient is unable to roll back the MLP balance to accumulation phase and keep it there. The only changes that can be made in an SMSF are:
(a) For an MLP – amend the term, which would then impact the annual payment amount. It is important to note any amendment to the term must
Continued on next page
Continued from previous page
be in accordance with the rules, being it can be a minimum remaining term equal to the life expectancy of the pensioner or reversion, and to a maximum term of the number of years to age 100 of the pensioner or reversion.
(b) For a non-MLP – to cease the pension and commence a new MLP from the capital within the SMSF.
It wasn’t uncommon for a CDBIS to be in excess of the TBC in its own right. In that situation, ITAA section 294-125 operated such that if the special value of the CDBIS of a taxpayer was greater than their TBC, as long as it did not exceed the taxpayer’s capped defined benefit balance, then there would be no excess. The capped defined benefit balance is the special value of any CDBIS the taxpayer has. However, a nonCDBIS the taxpayer may have in place, for example, an account-based pension (ABP), would be excessive as the taxpayer does not have a separate applicable TBC (see Example 1).
The rules with respect to the calculation of the special value for an MLP were more often disadvantageous for those who had an MLP asset balance under $1.6 million, as the special value was always higher than the capital amount supporting the income stream. This then limited the amount these
Lifetime pension Homer (62) had an MLP at 1 July 2017 with the following details:
• the capital value per accounts was $1,560,000,
• the remaining term was 30 years,
• the factor (SIS Regulation Schedule 6) was 18.39, and
• the annual pension was $85,000. Therefore, the special value was $2,550,000 ($85,000 x 30). This is significantly higher than the capital value supporting the income stream as outlined in the accounts for the fund. So, would there be a prima facie excess to the general TBC or not?
Homer would have a modified cap equal to the special value of the CDBIS, so wouldn’t have an excess. However, if he had other pensions, such as an ABP, the entire balance of his ABP would be in excess of his modified cap and would have to be commuted prior to 30 June 2017.
members could retain in an ABP even though the capital supporting all of their income streams was less than the $1.6 million cap.
However, there was a strategy for such members to commute their MLP back to accumulation and commence a new one with the resulting benefit. Where this was undertaken after 1 July 2017, the MLP was no longer a CDBIS, as it requires the MLP to have been in place prior to 1 July 2017, and therefore the account balance would be assessed towards the TBC and not the special value. This has the benefit of enabling the pension member to have a higher level of benefits in an ABP within their TBC (see Example 2).
However, even though many in the industry considered the calculation of the transfer balance debit was uncontentious as in Example 2, the ATO took the view that, at the time of the MLP commutation, the transfer balance debit value would be nil as there would be no annual entitlement because the pension was being commuted.
Accordingly, where the strategy was in Example 2 implemented, for example, for Andrew, there would be a nil transfer balance debit on the commutation of the MLP and the commencement of a new MLP would result in an excess.
This was a substantial issue for many members with MLPs because if they undertook the transaction in Example 2 and had a TBC excess, they would not
be able to resolve the excess and would have an excess accumulating until they died because the MLP was non-commutable.
On 14 June 2018, the ATO released SMSF News Alert 2018/3:
“We are aware of circumstances where an individual was receiving a life expectancy or market-linked pension just before 1 July 2017, which was a capped defined benefit income stream; they then commuted the pension on or after 1 July 2017 and the transfer balance debit, worked out under the special value rule in Income Tax Assessment Act 1997 subsection 294-145(1), is nil. Where the individual then commences a new market-linked pension, this may cause them to exceed their transfer balance cap or have a higher than anticipated account balance.
The government recognises the unintended consequences associated with the current law and is committed to ensuring smooth implementation of the 2016 super reform measures.
If an individual’s circumstances align with the above, our practical compliance approach will be:
• We will not take compliance action at this stage if a fund does not report the transfer balance account events of the commutation or the commencement of the new market-linked pension.
• We will not apply compliance resources, at this stage, where the fund has reported
Continued on next page
In April 2022, new law allowed excess transfer balance amounts arising from the restructure of a CDBIS to be commuted from that pension back to accumulation.
As at 30 June 2017, the various factors and values with respect to Andrew’s MLP were as follows:
MLP balance: $500,000
Remaining term: 30 years
Pension valuation factor: 18.39
Annual pension: $27,190
Less 10%: $24,470
Add 10%: $29,910
Special value (assumed lowest pension amount selected for 2017/18) $734,100
As at 30 June 2018, the balance in Andrew’s MLP is as follows:
member account balance: $510,000
Remaining term: 29 years
Pension valuation factor: 18.04
Annual pension: $28,270
Less 10%: $25,440
Add 10%: $31,100
If Andrew commuted the pension on 2 July 2018, the original industry-wide practice of calculating the debit value of the pension would be the special value just before the commutation, based on the annual pension amount (let’s assume again the lowest amount), multiplied by the remaining term:
$25,440 x 29 years = $737,760
The transactions with respect to Andrew’s transfer balance account would be as follows assuming he fully utilised his TBC with an ABP in place at 30 June 2017:
the transfer balance debit for the commutation as other than nil.”
The above issues with respect to the determination of the transfer balance debit for a CDBIS commutation led to consultation with Treasury to provide a solution, and for any taxpayer who had restructured to ‘sit pretty’ with respect to the TBC position until such time as a solution was determined.
In 2020, the relevant provisions in ITAA Division 294 were amended to address the above issue.
In summary, the changes were:
1. For life expectancy pensions:
a. The transfer balance debit is the value of the transfer balance credit at 1 July 2017.
b. The taxpayer would have a TBC of $1.6 million and therefore they could restructure to use this amount, or where they had an ABP as well, an amount using the remaining balance up to the $1.6 million.
2. For MLPs:
a. The transfer balance debit is the value of the transfer balance credit at 1 July 2017 reduced by the pension payments received since 1 July 2017 for the account.
b. The taxpayer has a TBC of $1.6 million.
c. So effectively the available amount they have to retain in pension phase after a restructure is the $1.6 million TBC, less the value of the pension payments received over the period from 1 July 2017 through to the date of the commutation.
Therefore, this transaction would enable Andrew to commit an additional amount of his accumulation account to an ABP and remain within his TBC.
However, despite this clarification, where a CDBIS member restructured post 30 June 2017, it could be the case they would still have a non-commutable pension in excess of the TBC and would be unable to resolve it.
Continued on next page
• A pension was commenced in 2004 for RBL compression purposes – based on a 26-year life expectancy (his life expectancy at the time as if he was five years younger).
• In 2017 – $1.8 million value, remaining term of 13 years (pension value factor of 10.3), selected pension was $174,760, so the special value for TBC purposes was $2,271,880 (13 x $174,560).
• Could retain the entire MLP balance in pension phase, however, couldn’t have any other pension account in superannuation as would be excess to TBC.
• Subject to CDBIS income threshold since then of $100,000 until 30 June 2021 when it was indexed.
• Currently, the remaining term is seven years, so calculated pension now is $308,510 (based on pension value factor in Schedule 6 of SIS regulation 6.11)
• Plus 10% $339,360
• Less 10% $277,660
• Ned nominates $280,000 for the year (within his minimum and maximum).
• Subject to CDBIS income cap of $118,750, so $80,625 fully taxable at Ned’s marginal rate.
• Ned’s pension payment history is detailed in the table to the right.
Considerations:
Ned wanted to do some estate planning for his children, so restructured the account at 1 July 2023.
What would that look like (see below)?
• Rule of thumb – value of the pension payments received ($1,139,330) since 1 July 2017 will reduce down the available TBC from the original $1.6 million in terms of how much can be kept in pension phase after restructure and commutation.
• Ned can restructure the MLP by changing the term up to 23 years.
• TBC position:
Special value (orig TBCr)
TB Debit of restructure ((a) – (b))
$2,271,880
(a) Original SV $2,271,880
(b) Less: Pension payments since 1 July 2017 $(1,139,330)
(c) $1,132,550
(d) New TBCr (MLP balance) $1,885,000
Transfer balance ((a) – (c) + (d)) $3,024,330 TBC applicable $1,600,000 Excess to TBC
• Commutation authority would be sent through for the excess of $1,424,330.
• Commutation allowed from the MLP to accumulation.
• Revised balances (not factoring in the tax on excess transfer balance - see following page):
Continued from previous page
It is also important to note that where an MLP is restructured post 1 July 2017, it is no longer classified as a CDBIS and no longer subject to the CDBIS income cap ($118,750 from 1 July 2023), whereby 50 per cent of any amounts above this cap is taxed at the individual’s marginal tax rate.
For some individuals, this is a relevant consideration to any restructuring as it means they don’t have to pay personal tax on the income payments, although where that is invariably the case, they would then be missing out on the exempt current pension income (ECPI) on a pension account balance higher than the TBC.
Where a member had more than $1.6 million of capital in their MLP, they were eligible for ECPI with respect to that higher balance. In such a case, if the MLP paid more than the cap as a pension, 50 per cent of the excess would be taxable to the individual.
As part of the 2021/22 federal budget, an announcement was made to allow CDBIS or legacy pensions to be commuted (with relevant snippets below):
• temporary option to transition from legacy retirement products to more flexible and contemporary retirement products,
• a two-year period will be provided for conversion,
• it will not be compulsory for individuals to
take part,
• completely exit these products by fully commuting the product and transferring the underlying capital, including any reserves, back into a superannuation fund account in the accumulation phase,
• any commuted reserves … will be taxed as an assessable contribution of the fund (with a 15 per cent tax rate),
• the existing social security treatment … will not transition over for those who elect to take advantage of the conversion,
• exiting a product will not cause reassessment of the social security treatment of the product for the period before conversion,
• existing rules for income streams will continue to apply so that individuals starting a new retirement product will be limited by the transfer balance cap rules,
• the existing transfer balance cap valuation methods for the legacy product, including on commencement and commutation, continue to apply.
This announcement was a positive for the industry, however, to date we are only halfway there.
In April 2022, new law allowed excess transfer balance amounts arising from the restructure of a CDBIS to be commuted from that pension back to accumulation.
The change to allow the commutation is as follows within SIS regulation 1.06(8)(d)(ix) for MLPs:
(d) the market linked pension cannot be commuted except in any of the following circumstances:
…(ix) in order to comply with section 136-80 in Schedule 1 to the Taxation Administration Act 1953….
We still don’t have a position on the full commutation to accumulation of a legacy pension, so that it can either be held in accumulation, if desired, or an ABP can be commenced with the resulting amount (subject to having TBC available).
The downside to any restructure is:
1. If an ATE pension, ATE status would be lost, so then there would be Centrelink age pension considerations (although this wouldn’t technically be backdated as any such debt would be waived).
2. If the age pension is impacted, then any aged-care costs are also likely to be impacted.
3. If an MLP, only the amount up to the remaining TBC after considering the pension payments since 1 July 2017 is available to have in pension phase and eligible for ECPI. Therefore the following must be considered:
a. The personal tax on any income payments (if above $118,750) versus the loss of ECPI.
b. The amount that might be available in pension phase subsequent to a restructure.
c. The advantage of a restructure from a flexibility perspective and estate planning, rather than purely short-term tax.
We still don’t have a position on the full commutation to accumulation of a legacy pension, so that it can either be held in accumulation, if desired, or an ABP can be commenced with the resulting amount.
We are delighted to announce our rebrand from SMSF AAA to "The Auditors Institute Ltd". While full membership is currently limited to SMSF Auditors, we will be introducing an Associate membership based on member feedback to provide access to our resources to a broader range of auditors and accountants.
Join us in embracing the future of the auditing profession by becoming a part of The Auditors Institute Ltd. Visit our website at www.auditorsinstitute.com.au to explore the exciting changes and discover how we can support you in achieving excellence. Stay connected with us through our social media channels to stay updated on the latest industry insights, resources, and networking opportunities. Together, let's shape the future of auditing and safeguard retirement benefits with assurance and integrity.
• Representation and SMSF auditor advocacy with the regulator
• Members-only forum to ask and discuss technical questions
• 20 new webinars every year
• Access to our extensive back catalogue of SMSF webinars
• Conference discounts
• Access to our Technical SMSF resources library
• Connection to SMSF experts
• Listing on the members-only SMSF Auditor directory
• A professional network of ASIC-registered SMSF Auditors
• SMSF expertise, advocacy, opportunities and peace of mind
• Over 20 Hours of Continuing Professional Development
The government has now released a consultation paper on the additional 15 per tax it is proposing to charge on total super balances above $3 million. Michael Hallinan lays out how the measure will be applied.
Back in February, the government announced its intention to impose an additional 15 per cent tax on people whose total super balance exceeds $3 million. The proposed start date of the measure is 1 July 2025 and the tax, tentatively called Division 296 tax, will first apply to the 2026 financial year.
The two key features of the proposed tax are:
• it operates at the member level, and
Division 296 tax will be determined in a three-step process:
1. Determine the increase in the TSB of a member during the financial year. This increase will be treated as the total earnings of the member for the financial year with regard to Division 296.
2. Determine the amount of total earnings that is attributable to the portion of the super balance in excess of $3 million.
3. Apply the 15 per cent tax rate to the amount of total earnings attributable to the super balance in excess of $3 million.
MICHAEL HALLINAN is self-managed superannuation executive consultant
• it is based on the increase in the total superannuation balance (TSB) of the member during the financial year.
As the tax operates at a member level, assessments will be issued to the member and not to the super fund. The member can either pay the assessed tax personally or have the tax paid by their super fund on their behalf, with the super fund debiting the member’s account with the payment. The operation of the new tax will be very similar to the current operation of Division 293. Consequently, as the ATO will initiate the tax assessments, the member will not be required to lodge any returns in relation to the tax.
As the tax is based on the increase in the TSB and not actual, realised earnings, it will apply to both realised and unrealised capital gains and also limited recourse borrowing arrangement (LRBA) repayments if the fund is an SMSF.
Since the first announcement of Division 296 tax, a consultation paper was released on 31 March 2023. The following explanation is based upon that paper.
Currently the tax has no name. Divisions 290, 291, 292, 293, 294 and 295 are currently taken. Consequently the first available division number, Division 296, has been chosen.
The application of Division 296 tax is not predicated on either age or retirement status.
Example
John has a TSB as at 30 June 2025 of $3.2 million and a TSB of $4.5 million at 30 June 2026. Additionally, he made $110,000 of nonconcessional contributions to his super fund and withdrew $200,000 as benefit payments (it is irrelevant whether the benefit payments are pension payments or lump sum payments).
1. Determine John’s Division 296 ‘earnings’ over the financial year
The taxable increase in the TSB for John for the year ended 30 June 2026 will be:
$4,500,000 - $3,200,000 + $200,000 - $110,000 = $1,390,000
That is, the TSB at year end less TSB at the start of the year with benefit payments added back and non-concessional contributions excluded or taken off.
If benefit payments were not included in the Division 296 earnings amount, the tax could be avoided by the simple practice of cashing out sufficient super to match the increase in the TSB. One consequence of including benefit payments is the Division 296 tax will apply to both benefit payments, which are taxable in the hands of the member, as well as benefit payments which are tax exempt in the hands of the member.
Why take off contributions?
Contributions are not earnings but capital injections into super. If the contribution is not assessable in
Continued on next page
Continued from previous page
the hands of the super fund trustee, the face value of the contribution is used. If the contribution is assessable in the hands of the super fund trustee, then 85 per cent of the face value of the contribution will be used.
For this purpose, excess TSB is the amount of TSB at year’s end which is in excess of $3 million.
The amount of Division 296 earnings attributable to the excess TSB is determined by the proportion of the TSB at year end in excess of $3 million compared to the TSB. For example, if the proportion of the TSB at year end in excess of $3 million was 20 per cent, then that would be the amount of Division 296 earnings taxable.
Returning to John. As at 30 June 2026, the excess portion of John’s TSB is $1.5 million (that is, $4.5 million less $3 million). The proportion of John’s Division 296 earnings attributable to the excess portion will be one-third (that is, $1.5 million divided by $4.5 million).
Consequently, the taxable portion of John’s Division 296 earnings will be one third of $1,390,000 or $463,000 (rounded down to the nearest $1000).
3. Division 296 tax
The tax will 15 per cent of the Division
296 earnings attributable to the excess TSB. In John’s case this will be: 15 per cent of $463,000 or $69,450.
As John has attained age 65, or any other unrestricted release condition, he could either pay the Division 296 tax assessment personally or direct his super fund to pay the assessment on his behalf with the fund debiting his super account with the tax liability.
If John had not attained age 65, or otherwise not satisfied an unrestricted release condition, he would not have the option of paying the Division 296 tax personally. Instead he could only direct his super fund to pay the assessment on his behalf with the fund debiting his super account with the tax liability.
What if John had superannuation interests in various funds?
This would make no difference as the TSB is the aggregate of the balances of all his superannuation interests and in determining his ‘benefit withdrawals’ it will be the aggregate of all benefit withdrawals and similarly with contributions.
What if John had a retirement pension?
The value of the retirement-phase pension would be taken into account in determining John’s TSB.
What if the TSB transcends $3m during the financial year?
If John’s TSB on 30 June 2025 was $2.8 million and $3.2 million on 30 June 2026 with no withdrawals or contributions, his Division 296 tax would be calculated as follows:
Step 3: Division 296 tax
15% x 6.25% x $200,000 = $1875
What if the TSB falls below $3m during the financial year?
If John’s TSB on 30 June 2025 was $3.4 million and was $2.8 million on 30 June 2026 with no withdrawals or contribution, then the Division 296 calculation would be: Step 1: Division 296 earnings
$2,800,000 - $3,400,000 = -$600,000 As the Division 296 earnings figure is negative, steps 2 and 3 are not engaged.
In this case, John is not liable for Division 296 tax in respect of the 2026 financial year as his Division 296 earnings are negative. The negative earnings will be carried forward to the next financial year. It is not known whether the carried forward is indefinite or subject to a time restraint. Presumably, carried forward or negative Division 296 amounts will be applied in the order in which they occurred.
What if the TSB is below $3m in year 1 and then above $3m in year 2?
Let’s assume the TSB at the start of financial year 1 is $3.3 million and at the end of that year it is $2.8 million. Neither contributions nor benefit payments were made during the year. Then in year 2 the TSB at year end is $3.7 million, again with no contributions or benefit payments.
For year 1: The TSB earnings are negative $500,000 ($2,800,000 less $3,300,000).
As the earnings are negative, no Division 296 tax arises in year 1
For year 2: The TSB earnings are positive $900,000 ($3,700,000 less $2,800,000).
The negative Division 296 earnings from year 1 are carried forward to year 2, consequently, the net earnings for year 2 are $400,000 ($900,000 less the carriedforward of negative earnings of $500,000).
The proportion of Division 296 earnings for year two is:
Continued on next page
If benefit payments were not included in the Division 296 earnings amount, the tax could be avoided by the simple practice of cashing out sufficient super to match the increase in the TSB.
Continued from previous page
($3,700,000 - $3,000,000)/$3,700,000 = 19% (rounded).
Division 296 tax for year 2 is: 15% x 19% x $400,000 = $11,400
Will rolling back a pension to accumulation phase have an impact?
Rolling back to accumulation phase will have no impact on the TSB.
Will a rollover to another fund have an impact?
Rolling over to another superannuation entity will have no impact on the TSB.
Will the timing of benefit withdrawals or contributions matter?
In general, no. This is because it is the aggregate (irrespective of when the transaction occurred) of the withdrawals and contributions with no time weighting that is taken into account. However, there may be an indirect impact as timing will affect the amount of earnings.
Can spouses share the $3m cap?
Unfortunately, no. If Bill has a TSB of $4 million and Jill has a TSB of $1 million, there is no ability to average the two balances to produce a result so neither member triggers Division 296. Bill’s TSB is in excess of $3 million so he will be subject to the additional tax.
Is the $3m threshold indexed?
There is no mention that the Division 296 threshold will be indexed. It may be adjusted from time to time. If the $3 million threshold is not indexed or regularly adjusted, it will over time affect an increasing proportion of superannuants.
What about investment losses?
Investment losses will have an impact on
Division 296 tax as the investment loss will reduce the TSB value at year’s end.
Does the CGT discount for long-term capital gains reduce Division 296 tax?
Based upon the information released to date, the discount for long-term capital gains will not automatically reduce the ‘earnings’ to which Division 296 tax applies. This is because the capital gains tax (CGT) discount is relevant to the determination of the super fund’s tax liability if and when there is a CGT event in relation to a fund asset.
The introduction of Division 296 tax may spark an interest in SMSFs for valuing on a net of tax basis, though the costs of doing so may be significant.
Does asset segregation have an effect?
In this context segregation means holding an asset exclusively for one or more members but not all members of an SMSF.
The segregated asset could be supporting retirement-phase interests or accumulation interest.
Segregating an asset will have an impact on the determination of the TSB of a member. The value of the asset will directly
affect the TSB of the members for whom the asset is held in proportion to the member’s economic interest in the asset.
What if the member completely rolls out of super before year end?
The design logic of Division 296 tax is that the member will still be liable to Division 296 tax in respect of the financial year during which the member exits the superannuation system.
What is the impact of death?
Presumably, Division 296 tax will still apply. Most likely Division 296 will apply until the death benefit is allocated, whether as a lump sum payment or used to commence a pension, and for each intervening financial year or part financial year between the date of death and the date of benefit allocation.
If Division 296 tax is payable, again presumably, the assessment will be issued in the name of the estate of the deceased member with the executor having the option of either paying the assessed tax as an estate expense or having one or more of the deceased super accounts pay the tax.
Will insurance proceeds form part of the TSB?
In this context, the insurance proceeds would arise from a term life insurance arrangement. Whether the insurance proceeds are treated as the realisation of an asset held exclusively in respect of the deceased member or treated as a contribution for the deceased member, the Division 296 tax outcome will be the same.
The insurance proceeds will be included in the TSB of the deceased member. Given the nature of insurance proceeds, possibly the implementing legislation will only treat the life policy as having a value for Division 296 purposes if and when the insurance proceeds are received by the super fund trustee.
Based upon the information released to date, the discount for long-term capital gains will not automatically reduce the ‘earnings’ to which Division 296 tax applies.
The use of an SMSF testamentary trust can provide significant estate planning benefits. Grant Abbott details how effective an asset protection mechanism they can be.
When it comes to SMSF estate planning, binding death benefit nominations (BDBN) have long been viewed as a standard tool for trustees despite the huge number of cases where they have been litigated. And with more than $400 billion to be transferred out of SMSFs through the death of members in the next 20 years, expect a lot of litigation on the horizon.
This means accountants and specialist SMSF advisers preparing SMSF estate planning documentation may find themselves unwittingly in the firing line if something goes wrong courtesy of section 54C of the Superannuation Industry (Supervision) (SIS) Act and the strict damages provisions of section 55(3). It beggars belief BDBNs are being done without any protection or providing secondary choices in the event that the primary
dependent beneficiary is no longer on the scene, is bankrupt or in the midst of litigation.
At Abbott and Mourly Lawyers, like many specialist SMSF legal firms, we review a lot of BDBNs and the first problem we see is many of them are invalid because either:
1. The governing rules require the trustee to establish an approved form for a BDBN that has not been done, placing any purported BDBN ineffective at law, and
2. An approved BDBN must be used, as stipulated by the trust deed, but instead a standard one from an online document provider has been implemented, again rendering the purported BDBN invalid.
For a specialist lawyer these are dangerous rookie mistakes, but it is the next level that is worse. Nearsightedness in drafting a BDBN is an affliction.
Continued on next page
Continued from previous page
The standard BDBN that has all one spouse’s super going to the other and vice versa, but does not countenance what happens if they both die together is an accident waiting to happen. Only recently a financial planner said to me it was crazy to cover this scenario, which was highly unlikely to happen. I asked did they know not only a couple, but a mother and daughter were killed in the recent wedding bus crash in the Hunter Valley? Plus, I also reminded him of his duties as a planner to cover all contingencies. The golden rule then must be to always prepare for the worst because if the worst happens, you have done your duty and the client’s family is covered.
No. There can be no doubt SMSF advisers must be vigilant, proactive and more importantly protective when it comes to securing a member’s superannuation benefits for their dependants or nondependants as the stakes are simply too high.
Section 62 of the SIS Act states the sole purpose test provides that the trustee of an SMSF can pay death benefits to a dependant, which includes a spouse and children, even if they’re adults. However, a lump sum or commutation of a pension payment may be simple, but on a protection scale only rates a one out of 10. The truth is, it places your assets at risk, whether from the clutches of family law disputes, creditor claims, ATO claims or family provisions litigation, if the dependant passes away.
Consider the case of John Smith, a successful businessman who, unfortunately, passed away, leaving his superannuation benefits to his adult son, Alex. Within two years of John’s passing, Alex found himself entangled in a messy divorce and so John’s hard-earned super was now in play as a divisible asset.
On the other hand, what if super is paid directly to the deceased’s estate? It would seem like a logical choice, wouldn’t it? But here, timing and litigation loom large. Probate can be a lengthy process, and with nearly 50 per cent of all wills now being contested through family provisions claims, it’s like playing Russian roulette with a client’s super.
Sarah was a diligent SMSF member who nominated her estate as the beneficiary of her super. When she passed away, her will was contested by a long-estranged daughter. The super she had intended for her other children was now part of a protracted legal dispute and was eventually eroded by the costs of litigation and settlement.
A BDBN solution to transfer all of the deceased member’s superannuation death benefits to their estate can be dangerous, courtesy of family provisions claims. If the member’s death benefits are to be paid to the deceased member’s estate and it
is subsequently wrapped up in a family provisions claim, is there a duty of care to warn of any possible family provisions action? Not advising on a potential family provisions claim has been increasingly litigated, notwithstanding the High Court decision in Robert Badenach & ANOR v Roger Wayne Calvert [2016] HCA 18. The big questions being firstly, is preparing a BDBN considered legal work and secondly, whether it is or not, does the duty of care to advise a client of a potential family provisions claims extend to SMSF advisers and accountants who recommend death benefits be paid to an estate when a proper review of potential family provisions claims by eligible persons is not undertaken?
In the face of these dangers, it’s time to turn to the rare gem of estate planning, the SMSF testamentary trust (TT). This is not a regular TT; it’s a purpose-built vehicle designed to shield a member’s super from the trials and tribulations of life, death and litigation. It can be optional, such as the CBUS industry super fund TT option, or mandatory in that the BDBN requires the trustee to create and settle an SMSF TT on death.
An SMSF TT is a special purpose testamentary trust that must meet the conditions of section 102AG(2) of the Income Tax Assessment Act 1936 (ITAA) This provision ensures any income a minor beneficiary derives from the trust due to a super death benefit is taxed at adult rates, providing a substantial tax benefit. It is not only the tax benefits making an SMSF TT attractive, but also the ability to offer adult beneficiaries asset protection.
1. Asset protection: One of the primary benefits of an SMSF TT is the protective barrier it forms around the assets from family law and creditor claims. The structure ensures the assets within the trust are not held directly by the beneficiaries, thereby
Continued on next page
The standard BDBN that has all one spouse’s super going to the other and vice versa, but does not countenance what happens if they both die together is an accident waiting to happen.
shielding them from potential legal disputes or insolvency proceedings. With family law the important positions of trustee and appointor need to be carefully considered and we advise seeking a legal firm with a specialisation in protective estate planning and SMSFs be used as a sounding board.
2. Family provisions claim protection: An SMSF TT also offers a safeguard against family provisions claims on the estate. By circumventing the estate and directing super benefits into a TT, the exposure to litigation is minimised, ensuring the assets reach the intended beneficiaries.
3.Flexibility: SMSF TTs provide great flexibility, allowing for a wide range of beneficiaries, including bloodline only. This means the trustee has the discretion to distribute the income and capital of the trust to any of the specified beneficiaries, based on their needs and circumstances.
4. Bankruptcy protection: If a beneficiary is declared bankrupt, the assets within an SMSF TT are protected from trustee-inbankruptcy claims. This ensures the family wealth is preserved and isn’t eroded by
unfortunate financial circumstances.
5. Control: The control of the trust can be passed down through generations, thereby ensuring the family wealth is managed in accordance with your wishes, even after your demise.
6. Longevity: A testamentary trust has the potential to last 80 years, providing long-term benefits to your descendants. Interestingly, if established under South Australian law, the trust can continue indefinitely, ensuring the perpetuation of your legacy.
7. Minors taxed as adults: Lastly, under section 102AG(2) of the ITAA, any income derived by a minor from the trust due to a super death benefit is taxed at adult rates. This provision can result in significant tax savings, especially when compared to the hefty tax rates applicable to unearned income of minors.
Providing the opportunity of an SMSF BDBN with an in-built testamentary trust is important advising and legal work. It’s crucial to engage experienced professionals to ensure an SMSF estate planning strategy is sound, protective, compliant and, most importantly, aligns with the client’s intentions
because when it comes to protecting your clients and their family’s wealth, it pays to be at the top of your SMSF advising game and not playing in the thirds.
SMSF advisers must be vigilant, proactive and more importantly protective when it comes to securing a member’s superannuation benefits for their dependants or non-dependants as the stakes are simply too high.
Continued from previous page
Much has been discussed in the mainstream press about the cost-of-living pressures many Australians are facing currently. Over the past 12 to 18 months, at least, prices have been rising. According to the latest data from the Australian Bureau of Statistics, inflation is at 5.6 per cent, which is well above the Reserve Bank of Australia’s (RBA) target of 2 per cent to 3 per cent. Meanwhile, wages not have not grown at the same rate.
Interest rates have also been increasing, with the RBA announcing 12 rate rises across its past 14 meetings.
However, it is not only individuals who might be feeling the pain; some SMSFs could be too.
Like individuals, SMSFs face expenses on a daily basis, and those expenses have been increasing due to inflation. SMSFs need to be conscious of this, and in line with requirements under the sole
Continued on next page
The impact of higher inflation and interest rates not only applies to individuals, but also to SMSFs. Bryan Ashenden recognises some of the issues facing trustees stemming from the current economic environment.BRYAN ASHENDEN is head of financial literacy and advocacy at BT.
purpose test and their investment strategy considerations, trustees need to ensure they have sufficient liquidity to meet the needs of the fund. For many SMSFs, this may be a simpler requirement related to administration-related costs. But where there are different investments, such as property or exotic investments, like artwork or antiques where there is insurance in place, it is important to be aware of any potential increases occurring on those insurance policies as they could be substantial in the current environment.
There is an even greater need for consideration of these aspects when members of the SMSF undertake any relevant services themselves for the fund. In recent times we have seen a greater focus from the ATO on any related-party dealings in the SMSF environment. Where services are provided and not charged or paid for on an arm’s-length basis, there is the potential for the non-arm’s-length income (NALI) provisions to be triggered. Similarly, there are non-arm’s-length expenditure (NALE) provisions that apply to ensure expenses are charged and paid for on an arm’s-length or third-party market basis. Failure to meet these requirements runs the risk the income of the SMSF could be subject to tax at penalty rates equal to the highest marginal tax rate.
For accountants, as an example, when undertaking the administration and taxation work for their own SMSF, they need to consider how much they are charging other clients for the same work. The amount charged to their own fund should be based on a similar methodology. Recent draft legislation is proposing the difference between the expense charged and what would be the market rate for that expense will be subject to penalty tax under the NALE provisions. The draft legislation on this, contained in the Treasury Laws
Amendment (Measures for Consultation) Bill 2023: Non-arm’s Length Expense Rules for Superannuation Funds, released for consultation in mid-June, contains the following on this point in example 1.1 of the accompanying draft Explanatory Memorandum:
“Al is the sole trustee of their SMSF of which they are the sole member. Al is an accountant and provides general accounting services worth $3000 to their SMSF, which the SMSF acquires free of charge.
The acquisition of accounting services by the SMSF constitutes a scheme between Al and his SMSF in which the parties were not dealing with each other at arm’s length, and no expense was incurred when the SMSF would have been expected to have incurred an expense in respect of its acquisition had the parties been at arm’s length, so the non-arm’s-length expenditure provisions apply.”
While this example focuses on a situation where the services were provided for free, there are other examples where the services were not free, but provided at a cost less than a market rate. So
while the expense rate could have been appropriate in the past, not adjusting it for prevailing market conditions, where the rate may have been impacted by inflationary pressures, could result in potential breaches into the future.
Perhaps, importantly, another example in the draft Explanatory Memorandum, example 1.3, provides a reminder for financial advisers about charging fees for the investment advice provided to their own SMSF, with the commentary noting such services provided at a rate less than market value, including being provided at no cost, could invoke the NALE provisions.
In response to inflationary pressures, we have seen the RBA act to raise interest rates in a move designed to bring inflation under control and ideally back to within a targeted range. These increases in interest rates over the past 12 months have seen many Australians impacted as the variable rates on their loans have risen. Again, SMSFs are not immune from similar pressures.
Where an SMSF has a related-party borrowing in place, a key consideration has always been the interest rate charged on that loan. In order to be viewed as a loan made on an arm’s-length basis, within the ATO’s safe harbour approach as set out in in Practical Compliance Guideline (PCG) 2016/5, the interest rate needs to be calculated by reference to the RBA’s indicator lending rate for banks providing standard variable housing loans for investors. If the loan is in respect of real property, the relevant rate is that indicator rate. If the loan is in respect of a parcel of listed shares, it is the indicator rate plus 2 per cent.
For the year commencing 1 July 2023, the relevant indicator rate is 8.85 per cent – a jump of 3.5 percentage points from the indicator rate that applied for 2022/23 of 5.35 per cent. For loans used to acquire a
Continued on next page
Like individuals, SMSFs face expenses on a daily basis, and those expenses have been increasing due to inflation. SMSFs need to be conscious of this.
Continued from previous page
parcel of listed shares, the new rate will be 10.85 per cent.
While fixed rate loans are an option to be considered, it is important to note the rate to be used for a fixed rate loan, which under the safe harbour approach can be for a maximum of five years for a propertyrelated loan or three years for a loan for listed shares, is the same rate. There is no adjustment up or down for expected interest rate movements into the future. This means an SMSF trustee who had been savvy enough to fix a portion of their loan before the end of the financial year could have a fixed rate loan of 5.35 per cent. Unfortunately doing it now will mean a fixed rate of 8.85 per cent will apply.
SMSFs with these related-party loans may, as a result, feel a greater impact from
the inflationary pressures and their impacts on interest rates from 1 July 2023 due to the substantial rise and will need to ensure they have liquidity plans in place to meet these increased costs. SMSFs with thirdparty loans from a financial institution do not need to rely on PCG 2016/5 as the loan is likely to be on an arm’s-length basis already. Again, they are not immune from the increase in interest rates, but the change may have been felt gradually over the past 12 months with smaller but more regular increases to interest rates over that period.
A final area of which SMSF trustees will need to be cognisant in the current environment is the pension needs of members. While awareness should not be an issue, given the trustees are also the members, it is the impact of cost-of-living pressures and inflation that may require changes to strategies for a number of reasons, including the following:
1. For the 2024 financial year, the previous 50 per cent reduction in the minimum income stream payment amounts for market-linked income streams no longer applies. For members who had been drawing at the reduced minimum levels, higher payments will now be required to be taken. Hence SMSF trustees will need to ensure there is adequate liquidity to enable this. Where a reduced payment continues to be taken throughout the year, with a planned catch-up payment to be made at
the end of the year, it will be important to ensure a larger payment is made before 1 July 2024, and that the total payments across the year are at least equal to the standard minimums now applying. Failure to do so can mean the income stream does not exist, and the tax-free status on underlying earnings in the fund could be lost.
2. Irrespective of the legislated minimum payments from income streams, members may need to access additional funds to meet their cost-of-living requirements. SMSF trustees should be prepared to ensure there is sufficient liquidity for those requirements.
Finally, it is worth noting some SMSFs may still be running lifetime complying income streams set up many years ago, with the income streams structured to have annual payment amounts indexed to movements in the consumer price index. With the rate of inflation having risen significantly in recent times, the payment requirements from these income streams may have increased significantly. While this gives rise to liquidity considerations, similar to those discussed earlier, it also raises questions over the investment strategy for the underlying assets supporting these pensions to ensure they can continue to meet the income needs of the member for the expected remaining life of those income streams.
In recent times we have seen a greater focus from the ATO on any related-party dealings in the SMSF environment.
SMSF Professionals Day 2023 took the form of a multiple-city roadshow for the first time in four years with presentations made in Sydney, Melbourne and Brisbane. The Sydney event was held at Rydges World Square..
Treasury recently released for consultation the Treasury Laws Amendment (Measures for consultation) Bill 2023: Non-arm’s Length Expense Rules for Superannuation Funds. The purpose of this exposure draft is to enact legislative amendments to the non-arm’s-length income (NALI) provisions announced recently in the 2023/24 budget.
The extension to NALI, to include non-arm’slength expenditure (NALE), started on 28 July 2021, when the ATO released Law Companion Ruling 2021/2. This instrument introduced the concept that there must be a ‘sufficient nexus’ between the NALE and the relevant income identified as NALI. The concept of ‘general’ and ‘specific’ expenses was discussed and that a ‘general’ expense, such as actuarial, bookkeeping, audit and administration costs in managing the fund, and accounting fees may have a sufficient nexus to all of the ordinary and statutory income of the fund. The industry was concerned this treatment to taxing all the income of the fund at the highest marginal tax rate was disproportionate and unfair since NALE from ‘general’ expenses could in fact be only small amounts.
In response to industry lobbying, on 24 January 2023, Treasury released a consultation paper proposing that SMSFs and small Australian Prudential Regulation Authority (APRA)-regulated funds (SAF) be subject to a factor-based approach on calculating the maximum amount that would be taxable as NALI. This was to be five times the level of the difference between the arm’s-length expense and the actual amount charged. Large APRA-regulated funds were to be exempted from these provisions. Even though the proposed amendments were welcomed in limiting the amount of NALI, further clarity was still required on the practical application of these amendments.
Hence the release of the recent exposure draft. The key proposed amendments of this exposure draft are as follows:
• large APRA-regulated funds are to be excluded and hence rules will be limited to SMSFs and SAFs. However, public offer funds are still subject to the current NALI rules,
• the concept remains that expenses subject to NALE are distinguished between ‘specific’ and ‘general’ expenses,
• for ‘specific’ expenses, the existing treatment
will continue to apply. Examples of ‘specific’ expenses as per the exposure draft are as follows
(not exhaustive):
• maintenance expenses for a rental property,
• investment advice fees for a particular pool of investments,
• a limited recourse borrowing arrangement for the purchase of an asset, and
• the purchase of an asset such as a rental property or shares,
• the upper limit to what is taxed as NALI for ‘general’ expenses will be reduced to a factorbased approach of two times the initial proposal and not five times. If a fund’s taxable income, excluding net assessable contributions, is less than this calculated amount, NALI will be limited to the taxable income,
• expenses incurred or expected to have been incurred before 1 July 2018 cannot result in the application of the NALE rules, and
• to apply from the 2023/24 financial year onwards, but subject to when the act receives royal assent.
Even though this exposure draft has provided welcome clarity on the capping of the upper limit of NALI from ‘general’ expenses to more of a reasonable approach, it has not addressed the unfair treatment to future capital gains from the sale of assets that have had in the past a ‘specific’ expense breach. As it currently stands should, for example, a maintenance expense on an investment property be treated as a ‘specific’ expense breach, not only does the net rental income get taxed as NALI in the year of the breach, but when the property is subsequently sold many years later, the net capital gains will also be treated as NALI and taxed at the top marginal tax rate. Also, as the legislation currently stands, there is no ability for a trustee to rectify any NALE breaches.
The ATO is set to release Taxation Determination 2023/D1 on how the NALI provisions in subdivision 295-H of the Income Tax Assessment Act 1997 and the capital gains tax provisions in part 3-1 (in particular, section 102-5) of that act interact in determining the amount of statutory income that is NALI where a capital gain arises as a result of non-arm’s-length dealings. We will await with bated breath to see what this taxation determination will hold.
The consultation period on the exposure draft ended on 7 July 2023.
Allow the editor to talk you through what the news service can offer you as an SMSF trustee.
receive our digital trustee enewsletter straight to your inbox.
Required reading for SMSF trustees
Like many of us, Megan* never thought it would happen to her – she never imagined she would need to escape a violent relationship; she never imagined her own family would turn their backs on her; she never imagined she and her daughter would become homeless and have to live out of their car.
Right now, there are thousands of Australians like Megan* experiencing homelessness but going unnoticed. Couch surfing, living out of cars, staying in refuges or transitional housing and sleeping rough – they are often not represented in official statistics. In fact, for every person experiencing homelessness you can see, there are 13 more that you can’t see.
Together we can help stop the rise in homelessness.
