Self Managed Super: Issue 46 by Benchmark Media

QUARTER II 2024 | ISSUE 046 | THE PREMIER SELF-MANAGED SUPER MAGAZINE

NO EXIT The status of legacy pensions

FEATURE

COMPLIANCE

STRATEGY

COMPLIANCE

Legacy pensions The current situation

Early access to benefits Time for a review

Unit trust investments Governing rules

Documentation Best practices

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COLUMNS Investing | 20 A new approach to fixed income.

Investing | 24 Active versus passive assessment.

Compliance | 30 Change in overseas pension transfer process.

Strategy | 34 Investing in alternative structures.

Compliance | 38 Early access of benefits.

Strategy | 42 Potential impact of AI.

Compliance | 46 Winding up an SMSF.

Strategy | 50

NO EXIT The status of legacy pensions

NO EXIT THE STATUS OF LEGACY PENSIONS Cover story | 12

Incorporated financial product fees.

Compliance | 52 Required record-keeping.

Compliance | 56 Implications of employee classification.

FEATURE

IPA | 10

Leading the way | 16

Super events | 58

Regulation round-up | 11

Industry impact of SMSFs.

QUARTER II 2024 1

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

Where do we go from here? The saga of the proposed tax on total super balances over $3 million keeps bubbling away and it’s turning into a situation where just when you think it couldn’t get any worse, it does. And the most recent developments have got me asking: where do we go from here? Since the announcement of the measure, subsequent analysis has uncovered flaw after flaw associated with it from multiple perspectives, including its compatibility with the existing taxation system, core policy aspects and even the drafting of the relevant parliamentary bill. I’ve said on numerous occasions all this adds up to only one conclusion – all round it is a very poor piece of superannuation policy. The bill to bring in the Division 296 tax is still being debated in Canberra and the proceedings so far really do make you wonder what sort of rabbit hole we are heading into and exactly how dark and deep it will be. In the latest development, the Greens party has put forward a few amendments, I would describe as hare-brained, that it would like to see before it will give any support for the passing of the bill. This includes having one old anti-SMSF chestnut rear its ugly head again. To this end, the Greens want to ban the ability for SMSFs to use limited recourse borrowing arrangements (LRBA). This is because by their logic these gearing facilities allow more SMSFs to invest in the residential real estate market, in turn exacerbating the current housing shortage in Australia. Forget the fact there is no justification from a superannuation risk perspective,

from a factual point of view there is nothing to back the call up either. As the SMSF Association pointed out when the Greens declared their position, a reference to ATO 2021/22 statistics in combination with CoreLogic real estate data shows SMSFs only account for 0.7 per cent, or $76.9 million, of the country’s entire residential property market valued at $10.8 trillion. In layman’s terms you couldn’t even describe it as a drop in a bucket. The Greens also want the threshold of the tax to be lowered to $2 million. There’s a plan. If that was to be adopted, you can imagine how wide the net for this impost will be cast. Already the omission of an indexation mechanism to the measure means the tax will catch more Australians than the 80,000 originally estimated, so who knows what this number will grow to if $2 million is the trigger point. As you can see, the whole thing has degenerated into the proverbial dog’s breakfast. It highlights how problematic superannuation policy can be if a proposal does not have anything even resembling bipartisan support. But where do we go from here? Will these demands be seriously considered in any way, shape or form? And if not will the current bill experience an impasse that will prevent the measure from going through at all? Your guess will probably depend on whether you’re a glass-half-full or glass-half-empty person. Either way we can conclude this process has been most effective in further eroding people’s confidence in the superannuation system.

Editor Darin Tyson-Chan darin.tyson-chan@bmarkmedia.com.au Senior journalist Jason Spits Journalist Todd Wills Sub-editor Taras Misko Head of events and corporate partnerships Cynthia O’Young sales@bmarkmedia.com.au Publisher Benchmark Media info@bmarkmedia.com.au Design and production AJRM Design Services

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

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SMSF industry update – legislation, policy and trends

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5 July 2024 12.00pm-1.30pm AEST

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QLD 22 August 2024 Hotel Grand Chancellor Brisbane 23 Leichhardt Street, Spring Hill

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29 August 2024 William Angliss Institute 555 La Trobe St, Melbourne

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Valuations in SMSFs and the ATO’s focus

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Super Intensive Day 2024 VIC 21 August 2024 Rendezvous Hotel Melbourne 328 Flinders Street

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16 July 2024 Webinar 12.30pm-1.30pm AEST

26 September Webinar 1.30pm-3.00pm AEST

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2024 super quarterly update 5 September 2024 Webinar 12.30pm-1.30pm AEST QUARTER II 2024 3

NEWS

Div 296 tax outweighs other legislative changes By Darin Tyson-Chan

The latest Investment Trends research conducted on the SMSF sector has shown practitioners believe the proposed tax on total super balances above $3 million will be the most significant of a few current legislative changes that will impact their clients. This response was supplied when advisers and accountants were asked which of the changes to superannuation and tax law, with reference to the Division 296 tax, the non-arm’s-length expenditure (NALE) provisions and the stage three tax cuts would

have the biggest effect on their client base. “Both accountants and advisers identified the proposed tax on high super balances as the change that will have the most significant impact on their service. For accountants, 75 per cent of them said this will either have a somewhat significant impact or a very significant impact,” Investment Trends analyst Yigit Gunhan told selfmanagedsuper. “It was a similar story with advisers where 63 per cent said this change would be either somewhat significant or very significant on their servicing.” Respondents indicated the finalisation of the NALE rules

Residency rule amendment may be closer By Darin Tyson-Chan

The federal government has potentially provided an indication it will be taking action on the residency rules applying to SMSFs recently. “The current government has stated it will change the introduction date for the new residency rules to the first quarter after the relevant bill receives royal assent, which means perhaps it is thinking of bringing that measure in,” Adviser Digest director and founder Peter Johnson noted. “That’s the change to the definition of an Australian superannuation fund where the active member test will be removed, whereby you would still be able to make contributions while you’re overseas and increase the temporary safe harbour provision from two

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was the second most impactful legislative change for their customers. “Looking at accountants in particular, the second issue they identified as having at least a somewhat significant impact is the amendments to non-arm’s-length expenditure. Further, 15 per cent anticipate this to have a substantial impact,” Gunhan said. Overall, 51 per cent of accountants said the NALE rules would be significant for their clients, while 31 per cent of advisers who took part in the study shared this sentiment. The stage three tax cuts were ranked the least noteworthy legislative change out of the three

years to five years.” Johnson recognised the legislation as it stands actually presents an issue for SMSF auditors in their reporting obligations. “When you read the ruling on nonresidency, and this is important for auditors, if the fund becomes non-resident, it loses half of its assets in tax and this needs to be reported. To this end, I’d imagine 45 per cent of the total assets in the fund would be material error in the financial statements,” he said. According to Johnson, the government should be making a change to the existing wording to achieve its aim of relaxing these rules. “The act says if you’re temporarily outside of Australia for up to two years, you’re still deemed to be in Australia. Under the common law residency test, and this is what we adopt because it’s a tax matter, if you are temporarily outside of Australia, you are considered to be ordinarily a resident of Australia,” he noted. “If you are permanently outside of Australia, the minute you leave you are no longer considered to be an Australian resident so the superannuation safe harbour rules don’t apply. “I think the government wants the safe

initiatives. To this end, 15 per cent of accountants thought the tax package would have a very significant impact on clients, while 26 per cent believed it would have a somewhat significant effect. When assessing adviser responses, 5 per cent indicated the new tax cuts would be very significant for their services, while another 28 per cent thought the change would be somewhat significant. The analysis was performed from information gleaned from an online survey conducted during February and March in which 652 accountants and 177 advisers participated.

harbour rules to apply more broadly so it needs to remove that word temporarily and leave it at two years. “So that’s probably why they have to draft it correctly because at the moment the safe harbour rules mean nothing because you have to be temporarily outside of Australia and if you are temporarily outside of Australia, you are still in Australia so it doesn’t matter.” The amendments to the superannuation residency rules were first proposed in the 2021 federal budget.

Peter Johnson

NEWS IN BRIEF

BDBN ruling upheld The full Federal Court has upheld the Australian Financial Complaints Authority’s (AFCA) position to validate a binding death benefit nomination (BDBN) on the basis there was no formal termination of the relationship between the parties involved. In the case of Nguyen v Australian Financial Complaints Authority [2024] FCAFC 77, Victorian man Pino Corbisieri took out an insurance policy with NM Superannuation Pty Ltd and nominated his de-facto partner, James Nguyen, to receive 100 per cent of the BDBN, valued at $1.122 million, upon his death. However, on the morning of his death, Corbisieri sent a message via WhatsApp to his sister stating he wanted all his property and assets to go to his family and Nguyen should receive nothing because “he has put me in the position or stage of my life where I had enough”. Subject to this message the super fund trustee did not recognise Nguyen as Corbisieri’s spouse and did not honour the BDBN. On appeal AFCA overturned this action and this decision was subsequently contested successfully. The matter was then taken to the Federal Court where the AFCA ruling was endorsed.

New trustees like crypto SMSFs established in the past 12 months have favoured higher allocations to cryptocurrency than their established peers, with

a desire to choose these types of investments a key driver in the creation of the new funds, according to Investment Trends. The research house’s analysis indicated newly established funds have a 7 per cent allocation to cryptocurrency compared to less than 1 per cent for all SMSFs. Further, Investment Trends found the cohort of individuals who had been SMSF trustees for less than one year had a larger holding of cryptocurrency within the superannuation environment. To this end, it was revealed allocations to these digital assets accounted for 6 per cent of their investment portfolios outside of their SMSF.

Auditor’s report updated The ATO has released key changes to its SMSF independent auditor’s report (IAR), reflecting updates to the quality management requirements released by the Auditing and Assurance Standards Board in early 2021. The regulator stated the new IAR, carrying the code NAT 11466, has removed the reference to Auditing Standard ASQC 1 from Part B of the report and replaced it with a reference to Auditing Standard ASQM 1. In a related update on its website, the ATO further explained the change, noting Part B of the IAR was changed for the reporting period starting 1 July 2024 as ASQC 1 had been superseded on 15 December 2022 by ASQM 1 and systems of quality management in compliance with the new standard had to be in place by that date. The new IAR is available directly

from the ATO’s website, which has highlighted differences in its application for various financial years. “For all audits completed on or after 1 July 2024 you must use the SMSF independent auditor’s report NAT 11466. This includes audits you complete on or after this date regardless of what income year they apply to,” the ATO stated.

Lifestyles impacting downsizer A mid-tier accounting firm has noticed the inability to find a suitable residence to move into is preventing some retirees from disposing of a property to take advantage of the downsizer contribution provisions. “I’ve found most of my retiree clients [are living in a house that is] just way too big for them, for example, they never go up to the second level anymore, but they’re not able to find [a smaller property they like] out there and often the apartments they consider are too small,” HLB Mann Judd Sydney wealth management partner Jonathan Philpot revealed. To this end, Philpot noted often these individuals are still looking for a residence with at least three bedrooms. Fellow HLB Mann Judd Sydney wealth management partner Michael Hutton concurred and suggested retirees were using a particular rule of thumb to assess if a downsized property was applicable for their requirements. “They talk about the Christmas Day test. That is, if the family comes over on Christmas Day, [will they be able] to fit the whole family in [the new home].”

QUARTER II 2024 5

NEWS IN BRIEF

Focus on crypto reporting SMSF trustees should accurately document the sale of digital assets in their fund’s annual return as the ATO is cross-matching data from other sources to ensure compliance with reporting requirements. “The ATO has mentioned they are going to acquire data from cryptodesignated service providers for the 2023 financial year right up until the 2026 financial year and they are going to match it against their own systems to identify clients who fail to report a disposal of crypto-assets in the income tax return,” Institute of Financial Professionals Australia head of superannuation and financial services Natasha Panagis said. “If clients are using any entity to invest in crypto, the ATO is on the lookout and is going to be datamatching between those crypto data platforms and their own platforms to make sure that tax is recouped if people are selling their crypto-assets. “Be aware for clients of yours that might have an SMSF [holding cryptocurrencies] that change is going to happen.” Panagis noted the ATO took this course of action because no framework exists to regulate the asset class and SMSFs continue to report substantial losses from investing in cryptocurrencies.

SAN errors being made Accountants are making errors when lodging the annual return on behalf of their SMSF clients due to confusion over how to allocate the taxable components

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of superannuation payments. BT technical consultant Matt Manning observed some practitioners were struggling to distinguish between the tax-free and untaxed components of superannuation benefits and were reporting them incorrectly, leading to adverse outcomes for fund members. “I dealt with one particular case recently where the client asked me why they are paying so much tax in their return. I took a quick look and they’re not a particularly high-income earner and they received a tax bill for $30,000. So what went on here?” Manning said. “One of the biggest errors I see [is] the accountant on a superannuation withdrawal has declared the taxfree component in the untaxed component, which does happen from time to time.” He clarified accountants rarely need to allocate amounts to the untaxed component in an annual return as there are very few situations that require it. To this end, he recognised instances where this action would be necessary would mostly be when a death benefit is paid to a non-tax dependant broadly containing insurance.

Safe harbour rates rise The interest rates applied to related-party lending under a limited recourse borrowing arrangement (LRBA) have increased for the next financial year, but at slower rate than in the current year. The new safe harbour rate that ensures a related-party loan is consistent with arm’s-length dealings has risen by 0.5 per cent to 9.35 per cent for real property and by the same amount for listed shares and units, rising to 11.35 per cent for the 2025 financial year. The increase is less drastic than the

one that took place at the start of the 2024 financial year when real property rates rose from 5.35 per cent to 8.85 per cent and the listed shares and units rate increased from 7.35 per cent to 10.85 per cent. SMSF Alliance principal David Busoli said where an LRBA was reliant on related-party borrowings, it was very important that arrangement was properly administered to avoid a breach of the non-arm’s-length income rules, which carries harsh penalties

CSLR payments made The Compensation Scheme of Last Resort (CSLR) has made its first payments totalling $360,000, including a payment close to the maximum allowed under the scheme to a couple who received inappropriate advice regarding an SMSF. The CSLR stated it had paid $145,000 to a couple from southern Sydney who had received inappropriate advice from their financial planner relating to an SMSF. Another couple in the west of that city received $150,000 in compensation in relation to superannuation advice the Australian Financial Complaints Authority (AFCA) ruled was not tailored to reflect their circumstances or goals and in which the risks were poorly explained and it failed to consider alternatives. Two further compensation payouts were made in regards to borrowings, with a man from Sydney’s northern beaches receiving just under $17,000 after taking out a loan on the advice of a financial adviser to invest in a scheme with ‘guaranteed returns’, while a further $50,000 was paid to a Queensland couple who were advised by a mortgage broker to take out a loan that was inappropriate for their circumstances.

SMSFA

Advised SMSFs take a bad turn

PETER BURGESS is chief executive of the SMSF Association.

On the surface, it’s a good news story for the SMSF sector. The “Vanguard/Investment Trends 2024 Investor Report” shows the overall number of SMSFs continues to climb as establishment rates rise and wind-ups fall. There are now about 615,000 SMSFs following the establishment of 29,007 funds for the year ended December 2023, up from 25,813 in the previous year. The report, which was conducted between February and March 2024, and released in April, also highlights that trustees are setting up their SMSFs earlier – the average age is 46 – with an average balance of $320,000, a figure comfortably above the $200,000 threshold considered necessary to be as cost-effective as larger funds. In addition, SMSF average balances are at their highest, exceeding $1.5 million, nearly double what the average balance was in 2009. This all suggests a heathy SMSF sector that’s proving increasingly attractive as a superannuation option for individuals, couples and families. But beneath the surface, the report reveals a disturbing trend. Increasingly, SMSFs are being established without specialist advice, with the report showing nearly 40 per cent of funds were established after doing “internet research” and nearly 30 per cent after getting advice from a “friend or colleague” who was an SMSF member. The increasing reliance on the internet and social media for financial advice aligns with the growing influence of ‘finfluencers’ in Australia as the distinction between factual information and financial advice becomes increasingly blurred. In sharp contrast, the number of SMSFs being established after seeking professional advice has declined rapidly since 2015. The report shows since 2019 less than 15 per cent of SMSFs have been established after seeking professional advice from either an adviser or accountant. This is down from around 50 per cent between 2015 and 2019. The optimistic view is these new entrants to the sector know how to manage their superannuation. But in many instances this is not supported by the data, with ATO figures showing the unauthorised access to superannuation by SMSF members has reached significant figures – $381 million in 2019/20 and $256 million in 2020/21 – being one obvious manifestation of this. Another indicator is the dramatic

increase in trustee disqualifications in recent years. Indeed, the evidence suggests people are either getting poor advice – the “helpful” friend or colleague – or no advice. Consequently, SMSFs are being established for the wrong reasons, mistakes are being made, some costly, and in some cases there’s a deliberate breaching of the rules of which illegal early access of benefits is just one example. It’s always been our mantra SMSFs are not for everyone and those who opt to go down this path should get specialist advice. And it’s not just an issue of being advised on whether to establish an SMSF. For many SMSFs, specialist advice should be a necessary ingredient of their superannuation journey. Yet, as the report shows, the number of nonadvised SMSFs stands at a record high 475,000, while adviser use is at an all-time low with only 140,000 funds being advised in 2024, down from 160,000 in 2023 and 205,000 in 2019. Worryingly this year’s report also found newly established SMSFs are less likely to use advisers than established SMSFs. According to the report, the three key reasons cited for not seeking advice are the ability to manage their own financial affairs, the perceived high cost of advice and not currently needing advice. Previous poor experience with advisers comes a close fourth. To this list the SMSF Association would add the virtual exclusion of accountants from giving advice is a critical factor. In saying this we are not advocating breathing life back into the now defunct accountants’ exemption or the poorly calibrated limited licence regime as neither are fit for purpose. Accountants play an important financial role in the life of so many who want to set up an SMSF, such as farmers, professionals and small business owners, but are now excluded from having an input into their superannuation. It seems nonsensical. The fact this issue was ignored by the Quality of Advice Review was a missed opportunity. In urging a bigger role in SMSFs, we are not advocating encroaching on the financial advisers’ turf. This is not the role accountants want to play. But a regulatory environment that allows appropriately qualified accountants to provide limited advice on issues, such as establishment, fund wind-up and making contributions, and financial advisers to provide specialist sector advice in a cost-effective manner would be enormously beneficial to many SMSF members currently on auto-pilot.

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CPA

Review needed now with impending Div 296 tax

RICHARD WEBB is superannuation leader at CPA Australia.

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In an increasingly complex landscape, it is essential SMSF trustees regularly review their investment strategies. This is important as the investment landscape evolves, but also where regulatory frameworks shift, and where a fund is managing large unlisted assets, this presents different risks to funds than listed assets. With changes to tax fund earnings on larger superannuation balances proposed for July 2026, the issue of liquidity is likely to loom larger than normal. Although an investment strategy requires explicit review of funds’ liquidity risk, other factors, such as reinvestment risk and pricing/valuation risk, can also be present due to the illiquid nature of these assets. Consequently, an investment review provides the opportunity to review a fund’s exposure to these risks and examine ways to manage it. Large unlisted assets present in SMSFs can include private equity investments such as small business assets, real estate, including farms and business real property, and other assets that don’t necessarily have liquid markets. These assets can offer substantial returns and diversification benefits. Ordinarily they may form part of a compliant investment strategy that is appropriate to meeting the best financial interests of the fund and its members. However, they can also come with inherent significant risks that can impact the overall health and performance of an SMSF, particularly in terms of liquidity, reinvestment and valuation. Trustees should already be aware of any potential difficulties in converting assets into cash. Long periods can elapse between the decision to dispose of large unlisted assets through to final settlement. For members with total superannuation balances of more than $3 million, it is possible these changes have the potential to increase the need for liquidity within SMSFs. This need poses significant uncertainty and any future liquidity requirements to meet potentially larger future tax bills need to be factored in. Trustees must therefore continue to re-examine the reasons to hold large unlisted assets in a fund’s portfolio. Another issue is, in some cases, the extended timeframes needed to sell these assets open up the fund’s exposure to adverse market conditions that can dramatically affect the proceeds upon disposal. But even before considering the sale of assets, an additional complication is that where ordinary fund earnings tax only assesses capital gains realised on

disposal, the proposed Division 296 tax would assess unrealised capital gains, raising the need for additional liquidity. Right now trustees should be considering the likelihood of changed liquidity requirements to determine whether assets need be sold in a timely manner without incurring significant losses or disruptions to their fund’s financial stability. But liquidity is not the only consideration. Disposal of these assets can crystallise reinvestment risk, that is, the risk an asset that may have been invested in for reasons such as particular risk or return characteristics, may not have similar replacements available elsewhere if the asset was to be disposed of. Large unlisted assets can be unique and this may significantly limit the availability of similar investment opportunities. Likewise there is a degree of uncertainty associated with accurately valuing large unlisted assets because, unlike listed assets, they do not have readily available market prices, making their valuation more complex and subjective. These valuations can be significantly different to prices realised upon disposal. Under the proposed Division 296 tax there is a new risk a favourable valuation could lead to an assessment for the tax only for this assessed value to vanish upon disposal. Due to the lack of a clawback feature in the event of investment losses, pricing/valuation risk also means assessed tax can be unrecoverable in a future investment period. The implications of the proposed changes are farreaching so trustees should proactively investigate the potential impacts on their SMSFs. This could include conducting a liquidity stress test to determine the fund’s capacity to meet the new tax requirements. If the decision is to dispose of significant unlisted assets, it is essential to explore the feasibility and timing to ensure adequate liquidity is available when needed. Naturally, any applicable fund earnings tax assessable on realised capital gains needs to be considered as well. Large unlisted assets present unique challenges to SMSFs not found in other asset classes. By being aware of investment risks, trustees can ensure their funds remain resilient and capable of meeting new regulatory demands. Proactive planning and regular reviews are essential to safeguard the financial health of SMSFs in an increasingly complex and changing investment environment.

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IFPA SISFA

LRBAs at risk again

NATASHA PANAGIS is head of superannuation and financial services at the Institute of Financial Professionals Australia.

Limited recourse borrowing arrangements (LRBA) are back under the spotlight again as the Greens have pressured the government to ban SMSFs from borrowing to invest in return for their support for the bill to implement the Division 296 tax currently before parliament. The recommendation comes as the Division 296 bill was referred to the Senate Economics Legislation Committee for inquiry and report. Unsurprisingly, the recommendation from the committee was that the bill be passed without amendments. However, at the end of the committee’s final report, the Greens also recommended LRBAs should be abolished as allowing SMSFs to continue borrowing to purchase investment properties under this proposed tax structure would be a recipe for disaster. The key reason behind banning LRBAs is to ensure financial risks aren’t amplified by combining taxes on unrealised capital gains with borrowings by superannuation funds. The Greens view is that paying tax on lumpy assets while having an LRBA could cause too much risk. For those who remember Labor, when in opposition, previously proposed a ban on LRBAs in the lead-up to the 2019 election following a recommendation by the 2014 Financial System Inquiry (FSI) as part of its plan for housing affordability. The FSI considered prohibiting direct borrowing by superannuation funds would prevent unnecessary build-up of risk in the super system and the financial system more broadly. However, the coalition government at the time responded to the FSI in 2015, stating it did not agree with this recommendation, but commissioned the ATO and the Council of Financial Regulators (CFR) to monitor leverage and risk in the superannuation system and report back to government after three years. This report was completed in February 2019 and found LRBAs were used almost exclusively by SMSFs and while the level of this borrowing was not significant enough to pose a material systemic risk to the superannuation system or broader financial system, some individuals were putting their retirement savings at significant risk by using this gearing feature in inappropriate ways.

Rather than prohibit the use of LRBAs to reduce the risks identified, the report recommended continued monitoring of them and commissioned a further report by the ATO and CFR in another three years, which was due in February 2022, but finally provided in September 2022. Consistent with the first report prepared in 2019, the second report found LRBAs are unlikely to pose a material risk to the superannuation system or broader financial system and recommended continued monitoring and reporting on an ‘as needed’ basis to ensure appropriate oversight of these risks. But if we look at the most recent ATO annual statistics, only 11 per cent of SMSFs have an LRBA in place and these borrowings represent just 2.7 per cent of total assets for the sector. Furthermore, the 2022 CFR report provided insights into research conducted by the Reserve Bank of Australia indicating the nominal growth in LRBA investment in real property has had a modest impact on property prices in recent years as SMSFs only make up a small share of overall housing credit. This indicates SMSFs are not significantly driving up property prices or pushing buyers out of the housing market. While borrowing strategies are not appropriate for everyone, LRBAs have been an important tool for the SMSF sector. We often see LRBAs used as part of legitimate SMSF investment strategies for small business owners through the purchase of their business real property, as well as by other trustees investing in residential property. Rather than focus on the financial risks that may arise due to paying Division 296 tax on lumpy assets held under an LRBA, the government should focus on having a tax measure that is appropriately designed in a fair and equitable way, rather than taxing individuals on unrealised gains. There’s no denying LRBAs can represent a significant risk to some individuals’ retirement savings, particularly where they have low-balance SMSFs with high asset concentration and/or personal guarantees. However, this is where professional advice is key as it can help clients weigh up their options and ensure their investment strategy meets the members’ objectives and the legislative requirements. It would be a shame to see LRBAs banned due to political pressure being applied as a negotiation tool rather than what’s best for the SMSF sector.

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IPA

Poorly designed law looming over super

TONY GRECO is technical policy general manager at the Institute of Public Accountants.

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The proposed legislation introducing an additional impost on high-balance superannuation accounts in excess of $3 million, known as the Division 296 tax, has been referred to the Senate Economics Legislation Committee. The committee has rubber stamped its approval for the government to proceed with a majority recommendation to pass it unaltered. Only the Senate stands in its way. There was no mention of the new impost in the most recent federal budget other than to set aside over $9 million to help implement it for members of commonwealth defined benefits schemes, which points to the extra administrative burden this new impost will create on all funds more broadly. Instead of collaborating with key stakeholders to devise a practical framework to tax individuals with high super balances more, the government has chosen to push through a framework that adds unnecessary complexity, is inequitable and will result in unintended outcomes. What is not in question is the government’s right to reduce the concessionary tax benefits for those in a fortuitous situation and with a high balance. These impacted superannuants have done nothing wrong other than taking advantage of more generous contribution rules that are no longer available. It’s a legacy issue as it is quite difficult to accumulate a high balance with the existing contribution caps in place. It is estimated 80,000 superannuants will initially be impacted and this number is expected to increase over time as the threshold will not be indexed. Sound design principles of equity, simplicity and efficiency should still apply, irrespective of how many taxpayers might be impacted. The proposed policy’s complex design features are likely to increase the cost of administering the superannuation system more broadly. This new impost may discourage many from making additional contributions towards their retirement, potentially leading to unintended and detrimental outcomes. Another problem is the potential net revenue from this measure. Some individuals may move their super fund assets into alternative structures if they have met a condition of release and are able to do so. One of the policy’s centrepiece design aspects involves taxing unrealised gains, which is likely to cause cash-flow concerns for several funds and

set a dangerous precedent for our taxation and superannuation systems. Asset values can fluctuate wildly from year to year, resulting in little similarity between the actual gain made when realised and any tax paid while the asset was held based on the movements in its unrealised value over time. There is a good reason why this established principle is adhered to: it follows the money. In most cases, when assets are realised, there are proceeds to deal with any resulting tax liability. What makes the proposed policy even more flawed is there is no automatic refund of tax paid when the unrealised amount turns negative. Some might think it is starting to sound like a casino where the odds are stacked against you and they wouldn’t be far from the truth. Taxing unrealised gains without allowing timely recognition for losses other than negative superannuation earnings is inequitable. This is particularly important as there are many instances where carried-forward losses may never be used. Taxpayers should be able to use their current year’s losses to the extent they have paid Division 296 tax in a prior income year. A two-week consultation period after the initial announcement was a clear sign the government was not interested in considering other alternatives. Industry representatives appeared before the Senate Economics Legislation Committee and outlined the serious concerns about the proposed framework, which fell on deaf ears. Even though this cohort only represents 0.05 per cent of the Australian population, the law still shouldn’t be inequitable or complex. Proper tax law design around efficiency, fairness and equity should not be ignored irrespective of the number of individuals impacted. The superannuation system already has enough complexity and adding poorly designed law makes little sense when there are many alternatives to reduce the concessionary benefits super provides for wealthier Australians. Given only 80,000 individuals are immediately impacted, there seems to be little sympathy for opposing these inherently unfair measures to calculate this additional impost. The bigger issue is the way we tax superannuation needs reforming more holistically rather than a piecemeal approach that adds unnecessary complexity.

REGULATION ROUND-UP Division 296 tax regulations released

Nicholas Ali is SMSF technical services director at Neo Super.

The draft regulations in the Better Targeted Superannuation Concessions Bill contain provisions enabling the calculation of Division 296 tax for defined benefit interests. This is to deliver similar treatment as for accumulation benefit interests. This measure includes outlining methods to value defined benefit interests and making modifications to the Division 296 earnings formula to appropriately capture notional contributions attributable to defined benefit interests. The draft regulations also update existing methods to calculate notional contributions for defined benefit interests to reflect up‑to‑date economic parameters.

NALE bill passes Senate The non-arm’s-length expenditure (NALE) legislation was approved by the Senate on 27 March. The draft legislation, the (Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Bill 2023, which includes a limit on general NALE for SMSFs, now awaits approval from the House of Representatives. To quickly recap, the bill will, when it becomes law, reduce the tax impact where a lower or nil general expense is incurred by an SMSF by imposing an upper cap on the amount that is taxed as non-arm’s-length income under section 295-550(1)(b) and (c) of the Income Tax Assessment Act 1997. This cap is in the form of a two-times multiplier of the amount of the general expense not paid by the super fund taxed at 45 per cent.

Low-cap rate becoming redundant From 1 July, the preservation age will reach its final age level of 60, meaning individuals will reach their preservation age and when benefits can be received tax-free at the same time. Therefore, the low-cap rate ($235,000 for 2023/24) and the 15 per cent tax rate for taxable components above the cap withdrawn from super as a lump sum will become irrelevant. However, individuals under preservation age accessing their benefit as a lump sum will still be subject to 20 per cent tax on the taxable component (plus the Medicare levy).

Federal budget There were no notable announcements regarding superannuation, which is good, but many previous announcements were not addressed, such as residency issues and the commutability of legacy pensions. Some relevant inclusions are listed below: • The equivalent of superannuation guarantee (SG)

on paid parental leave (PPL) for children born or adopted after 1 July 2025 based on SG payments (12 per cent of their PPL). • The projected tax take from superannuation has been revised lower, forecast to be down $12.8 billion over the forward estimates. • More unclaimed superannuation monies being united with their members. • The government will provide $187 million over four years from 1 July 2024 to the ATO to strengthen its ability to detect, prevent and mitigate fraud against the tax and superannuation systems. • The government will also recalibrate the Fair Entitlements Guarantee Recovery Program to pursue unpaid superannuation entitlements owed by employers in liquidation or bankruptcy from 1 July 2024. • It will also allocate $9.2 million over four years from 2024/25 (and $1.1 million per year ongoing) to the Commonwealth Superannuation Corporation and the Department of Finance to implement the 2023/24 budget measure, Better Targeted Superannuation Concessions, for members of the commonwealth defined benefit super schemes. Again, there was reference to the government’s proposed objective of super, but the devil could be in the detail here. • Labor has committed $2.7 million over four years from 2024/25 (and $700,000 per year ongoing) to support the SuperStream Gateway Network Governance Body, an industry-owned not-forprofit organisation, to manage the integrity of the Superannuation Transaction Network, which allows gateway members to transmit contribution data between employers and superannuation funds, with funding provided through the ATO.

LRBAs under fire (again) Limited recourse borrowing arrangements (LRBA) are, once again, being attacked by political parties as increasing financial risk in the superannuation system and crowding first-home buyers. However, the facts do not support this assertion. The Council of Financial Regulators (CFR) has reiterated in two recent reports, in 2019 and 2022, that borrowing by SMSFs through LRBAs does not pose a material risk to the superannuation system or broader financial system since first permitted in 2007. What was recommended in the findings is action should be taken against individuals who can be at risk with their retirement savings. The CFR is comprised of the Australian Prudential Regulation Authority, Australian Securities and Investments Commission, Reserve Bank of Australia and Treasury.

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FEATURE

NO EXIT The status of legacy pensions

A dictionary definition for legacy indicates a gift, especially of money or personal property, but also of something received or carried over from the past. Often these historical oddities are no longer fit for purpose and this is very much the case for legacy pensions. Jason Spits writes the looming prospect of the Division 296 tax means it is more urgent than ever to find a way to leave the past behind.

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FEATURE LEGACY PENSIONS In 2007, Apple released the first version of the iPhone, hastening the movement of smartphones from the hands of the tech savvy into those of the mass consumer market. If you used an earlier phone, it is unlikely today you would still want to do so, let alone be forced to do so because of some restriction under law that prevented you from moving on. Yet for some superannuation fund members, including those with SMSFs, that’s the situation they find themselves in when it comes to the retirement income stream derived from their fund. They are locked into legacy pensions (see Pensions Ain’t Pensions below) that are hard to exit in some circumstances and still require regulatory intervention to allow them to move into another product or out of the income stream altogether. The federal government is not unaware of the issue, with successive ministers being briefed on the matter and making noises something will be done, but despite assurances a fix is on the way, the only place a solution can be found is on the wish list of the SMSF sector. One of the reasons for this is perhaps the government has other superannuation matters it wants to pursue, such as the introduction of the non-arm’s-length expenditure provisions and the proposed Division 296 tax. Alternatively, it may be the cohort of people affected, estimated at 8000, is too inconsequential for it to be a priority, despite only requiring simple changes to super and social security laws. However, the clock is now ticking because the implementation of the Division 296 tax will add a further layer of complexity to using these pensions and exiting them in the future, while placing more pressure on recipients and advisers to act. History repeating Accurium head of SMSF education Mark Ellem says the issues facing legacy pensions are not new and stem from the Simplified Super changes introduced in 2007, which effectively ended the need for them. “SMSFs have not been able to start a new defined benefit pension, such as a lifetime and life expectancy pension, since 1 January 2006 and since 20 September 2007, they could not start a market-linked pension (MLP)

excess to get back under the TBC and the excess becomes taxable,” Ellem explains. He adds, however, an older MLP could be commuted if a new one is started because, since 1 July 2017, it would not be treated as a capped defined benefit income stream. It means any payments from the new income stream will not be taxed under the defined benefit income cap and the pension itself will be assessed for TBC purposes under the account-based pension (ABP) rules, so any balances at commencement will be subject to excess transfer balance tax.

“If a legacy pension can’t be commuted inside the SMSF, it can be commuted to a retail product, but there are limited options available. For MLPs there is only one term allocated pension option and if there is only one product, that’s not an option.” – Mark Ellem, Accurium

from a member’s accumulation interest,” Ellem notes. “Where they could start a new MLP after that date was if the pension was commenced as a result of a commutation of a complying pension, which includes lifetime pensions, life expectancy pensions and pre-2007 MLPs.” While this transfer between these income streams sounds relatively simple, it was made more complex by the introduction of the $1.6 million transfer balance cap (TBC) for pensions in 2017, leading to issues every time an SMSF member looks to exit an older pension. “The issue with the TBC is since the older-style MLPs are non-commutable, where someone has more than $1.6 million in that pension it is not possible to roll back the

Opening the door Thankfully this is mostly history now as regulatory changes effective from 5 April 2022 have removed these barriers by allowing legacy pension holders to exit them by starting a replacement MLP. Heffron SMSF technical and education services director Leigh Mansell says the change allows people to make the transition from a legacy pension and all of its money, including reserves, can be moved to the new MLP without triggering any concessional contributions, while any TBC excess can be commuted back to accumulation mode within the fund. However, Mansell points out the treatment of the excess has some issues. “The downside of restructuring is the creation of the excess, which is taxed as earnings as soon as the member exceeds the TBC figure of $1.6 million, and that excess can’t be commuted in any way until a commutation authority is issued by the ATO,” she explains. “This currently takes three to four months and the whole time the excess is attracting a general interest charge, which at present is 11.36 per cent per annum, and is applied at a daily compounding rate. “With this long wait, the tax on the excess might look big, but legacy pension holders should view it in light of their pension level and what they hope to take out of the old income stream.” The other flaw is if a legacy pension does not exceed the TBC, it can only be rolled over into a new MLP, which is still noncommutable during the lifetime of the holder. “It all comes down to the fact you can get out if you can create an excess. How do you do that? Sometimes by restructuring what you’ve got or by adding an account-based pension to the mix, but to do so you need to Continued on next page

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FEATURE LEGACY PENSIONS

“We have flagged with Treasury the run-up to the introduction of the Division 296 tax would be a good opportunity for an amnesty and they are open to it, as well as how to deal with reserves. So we are confident it will be in place before the proposed tax applies.” – Peter Burgess, SMSF Association Continued from previous page

have accumulation money and not all legacy pension holders do.” Left in reserve The April 2022 changes also don’t address what happens to reserves used to fund a legacy pension and Ellem acknowledges there are very few options on the table. “If a legacy pension can’t be commuted inside the SMSF, it can be commuted to a retail product, but there are limited options available. For MLPs there is only one term allocated pension option and if there is only one product, that’s not an option. If it’s a lifetime pension, they have to be rolled over to a complying annuity and there are no retail products available,” he says. This may not be of concern to some legacy pension holders, Mansell adds, as the reserves were created in the days of reasonable benefit limit compressions and exiting the pension would expose those SMSFs to tax. Alternatively, pensions drawn from the reserves may have some form of asset test exemption they might want to retain. These arrangements though may be fine during the life of the pension recipient, but the fate of reserves after their death becomes very complicated. “The problem is the reserves are not a member benefit and they become locked in the fund after death. It means you need to approach the ATO for a ruling to get them out as part of a member’s balance. In doing so, they will be treated as a concessional contribution and if the reserves are large they can blow the cap and will be taxed to the hilt,” Mansell warns. “However, if the reserves can be removed from the legacy pension while the member is alive, then at death they are treated with the other SMSF assets as a death benefit and only taxed at 15 per cent.”

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The Division 296 deadline While the SMSF sector has been pushing for wider changes to allow any person to exit any legacy pension without penalty, the pressing task has been making holders of these income streams, most of whom are estimated to be in their 80s, aware of their options and what it means in the present and for their estate planning. However, the proposed introduction of the Division 296 tax, which will add an additional 15 per cent tax to the earnings of total super balances (TSB) above $3 million, has created a finite timeframe to act, according to MLC TechConnect senior technical services manager Julie Steed. Steed highlights that legacy pensions are included in the TSB definition used to calculate the impost in a different way than ABPs currently in use by SMSFs. “For pension holders who have rolled over to an MLP, calculating the account balance for the Division 296 tax will be simple as only its withdrawal value will be considered,” she says. “Valuations for ongoing legacy pensions will need an actuary to be involved as they will be based on the pension credit for the 2017/18 financial year and revalued at 30 June each year for Division 296 purposes using family law split factors.” While this is likely to create added cost and complexity, Ellem adds any exit from a legacy pension under the Division 296 regime may also push a fund member past the $3 million threshold. “Legacy pension holders will need to consider the effect of any restructuring from 2025/26 onwards because if they start a financial year with an older income stream and move it to a new MLP, there could be a large difference in TSB,” he explains. “This may occur because the movement of reserves out of a legacy pension will be treated as earnings for TSB purposes and the

Division 296 tax could apply. “Where the member has a noncommutable pension, they will not have the option to move at all, even if they are over 65, and may also be hit with the new tax.” Taking it all The favoured solution to the problems with legacy pensions is to allow an amnesty for those who hold them to not only exit them, including the associated reserves, but to do so without any further taxes being imposed on the way out. SMSF Association chief executive Peter Burgess says this has been a request of the sector for a number of years and the closest it has come to being delivered were plans contained in the 2021 budget that were not enacted. “When the plans for an amnesty were contained in the 2021 budget, legacy pension reserves were going to be treated as a contribution. Our preference is to allow legacy pensions to exit without any tax at all,” Burgess confirms. “The pension holders have not broken any laws and entered into those arrangements for good reasons under the legislation in operation at the time. As such, we shouldn’t be taxing reserves or legacy pension balances, but allowing them to be converted to a newer income stream.” He recognises a fixed-length amnesty may not deal with all legacy pensions though because some people may choose to continue with them due to the associated benefits, which will result in an even smaller cohort trapped at the end of the amnesty. “We would not be in favour of forcing people out of a legacy pension, but the government can make it attractive enough for people to want to move out. They could create incentives such as removing any grey Continued on next page

FEATURE

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areas about what happens to reserves on the death of the member,” he says. “We have flagged with Treasury the run-up to the introduction of the Division 296 tax would be a good opportunity for an amnesty and they are open to it, as well as how to deal with reserves. So we are confident it will be in place before the proposed tax applies.” Time to choose Steed believes sooner rather than later should be the timetable adopted for announcing any amnesty, even though the critical date for when the first Division 296 tax calculations will take place is 30 June 2026.

“The government does not need to announce an amnesty before the new tax regime starts on 1 July 2025, but it would be good to have it by then because these types of changes take planning and the way the Division 296 tax formula works some people may want to commute before that date,” she says. While the clock is ticking, she doesn’t advocate a “get out while you can” approach due to the differing circumstances of each individual. “Look at your clients and whether they should wait for an amnesty or is the April 2022 MLP approach suitable for them now?” she says. Mansell also sees the need to act now, but

not in haste and stresses being fully aware of all of the issues at hand is imperative. “If a client needs to restructure, leave enough time to do it because while June 2026 seems a long time away, it is not if you have to restructure these funds,” she adds. “No client will be the same and if they move out of a legacy pension, where will they go and what will the tax cost of that move be? If there is no amnesty, can you generate an excess to roll out of that pension? “There are fewer people who understand legacy pensions now, so more time will be needed to address any changes. It is going to be hard for some pension holders due to their lack of knowledge and the same may apply to the advisers assisting them.”

The term pension is used frequently in the SMSF sector in reference to what happens when funds move from the accumulation to the retirement phase and are paid periodically to a beneficiary, and for most practitioners and trustees the vehicle they will be familiar with is an account-based pension (ABP). This name refers to the retirement income stream that comes from a superannuation account and an ABP can be, in most cases, a market-linked pension (MLP) as the pension interest is linked to the market value of the underlying assets. However, ABPs were preceded by a series of older products collectively described as capped defined benefit income streams from 1 July 2017. This group

included lifetime pensions commenced at any time, life expectancy pensions and market-linked income streams (also known as term allocated pensions), which commenced prior to 1 July 2017. The names get a bit more confusing as lifetime and life expectancy income streams are defined benefit pensions so there are restrictions on how they can be used and how to exit them. These restrictions also apply to market-linked income streams as they too have a defined outcome set by the length or term of the pension when it was first created. Given all of these arrangements can no longer be offered via an SMSF, but can still operate, they fall under the title of legacy or complying pensions.

The rules governing their operation are contained in Superannuation Industry (Supervision) Regulation 1.06, subsections 2, 6 and 7, and require at least an annual payment to the pension recipient. Beyond that they differ from each other, and from current pension models, in that the annual payments are not based on an identifiable account balance and how that payment is calculated varies between the three types of income streams. What they do have in common is they can’t easily be partly or wholly commuted back to the accumulation phase or cashed out as a lump sum. Steps have been taken to create an exit methodology to move legacy lifetime pensions and market-linked income streams into new MLPs, but there are conditions around how this operates and it remains an incomplete solution for all funds.

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FEATURE

The SMSF sector has experienced strong growth and provided great satisfaction for its members, but can it continue? Todd Wills takes stock of the industry’s successes, areas for improvement and future prospects.

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FEATURE THE LEADER OF THE PACK

SMSFs have come a long way. Over the past decade, 110,000 new SMSFs have been established, adding 200,000 members, and the value of the assets they hold has almost doubled to over $900 billion. In the past year alone, over 1600 new funds were established per month on average. Originally described by former prime minister and treasurer Paul Keating as “an afterthought added to legislation as a replacement for defined benefit schemes”, SMSFs have evolved into a robust industry with its own growing ecosystem of professionals and practices. Recent evidence suggests the sector is not only thriving, but also setting benchmarks for retirement outcomes. For instance, the “2024 Vanguard/ Investment Trends SMSF Report” indicates SMSF members are less worried about outliving their retirement savings compared to those in Australian Prudential Regulation Authority (APRA)-regulated funds. Similarly, Roy Morgan’s January 2024 “Superannuation Satisfaction Report” found SMSFs have the highest member satisfaction among all superannuation options, reaching a two-year high. SMSF members appear to be entering retirement with more confidence compared to their counterparts in APRA-regulated funds. However, it’s worth considering why this is the case and whether it will always be so. This was a central focus of the thought leadership breakfast held on the first day of the 2024 SMSF Association National Conference in Brisbane in February. A key theme emerging from the panel discussion, which included representatives from both the SMSF and APRA-regulated fund sectors, was that while SMSFs are currently performing strongly when it comes to member engagement, industry funds are also embarking on their own period of growth and are looking to step up the retirement income products they can offer to members. There is clear competitive tension continuing between SMSFs and APRAregulated funds. Public offer funds must attract and retain members, especially those with larger superannuation balances, to maintain their economies of scale. Meanwhile, SMSFs must continue to justify the costs and effort that goes into managing them, particularly as industry funds enhance their market offerings.

Where SMSFs excel While control and flexibility are widely acknowledged as key motivators for setting up SMSFs, this doesn’t tell the whole story of their appeal. Unique opportunities and the agility with which trustees can implement emerging strategies are other “powerful” factors behind their popularity, according to SMSF Association chief executive Peter Burgess. “Self-managed super funds really put members in the driver’s seat and we shouldn’t underestimate how valuable that has been for many investors to be able to make their own decisions and have more investment flexibility,” Burgess explains. “Historically, SMSFs have been a leader in innovation in the superannuation industry. I can remember the days when large funds didn’t even offer a pension option to their members and SMSFs were really leading the way back then in terms of offering retirement income products to members. “There are certain strategies that we know can only be implemented in self-managed super funds. For example, think of contribution strategies or reserving strategies in the lead-up to 30 June where taxpayers are able to claim a double deduction in some situations. “We know that SMSFs have the ability to invest in real property and to borrow to invest. There are estate planning strategies as well. The ability to have multiple pensions, to quarantine different tax components in those pensions and to have that all supported by one pool of assets, again, is something unique in SMSF land. “SMSFs have led the way in the seamless approach to moving members from the accumulation to the pension phase without it being a capital gains tax event and they have certainly led the way when it comes to investment flexibility.” He also touches on another key point discussed at the thought leadership breakfast: SMSFs have driven innovation in Australia’s superannuation system for some time, a view shared by Heffron managing director Meg Heffron. She notes it would be difficult to find a strategy or service used in industry funds today that wasn’t first employed in an SMSF. “I think one of the reasons SMSFs lead the charge on innovation is because self-interest is a really powerful motivator. In an SMSF, you’ve often got only one or two members, therefore you can run it and do the things that make

“Self-managed super funds really put members in the driver’s seat and we shouldn’t underestimate how valuable that has been for many investors to be able to make their own decisions and have more investment flexibility.” – Peter Burgess, SMSF Association sense for that very small group of people,” Heffron observes. “A really simple example of that is when there’s a new investment product, SMSFs will often be one of the first investors because they don’t have to get it on a menu. If the member or the trustee researches it and decides it’s a good investment, then they go for it. “People like SMSFs because they’ve got control and flexibility, but I think SMSFs are about more than that. Every time you read a story about the poor widow who couldn’t get out her husband’s super when he died Continued on next page

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FEATURE THE LEADER OF THE PACK

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because it took ages for the fund to pay it out, that never happens in an SMSF. “Yes you might be sitting there waiting for the insurance claim, but you can take the death benefit from the balance that’s already in there and you could take that tomorrow if you wanted.” SMSFs also seem to have benefited from a broader shift in the superannuation system. Australians, regardless of their fund, are becoming more active with their super from a younger age. This shift can be attributed to several factors, including the maturity of the superannuation guarantee regime and the wealth of information available via social media and the internet. For example, findings from the aforementioned Vanguard/Investment Trends report indicate members are now establishing SMSFs at an average age of 46, whereas in 2005, the average age for fund establishment was closer to 51. “The genesis and motivation of people moving their super to a self-managed super fund is often for an investment opportunity – they think they could do it better – or small business owners wanting to buy a property for them to run their business from,” Cooper Partners Financial Services director Jemma Sanderson says. “We’re also seeing more people at a younger age look to use SMSFs as a retirement savings vehicle. Previously there would certainly be more people closer to retirement age [establishing funds] as they’re a bit more engaged with their super, but we’re definitely seeing people becoming more engaged with their super earlier on. “That engagement leads to them considering are they in the right fund. The one that was set up for them as a default many years ago when they started working and it’s been set and forget, has that actually been of benefit to them or not?”

Room for improvement Clearly, there is much to admire about the achievements of SMSFs in their short history within the superannuation system, but the sector will continue to face challenges. Regulatory intervention, illegal early access of benefits and misconduct by trustees and

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“I think one of the reasons SMSFs lead the charge on innovation is because selfinterest is a really powerful motivator. In an SMSF, you’ve often got only one or two members, therefore you can run it and do the things that make sense for that very small group of people.” – Meg Heffron, Heffron practitioners will pose long-term problems for the industry. In the short term, the provision of financial advice, while not an issue exclusive to SMSFs, remains a significant concern. “I think access to advice is one area that we need to improve. When you look at the research that’s come out recently in the Investment Trends report from Vanguard, it’s quite concerning that the number of SMSFs that are now seeking advice are at all-time lows. What we’re seeing coming out of this research is that people are turning to family, friends, colleagues and the internet to get information around SMSFs and that’s a concern,” Burgess observes.

“We’re seeing an increase in the amount of money taken out illegally and an increase in the number of individuals being disqualified, so we think it’s important that these individuals have access to advice.” As Burgess highlights, a shared concern within the industry is ensuring the integrity of information available to both existing and prospective SMSF trustees as many are now getting their information from non-traditional sources. The Vanguard/Investment Trends report revealed 40 per cent of SMSF trustees surveyed had established a fund after conducting internet research, whereas historically, accountants or advisers were the main influencers for establishing an SMSF. “I think we’ll always have to do better at education. SMSFs by definition are about people who are engaged with their super and there’s a lot of information on the internet which lends itself to some education,” Heffron notes. “However, I think much of the illegal early access that is happening is because people are not actually aware of how dangerous it is to take the money out of your SMSF. What we’re experiencing at the moment is the slight lag between information you need to set up an SMSF without the information you need to realise when you shouldn’t set one up.” SMSF Alliance principal David Busoli echoes the concerns of Burgess and Heffron regarding the need to improve communication in the SMSF community and adds the issue will only be exacerbated by a shortage of specialist advisers within the industry. “We’ve seen a significant reduction in SMSF adviser numbers, particularly since SMSF advisers were generally the more experienced, older part of the sector and they’re the ones that have been driven out. There’s not enough advisers who truly understand the benefits of SMSFs and the sector has some significant barriers to entry. There’s not a lot of people falling over to become financial advisers at the present time,” Busoli says. “The sector has lost those incubators, the AMPs and the National Mutuals – they were large organisations that applied quite significant resources to bringing new people in and that benefited the sector as a whole as they spread throughout. Continued on next page

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“Now that we’ve lost those, we’re really looking more to the industry funds, which is why the government has thought up this ‘qualified adviser’ tag to put on people who are trained out of industry funds. I can see they may be taking a little bit more of the lead in that regard. “That concerns me a little because industry funds have a vested interest to play down the benefits of SMSFs. I think there’s certainly not going to be the focus there may have been previously on SMSF education.”

The road ahead Another key takeaway from the panel discussion at the thought leadership breakfast was the potential for collaboration between SMSFs and industry funds to enhance the overall system. As noted earlier, SMSFs have been recognised as pioneers in innovation within the Australian superannuation landscape, but this may not always be the case. “There are certainly plenty of areas that we can work together. One obvious example is around cybersecurity and the risk that the whole industry faces from scams. No doubt the large funds are investing a lot of money in cybersecurity and artificial intelligence and this is one area where I think the SMSF sector can learn from the larger fund sector,” Burgess notes. “In the future, it’s going to be interesting because we know the larger funds are going to have a greater focus on the pension phase. We know the regulators and the government are expecting the large funds to do more in that space to come up with new retirement

income products that address things like longevity risk, to be educating their members more on retirement income products and the things they should be doing in the lead-up to retirement. “It’s inevitable we’re going to see the large funds investing a lot of money in their retirement income products. We may find they start to lead the way and then there will be things the SMSF sector can learn from some of the innovation that will occur in the large fund world around longevity risk and things like that.” While there is a space for collaboration between the two sectors, they remain opposed and it’s clear SMSFs will need to evolve to keep pace with industry fund developments. “What we are seeing is the bigger funds are becoming more competitive in the space that probably previously was more the SMSF realm. By that I mean they’ve got much wider investment options available,” Sanderson acknowledges. “The industry funds are considering if someone gets to a certain superannuation balance, are they going to be moving their money into a self-managed fund. In order for that not to be a consideration, they need to be competitive in terms of the products and the investment options that they’ve got, as well as ensuring the ease at which people can transact if they want to change their investment options. “Sometimes the investments that might be recommended by an adviser within a selfmanaged fund can actually be achieved in a non-SMSF space. If their financial adviser can get access to the same investment menu in a non-SMSF environment, then they might go down that path instead.”

One instance of APRA-regulated funds enhancing their commitment to providing products for SMSF trustees comes from industry super fund Hostplus. Hostplus introduced its Self-Managed Invest (SMI) product in 2019, enabling SMSF members to access to several of its investment options and therefore leverage the advantages of the fund’s scale, as Hostplus executive manager of intermediary distribution and growth Lisa Palmer highlights. “We created our Self-Managed Invest offering because we recognised many of our assets, such as our property, infrastructure and venture capital investments, are typically beyond the reach of an SMSF investor. Our SMI product is designed to offer the choice and control many SMSF investors are looking for alongside the investment opportunities and diversification that come with a fund having the scale of Hostplus,” Palmer says. “We have gathered feedback from investors in the past and while several factors typically influence their decision to invest in SMI, including our competitive fees and costs compared with other investment products, most have emphasised the importance of portfolio diversification. They particularly value access to unlisted assets and investments, and they appreciate Hostplus’s reputation as a longterm investor.” Most signs suggest SMSFs are leading the pack where it matters – in member engagement and retirement outcomes – however, the ongoing evolution of industry and APRA-regulated funds will test the sector. While adaptability has traditionally been its strong suit the uncertainty lies in how long SMSFs can remain in front.

“Sometimes the investments that might be recommended by an adviser within a self-managed fund can actually be achieved in a non-SMSF space. If their financial adviser can get access to the same investment menu in a non-SMSF environment, then they might go down that path instead.” – Jemma Sanderson, Cooper Partners Financial Services

QUARTER II 2024 19

INVESTING

A new fixed income lever

Fixed income traditionally relies on two levers to manage risk – credit and duration – but the asset class has undergone a regime shift displaying greater volatility and equity-like fluctuations. Gopi Karunakaran explores a third lever to improve diversification, mitigate risk and drive returns.

GOPI KARUNAKARAN is co-chief investment officer at Ardea Investment Management.

20 selfmanagedsuper

Self-directed investors have faced tremendous change over the past decade and perhaps an even more radical shift in recent years as ultralow inflation and zero, even negative, interest rates gave way to sky-high pricing and aggressive tightening by central banks in both the developed and emerging world. Rapidly rising interest rates have been particularly painful for investors, contributing to equity market uncertainty and

creating dislocations in the relationship between asset classes. An extreme example of this occurred in 2022 when the market saw significant, correlated dips in both bonds and equities. Central banks have suffered criticism for their response to the challenge of rising inflation and dwindling economic growth, and while some of Continued on next page

Continued from previous page

this may be unfair, central banks in fixed income markets have undeniably shifted from suppressors of market volatility to volatility amplifiers. Until recently, central banks were quick to intervene whenever there was some form of market stress, either in the shape of interest rate cuts or quantitative easing, and that intervention was easy to justify given their objectives of price stability and economic growth were perfectly aligned. Inflation was running well below target, so whatever policymakers did to facilitate stable prices was consistent with supporting growth. These objectives are

now misaligned, with the options available to tame inflation undesirable from the perspective of economic prosperity.

and the path of interest rates introduces a more variable correlation between bonds and equities (see Graph 1). This is particularly relevant for multi-asset portfolio managers because the composition of their fixed income allocations now carries more weight. Historically, investors could simply rely on duration, that is, government bonds, to diversify equity risk, but today that duration component is more volatile and also has a more unstable relationship with equities. Fixed income investors face a similar dilemma, with corporate bonds suffering the same upward pressure on yields

Bond yields in a structurally higher volatility regime These conflicting objectives, the associated policy uncertainty and central banks aggressively running down their pandemic-era bond portfolios are why we consider the world’s reserve banks to be amplifiers of volatility. This also means interest rates and bond yields are in a structurally higher volatility regime than they have been for most of the post-global financial crisis era since 2008. Furthermore, uncertainty about inflation

Continued on next page

Graph 1: Bond versus equity correlation is positive again

Bond Vs Equity Correlation Is Positive Again positive bond vs equity correlation

0.60

0.40

0.20

0.00

-0.20

Rolling 90-day correlation of Global Government Bond vs Equity Indices Mar

Jun

2022

Sep

Dec

Mar

2023

Jun

Sep

* Data as at 20-Oct-2023. Global Government Bond Index = Bloomberg Global Aggregate Treasuries Index; Global Equity Index = MSCI World Index

QUARTER II 2024 21

INVESTING

and downward pressure on prices as government-issued debt, but with greater potential for default. This means the two traditional levers of fixed income portfolio management, being duration and credit, now have more uncertainty.

structural factors, such as regulation, mandate restrictions and varying investor use objectives, cause market participants to transact for reasons other than profit maximisation. As such, we continually observe pricing inconsistencies between closely related securities that have very similar risk characteristics. These pricing inconsistencies can be isolated using a wide range of risk management tools, including derivatives, which strip out unwanted market risk, allowing the strategy to target the generation of positive returns regardless of the level of bond yields or the direction of interest rates. A strong bias to outperformance when markets incur losses makes PRV an ideal risk diversifier (see Table 1).

An additional lever Pure relative value (PRV) investing does not rely on conventional fixed income sources of return and is not impacted by the level of bond yields, regardless of whether they are high, low or even negative. With PRV returns are extracted by exploiting market inefficiencies through trading strategies. It has a return profile independent of yields, interest rates, inflation and macroeconomic pressures, all of which impact the two traditional defensive levers dramatically. The global fixed income market contains a huge array of securities that are explicitly linked to each other by well-defined relationships. In an efficient market these securities would always be consistently priced with one another, but the fixed income market is not efficient. Underlying

The power of three In a period of heightened market volatility, incorporating a PRV investing element into fixed income allocations can offer investors compelling diversification benefits when blended with duration and

In a period of heightened market volatility, incorporating a PRV investing element into fixed income allocations can offer investors compelling diversification benefits when blended with duration and credit. credit. It offers investors a much needed third lever, which over the long term can result in superior portfolio construction and market performance. When the two traditional levers of fixed income portfolio management – duration and credit – face more uncertainty, it may pay to embrace the power of three.

Table 1: The three levers in action YTD Return (%)

YTD Vol (%)

2022 Return (%)

2022 Vol (%)

2021 Return (%)

2021 Vol (%)

2020 Return (%)

2020 Vol (%)

RV lever Ardea Real Outcome Fund: net

4.8

4.1

1.0

4.1

-0.6

1.2

5.7

1.8

Duration lever Ausbond Government Bonds Index

2.1

7.2

-10.7

7.1

-2.9

6.9

4.5

3.0

Credit lever Global Corporate Bond Index, A$

3.5

7.2

-16.2

9.7

-1.0

3.1

7.5

9.8

Source: Bloomberg and Ardea Investment Management (Ardea IM), to 30 November 2023. Index perforamce is hedged to A$. Fund performance is net of fees.

22 selfmanagedsuper

GROW AND MANAGE

YOUR SMSF WITH

HOSTPLUS

SMI hostplus.com.au/smi

General advice only. Consider your circumstances and the Hostplus Self-Managed Invest (SMI) Product Disclosure Statement and Target Market Determination at hostplus.com.au before making a decision about SMI. SMI is issued by Host-Plus Pty Limited ABN 79 008 634 704, AFSL 244392 as trustee for the Hostplus Pooled Superannuation Trust ABN 13 140 019 340.

INVESTING

Active versus passive

SUE LEE is a director and AsiaPacific head of index investment strategy, TIM EDWARDS is managing director and global head of index investment strategy and DAVIDE DI GIOIA is index investment strategy director at S&P Dow Jones Indices.

Arguments are being continually made as to whether active investing produces better returns than passive investing. Sue Lee, Tim Edwards and Davide Di Gioia provide quantified performance analysis. The SPIVA Australia Scorecard measures the performance of actively managed funds relative to benchmarks over various time horizons, covering equity, real estate and bond funds, and provides statistics on outperformance rates, survivorship rates and fund performance dispersion. In the yearend 2023 edition, domestic equity funds in New Zealand are included for the first time.

2023 highlights It was among the best of times and the worst of times for actively managed funds in 2023. In the Australian equity general category, more than three-quarters of active managers failed to keep up with the S&P/ASX 200, and a similar story was seen in the international equity general category. Meanwhile, active bond managers had

24 selfmanagedsuper

an exceptional year, with almost three-quarters of Australian bond funds beating the S&P/ASX Australian Fixed Interest 0+ Index. Exhibit 1 summarises the results across all our reported categories. Australian equity general funds: The S&P/ ASX 200 ended the year up 12.4 per cent and Australian equity general funds struggled to keep up; the one-year underperformance rate of 77 per cent was the second highest in our records (see Exhibit 8). Longer term, underperformance rates were even higher, rising to 85 per cent of funds underperforming the benchmark over 15 years. Australian equity mid and small-cap funds: The S&P/ASX Mid-Small Index gained 7.8 Continued on next page

In 2023, as in many previous years, central bank policy decisions domestically and abroad dictated much of the market sentiment.

Exhibit 1: Percentage of underperforming active Australian and New Zealand funds 1-Year

% Underperforming

100

3-Year

5-Year

10-Year

15-Year

Australian Equity General

Australian Equity Mid- International Equity and Small-Cap General

Australian Bonds

Australian Equity AREIT

New Zealand Domestic Equity

Source: S&P Dow Jones Indices LLC, Morningstar. Data as of Dec. 31, 2023. Past performance is no guarantee of future results. Chart is provided for illustrative purposes. Underperformance rates for the Australian Equity Mid- and Small-Cap and Australian Bonds categories are reported for time horizons over which the respective benchmark indices were live.

Continued from previous page

per cent in 2023 and a firm majority (64 per cent) of actively managed Australian equity mid and small-cap funds managed to beat it. Funds in the category gained 10.8 per cent and 13.0 per cent on an equal and asset-weighted average basis, respectively. More such years will be required to change the longer-term statistics, however, with 77 per cent of funds currently lagging over 10 years. International equity general funds: International equity funds posted average 2023 returns of 20.3 per cent and 19.2 per cent on an equal and asset-weighted basis, respectively, with 81 per cent of funds trailing the S&P Developed ExAustralia LargeMidCap’s total return of 24.1 per cent. Over the 10 and 15-year horizons, around 94 per cent of funds underperformed. Australian bonds funds: Active managers in the Australian bonds category posted their lowest one-year

underperformance rate since the 2015 launch of the S&P/ASX Australian Fixed Interest 0+ Index, with just 26 per cent of funds lagging the index. The longer-term record was also better relative to other categories, with 56 per cent and 46 per cent underperforming over the three and five-year periods, respectively. Australian equity AREIT funds: After a challenging start to the year, active managers in the Australian equity Australian real estate investment trust (AREIT) category improved their underperformance rate to 69 per cent over the full year. Over the 15-year period, 80 per cent of active funds underperformed. New Zealand domestic equity funds: Over the one-year period, actively managed funds in the New Zealand domestic equity category gained 4.8 per cent and 5.1 per cent on an equal and asset-weighted basis, compared to a 3.5 per cent gross return with imputation for the S&P/NZX 50 Index. Within this

category, 54 per cent of active funds outperformed over one year, but just 23 per cent outperformed over the 15-year period. Fund survivorship: Liquidation rates for most active fund categories were moderate in 2023. International equity general funds recorded the highest liquidation rate at 7.7 per cent. In contrast, none of the New Zealand domestic equity funds were liquidated, while only 1.3 per cent of Australian equity mid and smallcap funds failed to survive. The attrition rate increased over longer time horizons, with 57 per cent of funds across all categories merged or liquidated over the 15-year period.

Market context In 2023, as in many previous years, central bank policy decisions domestically and abroad dictated much of the market sentiment. The Reserve Bank of Australia increased its target rate five times during Continued on next page

QUARTER II 2024 25

INVESTING

In the fixed income markets, the winds appear to have been more favourable for active managers, particularly those taking on a little more duration or a little more credit risk than their category benchmark.

Exhibit 2: Rates and bond yields during 2023 8.0 RBA Target Rate 7.0

S&P/ASX Australian Government Bond 5-10 Year Index S&P/ASX Corporate Bond 5-10 Year Index

Rate (%)

6.0

5.0

4.0

3.0

2.0 Dec. 2022

Mar. 2023

Jun. 2023

Sep. 2023

Dec. 2023

Source: S&P Dow Jones Indices LLC and RBA. Data as of Dec. 31, 2023. Past performance is no guarantee of future results. Chart is provided for illustrative purposes.

Continued from previous page

Exhibit 3: Australian equities posted gains but trailed other developed markets Index Relative Performance

130

120

S&P Developed Ex-Australia LargeMidCap S&P/ASX 200 S&P/ASX Mid-Small S&P/ASX Australian Fixed Interest 0+ Index

110

100

90 Dec. 2022

Mar. 2023

Jun. 2023

Sep. 2023

Dec. 2023

Source: S&P Dow Jones Indices LLC. Data as of Dec. 31, 2023. Index performance based on total return in AUD. Index levels rebased to 100 on Dec. 30, 2022. Past performance is no guarantee of future results. Chart is provided for illustrative purposes.

the year, while fluctuating long-term inflation and economic expectations sent longer-dated government bond yields lower, then higher, before they ended the year close to where they began. Credit spreads moved mildly lower, with the spread between the S&P/ASX Australian Government Bond 5 to 10 Year Index and S&P/ASX Corporate Bond 5 to 10 Year Index falling from 209 basis points to 159 basis points over the year (see Exhibit 2). Australian equities see-sawed over the year. Despite having a flat return as late as October, the fall in longer-dated bond yields in the final two months of the year accompanied a ‘risk on’ dynamic that Continued on next page

26 selfmanagedsuper

Continued from previous page

Exhibit 4: Sector reversals in Australian equities 35% 30%

Information Technology

2023 Return

25% Consumer Discretionary 20% Communication Services 15%

Financials

10% 5% 0% -40%

Materials

Industrials

Real Estate

Health Care -30%

-20%

-10%

Energy

Utilities

Consumer Staples 10%

20%

30%

40%

50%

60%

2022 Return Source: S&P Dow Jones Indices LLC. Data as of Dec. 31, 2023. S&P/ASX 200 sector performance based on total return in AUD. Past performance is no guarantee of future results. Chart is provided for illustrative purposes.

35%

30%

12-Month Trailing Dispersion

Exhibit 5: Sector and country dispersion dropped in the second half of 2023

25% 20%

15% 10%

25% 20% 15% 10%

S&P/ASX 200 Stock Dispersion S&P/ASX 200 Sector Dispersion

S&P Developed Ex-Australia LargeMidCap Stock Dispersion S&P Developed Ex-Australia LargeMidCap Country Dispersion

Source: S&P Dow Jones Indices LLC. Data as of Dec. 31, 2023. Dispersion is annualized and calculated on a monthly basis. Past performance is no guarantee of future results. Chart is provided for illustrative purposes.

drove Australian equities into doubledigit gains; the S&P/ASX 200 finished the year with a total return of 12.4 per cent. Global equities had more consistent gains through the year, with the S&P Developed Ex-Australia LargeMidCap posting a total return of 24.1 per cent (in A$) (see Exhibit 3). Sectors played an important role in driving performance, with information technology contributing almost half of the developed benchmark’s gains. In Australia, equities experienced noticeable rotations among sectors from the prior year: information technology and consumer discretionary were the bestperforming sectors, with gains of 31 per cent and 22 per cent in 2023 contrasting with losses of 34 per cent and 20 per cent in 2022, respectively. Meanwhile, energy and utilities, which had strong gains of 49 per cent and 30 per cent in 2022, respectively, barely remained in positive territory in 2023 (see Exhibit 4). Dispersion, which measures the opportunity set for active outperformance via stock, sector or country selection, fell in the second half of 2023 in both domestic and international equity markets. The 12-month trailing S&P/ASX 200 sector and stock-level dispersion fell to levels unseen since December 2018, while there was a notable decline in country-level dispersion within the S&P Developed ExAustralia LargeMidCap (see Exhibit 5). Exhibit 6 illustrates a narrowing of Continued on next page

QUARTER II 2024 27

INVESTING

Exhibit 6: Interquartile performance range of Australian equity and international general funds Australian Equity General Funds

3rd Quartile 2nd Quartlie 1st Quartile S&P/ASX 200

12 10

25 20 % Return

% Return

8 6

Continued from previous page

International Equity General Funds 3rd Quartile 2nd Quartlie 1st Quartile S&P Developed Ex-Australia LargeMidCap

15 10

2 0

H1 2023

H2 2023

1-Year

H1 2023

H2 2023

1-Year

Source: S&P Dow Jones Indices LLC, Morningstar. Data as of Dec. 31, 2023. Index performance based on total return in AUD. Chart is provided for illustrative purposes. Past performance is no guarantee of future results.

Exhibit 7: Large-cap dominance in the S&P/ASX 200 extended further in 2023 S&P/ASX 50

30%

S&P/ASX 200

S&P/ASX 200 Equal Weight Index

25% Annualized Return

20% 15% 10% 5%

0% -5% -10% -15%

2017

2018

2019

2020

2021

2022

2023

Source: S&P Dow Jones Indices LLC. Data from Dec. 30, 2008, to Dec. 31, 2023. Index performance based on total return in AUD. Past performance is no guarantee of future results. Chart is provided for illustrative purposes.

Exhibit 8: Percentage of Australian equity general funds underperforming the S&P/ASX 200 Australian Equity General Funds % Underperforming

100 86

80 70

Average: 60%

60 50 40 30 20 10 0

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

Source: S&P Dow Jones Indices LLC, Morningstar. Data as of Dec. 31, 2023. Chart is provided for illustrative purposes. Past performance is no guarantee of future results.

28 selfmanagedsuper

active fund performance that occurred in the Australian equity general category in 2023 and, during the second half of the year, in the international equity general category, via the interquartile performance within each category. In both categories, over the full year, even top-quartile performance was not necessarily sufficient to match the benchmark’s return. Another notable trend was the outperformance of the very largest Australian stocks. In 2023, the mega-cap S&P/ASX 50 outperformed the S&P/ ASX Mid-Small by 7.0 per cent, while concurrently the S&P/ASX 200 Equal Weight Index, which has a small-cap tilt relative to the S&P/ASX 200, extended its underperformance to a third consecutive year (see Exhibit 7). This indicates challenges for the Australian large-cap active equity managers that sought opportunities outside of the stocks most heavily weighted in the capitalisationweighted S&P/ASX 200. Against this challenging backdrop, Australian large-cap equity active managers suffered their second-worst underperformance rate since 2009, much worse than their long-term average of 60 per cent (see Exhibit 8). Similarly, 81 per cent of active managers in the international equity general category underperformed the benchmark, also the second-worst result since 2009 and compared to a long-term average of 70 per cent (see Exhibit 9). In the fixed income markets, the winds appear to have been more favourable for active managers, particularly those taking on a little more duration or a little more credit risk than their category benchmark. Credit spreads narrowed over the year, while longer-dated bonds generally Continued on next page

Exhibit 9: Percentage of Australian equity general funds underperforming the S&P Developed ex-Australia LargeMidCap

outperformed shorter-dated bonds. Active fund managers appear to have been well positioned for these trends, with nearly three-quarters (74 per cent) of funds in the Australian bonds category outperforming the S&P/ASX Australian Fixed Interest 0+ Index in 2023. Offering a historical perspective on the impact of credit trends on the fixed income active fund performance rates reported in our Australia scorecard, Exhibit 10 shows that over the past nine years, the annual underperformance rate was generally lower in years with narrowing credit spreads.

100 87

90 International Equity General Funds % Underperforming

Continued from previous page

Average: 70%

80 70 60 50 40 30 20 10 0

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

S&P Dow Jones Indices LLC, Morningstar. Data as of Dec. 31, 2023. Chart is provided for illustrative purposes. Past performance is no guarantee of future results.

Exhibit 10: Effect of higher credit spread exposure on Australian bond funds

Australian Bonds Funds % Underperforming Australian Bonds Funds % Underperforming

100 100 2018 2018

9090 80 80

2015 2015

70 70

2019 2019

60 60

40 40

20 20 -0.6 -0.6

2022 2022

2016 2016 2021 2021

2017 2017

50 50

30 30

R²R²= = 0.36 0.36

2020 2020 2023 2023 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 12-Month Change in Spread in Australian 5-10 Year Corporate Bonds vs.Government Bonds 12-Month Change in Spread in Australian 5-10 Year Corporate Bonds vs.Government Bonds

1.0 1.0

Source: S&P Dow Jones Indices LLC, Morningstar. Data from Dec. 31, 2014, to Dec. 31, 2023. Credit spread is calculated as the yield of the S&P/ASX Corporate 5-10 YearData Indexfrom minus the31, yield of the Australian Government Bond 5-10 as Source: S&P Dow Jones Indices LLC,Bond Morningstar. Dec. 2014, to S&P/ASX Dec. 31, 2023. Credit spread is calculated Year Index. is provided for illustrative purposes. Past performance guarantee ofAustralian future results. the yield of theChart S&P/ASX Corporate Bond 5-10 Year Index minus the yieldisofno the S&P/ASX Government Bond 5-10 Year Index. Chart is provided for illustrative purposes. Past performance is no guarantee of future results.

QUARTER II 2024 29

COMPLIANCE

A twist in the transfer tail

A revised UK tax position could likely result in a change to the process followed when retirement savings amounts are transferred from this jurisdiction, writes Jemma Sanderson.

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

As outlined in previous articles in this publication, one of the strategies often employed to transfer United Kingdom pension accounts to Australia is relocating the increase in value since residency to an Australian Recognised Overseas Pension Scheme (ROPS), whereby the Australian ROPS fund pays the tax at 15 per cent on this component, with the balance being paid to the individual directly as two lump sum payments with no further tax to pay in either jurisdiction. The above was achievable from a UK perspective as His Majesty’s Revenue and Customs (HMRC) was satisfied, under the Double Taxation Agreement (DTA) between Australia and the UK, that Australia had the right to tax lump sum payments where there was more than one payment. Through a UK tax adviser, we obtained confirmation from HMRC on this treatment. An update In December 2023 we received information from both HMRC and the ATO that impacts the taxation treatment of UK and foreign pension transfers. Proposed HMRC changes In late December 2023, we received intelligence that HMRC was reconsidering its application of the DTA. A

30 selfmanagedsuper

summary of the previous view and proposed changes are as in Table 1. It is important to note Table 1 is based only on draft intelligence at the time of writing. However, in our discussions with a UK tax adviser, who also has been involved in discussions with HMRC officials with respect to this view, they are not recommending any individuals make any substantial payments from their UK scheme to themselves personally at this time even with a UK nil tax code in place. Relevantly, a nil tax code only results in the UK scheme not withholding tax on a payment and doesn’t mean HMRC won’t assess the individual personally on the lump sum payment after the end of the relevant UK tax year in the tax return lodgement process undertaken by HMRC. Although this is not an absolute final view, for now it is advised that, given this UK tax position, one-off flexible access drawdown (FAD) or uncrystallised fund pension lump sum (UFPLS) payments should not be initiated. ATO interpretative position In addition to the above UK position, we had discussions with the ATO just before Christmas with regard to their Continued on next page

Continued from previous page

interpretation of the formula to calculate the taxable amount under the Australian provisions of any transfer from an overseas pension scheme. This amount, referred to as applicable fund earnings (AFE), is generally the increase in value since residency. This is relevant where a partial amount of any UK scheme is transferred to Australia, whether to a super fund or to the individual directly. This interpretation is as follows with respect to the calculation of the AFE on any foreign pension transfer/payment: 1. Where a benefit is transferred from one foreign pension scheme to another while the individual is an Australian tax resident, the ATO considers a certain section of the Income Tax Assessment Act 1997 (ITAA) applies to the transactions than what is generally applied. 2. Where a partial transfer occurs, whether to the individual directly or to an Australian ROPS via a new UK account after residency that is often a self-invested personal pension (SIPP), this section would result in any partial transfer being taxable to the extent of the balance remaining after the partial transfer. 3. This would mean where a partial transfer

It is now more so than ever important to consider how best to manage any transfer so that an individual’s UK pension can be transferred to Australia tax effectively. was made, the payment may be fully taxable in Australia. 4. However, under an alternative section of the ITAA, widely applied across the industry and which has an alternative interpretation of the application of the provisions, it would not be taxable. 5. The application of this method to the transfer of any benefit as a small interim and final UFPLS payment is not tax prohibitive on the payment itself. Rather, it would result in there being a small amount of tax payable on the interim payment with no tax amount on the final payment, with the exception of any increase in value between

those two payments, or there being any leftover previous earnings that had already accrued. Example 1: An individual transferred the previously calculated AFE component of their UK scheme (SIPP1) to an Australian ROPS via a new UK pension scheme (SIPP2). This was calculated to be £300,000 of a balance of £800,000. The balance remaining in SIPP1 is £500,000 after the above action and is comprised of the value of their account in UK pension schemes at their date of residency. Subsequent to the initial transfer, the individual shifts another £300,000, whether to an Australian superannuation fund or to them personally, where the tax position would be as per Table 2, using an exchange rate of 1GBP:1.929AUD. As there is a balance of £200,000 remaining (E), that is the taxable amount of the £300,000 transfer, with a balance of £100,000 (K) being tax-free. Where the above transfer was transferred to: i. the individual directly, then the individual would pay tax on £200,000 at their marginal tax rate, ii. an Australian ROPS directly, the individual Continued on next page

Table 1 Previous view

Proposed changes

Transfers from a UK pension scheme to an Australian superannuation fund are not subject to tax in the UK where the transfer is less than the individual’s lifetime allowance (now overseas transfer allowance since 7 April 2024).

No change to tax position.

Payments received from an income/flexible access drawdown (FAD) were considered to be pension payments and as such the pension article under the DTA would apply where the country of residence (Australia in this case) would have the taxing right. Where multiple uncrystallised fund pension lump sums (UFPLS) were received, the pension article of the DTA would also apply such that the country of residence (Australia) would have the taxing right.

Any payments that are akin to lump sum payments will not fall within the DTA pension article and HMRC will assert its taxing right under the other income article. Payments would be included in the individual’s UK tax return, and taxed at marginal rates (up to 45 per cent). Where a one-off FAD/UFPLS is received personally, this would be subject to tax in the UK.

QUARTER II 2024 31

STRATEGY COMPLIANCE

Continued from previous page

would pay tax on the AFE at their marginal rate, as there remained a balance in this SIPP after the transfer, and the entire payment would be a non-concessional contribution (NCC), or iii. another SIPP to then flow to an Australian ROPS where there was no interest remaining after the transfer, the fund would pay tax at 15 per cent and the balance would be treated as an NCC. This interpretation and the application of this particular section of the ITAA is new and contrary to previous guidance and an alternative reading. The ATO has acknowledged this interpretation does not align with the legislative intentions. Notwithstanding this, our discussions with the ATO suggest this will be its interpretation and application of the provisions to UK and other foreign super fund transfers where the circumstances are relevant. In the absence of legislative change, given it is the ATO position, it is important to follow this approach so as not to end up with any adverse taxation implications. Example 2: Using the same circumstances as the example above, where the remaining benefit is transferred in full to a ROPS or to an individual directly, the calculation would be as in Table 3, noting this position remains unchanged from the prior view. As there is no balance remaining, there is no amount that is AFE and the entire transfer is non-taxable and classified as an NCC if paid directly to superannuation that is a ROPS in Australia. Interestingly, the lower the amount remaining, the lower the AFE. However, we then need to be alive to the NCC component. NCC component Where the amount is an NCC in excess of the individual’s available limit, it needs to be released from superannuation in order to mitigate 47 per cent tax on the excess (under the Australian tax provisions). The mechanism Continued on next page

32 selfmanagedsuper

Table 2

Partial transfer out

300,000.00

578,703.70

Contributions to SIPP1

Amount of the payment attributable to previous foreign transfer

300,000.00

578,703.70

A+B

300,000.00

578,703.70

Value at date of payment

500,000.00

964,506.17

D–C

200,000.00

385,802.47

Proportion of days Australian resident

100%

Previously Transferred AFE

ExF+G

200,000.00

385,802.47

Payment made

300,000.00

578,703.70

AFE on payment/future PEFE

200,000.00

385,802.47

Non-Taxable amount

100,000.00

192,901.23

500,000.00

964,506.17

Table 3

Full transfer out A

Contributions to SIPP1

Amount of the payment attributable to previous foreign transfer

500,000.00

964,506.17

A+B

500,000.00

964,506.17

Value at date of payment

500,000.00

964,506.17

D–C

Proportion of days Australian resident

1.00

Previously Transferred AFE

ExF+G

Payment made

500,000.00

964,506.17

AFE on payment

NCC/Non-taxable

500,000.00

964,506.17

Continued from previous page

works as follows: a. The ATO will consider the contributions made to superannuation for a relevant financial year once the relevant super fund has lodged its annual return for the relevant year. b. This could be for a contribution made in the 2024 financial year, say January 2025. c. The ATO will attribute an earnings rate (called associated earnings (AE)) to that excess amount, which is the general interest charge (GIC) rate for the year. In the 2024 financial year as an example, the rate is 11.19 per cent. d. That AE accrues from 1 July of the year of the excess (for a 2023/24 contribution this would be from 1 July 2023) until the ATO data matches and it issues a notice to the taxpayer regarding the excess (after the lodgement of the superannuation fund’s annual tax return and the individual’s personal tax return). e. Then an amount is ultimately released from superannuation that is equal to the excess, plus 85 per cent of the AE amount to factor in the fact earnings in super are taxed at 15 per cent. f. The AE is taxable at the individual’s marginal tax rate, less a 15 per cent offset given the above regarding the 15 per cent tax rate already in superannuation. g. The relevant fund then pays this amount, the excess and 85 per cent of the AE in cash to the ATO, which deducts any tax payable on the AE and then pays the balance to the taxpayer in cash. h. Based on the above scenario, the calculations would be approximately as in Table 4 where the individual has their full NCC limit available, with the AE dependent upon when the amount is released. i. Based on the above, the sooner the fund can lodge its return, the sooner the excess will be released and the cash then released. Under the three different scenarios, all dependent on when the amount is released, the personal tax would range from $37,368 to $51,087,

and the total amount to be released from superannuation would range from $733,766 to $770,205. The release of any excess contribution can be facilitated as follows: a. from other superannuation benefits in Australia (that is, not the receiving ROPS fund), or b. from the receiving ROPS fund, however, that requires the correct reporting to be undertaken to ensure no adverse HMRC implications. Next steps The above may be disappointing for some as the HMRC position means payments can no longer be made to individuals directly without the risk of UK tax, with even FAD payments considered irregular being potentially caught. Accordingly, it is now more so than ever important to consider how best to manage any

transfer so that an individual’s UK pension can be transferred to Australia tax effectively. There remain three possible courses of action: 1. Transferring the benefit to an Australian superannuation fund in full or in part, with consideration for the application of the Australian tax provisions. 2. Waiting for HMRC to release its view publicly and hope it is contrary to the above. As noted above, the intelligence in this regard is draft only and not legislation or a final view with an effective date of application. 3. Leaving the scheme in the UK and considering withdrawing as a pension or other payments. We recommend transfers that are in progress or intended to occur in the 2024/25 without consideration of the above provisions be revisited to ensure they remain appropriate and won’t give rise to adverse tax outcomes.

Table 4 $

31/12/2024

31/03/2025

30/06/2025

NCC

964,506

NCC cap

330,000

Excess NCC

634,506

Associated earnings rate

11.19%

Associated earnings

116,776

137,795

159,646

Personal tax on associated earnings

37,368

44,094

51,087

Net benefit

927,138

920,412

913,419

Effective tax rate

3.87%

4.57%

5.30%

Associated earnings

116,776

137,795

159,646

Amount to release from super (85%)

99,260

117,126

135,699

Excess NCC

634,506

Total release from superannuation

733,766

751,632

770,205

Timing of release

Release from superannuation

QUARTER II 2024 33

STRATEGY STRATEGY

Investment entity nuances

SMSF investments in unit trusts or companies must be approached with caution to avoid breaches of some specific superannuation system rules, writes Jason Hurst.

JASON HURST is technical superannuation adviser at Knowledge Shop.

34 selfmanagedsuper

There are different ways an SMSF might consider owning its assets. When entering into arrangements with other parties, it is common to have an SMSF invest in a private trust or company. These arrangements often involve purchasing or building property where the trust or company owns the underlying property and the super fund and other investors own the shares/units. Although the rules apply similarly to companies and trusts, it is more common that an SMSF invests through a unit trust rather than a company due to the flowthrough tax treatment. This can create opportunities for SMSFs and other investors to enter arrangements they may not have otherwise been able to on their own due to having insufficient capital to do so. However, the rules relating to investing via these structures are complex and different parts of superannuation and taxation legislation need to be carefully considered. Getting things wrong can have significant impacts as breaches in this area could result in investments needing to be removed from an SMSF and in some cases liquidated all together. The superannuation rules need to be considered at both implementation and on an ongoing basis. We regularly come across scenarios where trustees who don’t seek advice are getting things wrong. In some cases it involves entering into transactions they may regularly implement in their other personal or business structures without considering the retirement savings landscape. After considering the sole purpose test and the fund’s investment strategy, a key next step when entering an arrangement is to take into account the

parties involved, their level of control over the entity and any relationships between the parties.

When is an entity a related party? It is important to consider whether an entity in which an SMSF plans to invest is a related party. This can impact the allowable level of investment, whether a fund can acquire existing shares or units and whether other parts of the Superannuation Industry (Supervision) (SIS) Act 1993 and SIS Regulations 1994 need to be considered. A company or trust would be considered a related party of an SMSF if the fund members together with any of their related parties control the entity. Some cases are more obvious than others, but an important starting point can be to consider who might be a related party of the fund’s members.

Who is a related party of an individual? The following people/entities can be a related party of a super fund: • members of the SMSF, • a standard employer sponsor, and • part 8 associates (individuals, companies and trusts). Standard employer sponsor In our experience this is not common and would only apply if an employer contributes to the SMSF under an arrangement with the trustee. In most cases when an employer is contributing to a fund, it will be due to an arrangement with a member. Continued on next page

Continued from previous page

Part 8 associates Part 8 associates of an individual are contained in section 70B of the SIS Act and include: • a relative, being a parent, grandparent, sibling, aunt or uncle, nephew or niece, lineal descendants and adopted children of an individual or their spouse, • the spouse of any of the above people, • other members and trustees/directors of the SMSF, • a partner in a partnership, • a trustee of a trust where the individual and/ or other part 8 associates control the trust, and • a company that is sufficiently influenced by or the majority voting interest is held by members and/or related parties.

When will a company or trust be a related party? The definitions of control of a trust or company are specified in section 70E of the SIS Act. Broadly, individuals must look at whether the SMSF members and any of their related parties as a ‘group’ can control the entity either formally or informally.

Control of a trust A trust will be considered controlled by an SMSF if any of the following occurs: • a group including the SMSF members and any part 8 associates has a fixed entitlement to more than 50 per cent of the income or capital, • this group can appoint or remove trustees, or • the trustee or majority of trustees, either formally or informally, might be expected to act in accordance with the instructions of this group.

Company – sufficient influence A company will be controlled or ‘sufficiently influenced’ by an SMSF if any of the following occurs: • a group including the SMSF members and any part 8 associates are in the position to cast more than 50 per cent of the maximum

number of votes that might be cast at a general meeting of the company, and • a majority of the company directors are under an obligation to act in accordance with the wishes of this group. This could include influence through interposed entities. Generally speaking, the 50 per cent in both of the above definitions will relate to shareholding or unitholding, however, that may not always be the case.

Other elements to consider Where an SMSF invests in a related trust/ company, the starting point should be section 71 of the SIS Act to determine if any in-house assets are involved. Generally, an SMSF can only have in-house assets that are valued at up to 5 per cent of the market value of fund assets, however, there are exemptions to this rule. These include the following:

Section 71(1)(j)

Subdivision section 71A to section 71F

An asset specified in the regulations not to be an in-house asset – links to SIS Regulation 13.22C Pre-11 August 1999 investments and loans

Although pre-11 August 1999 investments are not a focus of this article, it is important to consider when any existing units or shares were originally purchased by the SMSF. These investments are exempt from the in-house asset rules and have greater scope to maintain borrowings or be involved in other activities that may no longer be allowable to unit trusts or companies where an SMSF has invested after this date.

SIS Regulations Division 13.3A and Regulation 13.22C Division 13.3A of the SIS Regulations provides an exemption from the in-house asset limits if a company or trust meets certain conditions. For this exemption, the entity must meet the

Getting things wrong can have significant impacts as breaches in this area could result in investments needing to be removed from an SMSF and in some cases liquidated all together. requirements in SIS Regulation 13.22C upon acquisition by the SMSF. SIS Regulation 13.22D also contains provisions. Certain similar aspects of this regulation need to be met in continuity to ensure the exemption continues to apply. The exemption is available by following the legislative pathway below.

Section 71

In-house assets

Section 71(1)

Exclusions from the in-house assets test

Section 71(1)(j)

Exclusion from in-house assets test for items set out in regulations not to be an in-house asset

SIS Reg 13.22C

When an asset is not an in-house asset linking back to section 71(1)(j)

Although not in the context of an SMSF, the Administrative Appeals Tribunal case of McCarthy and Commissioner of Taxation dealt with the issue of whether a relatively small development was considered carrying on a business. Should trustees wish to ‘develop’ property in a related trust or company while relying on SIS Regulation 13.22C, it is recommended they Continued on next page

QUARTER II 2024 35

STRATEGY

The superannuation rules need to be considered at both implementation and on an ongoing basis. We regularly come across scenarios where trustees who don’t seek advice are getting things wrong. Continued from previous page

seek specialised legal advice. As soon as the exemption available under SIS Regulation13.22C is lost due to a Regulation 13.22D event occurring, then the exemption from the in-house assets test is lost forever, even if the event causing the breach is rectified.

Investing in an unrelated trust or company (see example) If a trust or company is not controlled by the SMSF members and/or any related parties, it will not be an in-house asset. This means SIS Regulation 13.22C does not need to be met and it is possible an SMSF can invest in an unrelated entity where the entity is borrowing, has a charge over assets or is carrying on a business. Trustees should always consider the lack of control they may have when investing in an unrelated entity. Succession planning should also be considered carefully before proceeding. An entity with as little as two unrelated groups can be an unrelated entity if each group does not hold more than 50 per cent of the units or voting rights and cannot control the entity in any other way. While this can work in practice, succession planning needs to be even more carefully considered. Having two parties with neither having control can lead to

36 selfmanagedsuper

SIS Regulation 13.22C – Key requirements When the SMSF first invests, the company or trust must not: • be party to a lease to a related party unless the asset is business real property, • have outstanding borrowings, • hold an interest in another entity, • be providing a loan to another entity other than holding a bank account with a financial institution, • hold an asset with a charge placed over it, and • have acquired an asset from a related party other than business real property. SIS Regulation 13.22D broadly requires these conditions to continue to be met after the SMSF acquires an interest. SIS Regulation 13.22D also includes an added condition where an entity would fail SIS Regulation 13.22C if at any point it carries on a business.

Example – Unrelated trust with four groups Gareth, Maree, David and Josephine would like to use their SMSFs to invest equally in a unit trust that will hold a commercial property to be leased back to their business. Although they are all shareholders in the same company, they are not relatives and working through the rules we have established that they are not part 8 associates. Each SMSF will own 25 per cent of the units. Provided there is no other formal or informal control over this trust by any of the four parties, this would be an unrelated trust. This means the trust will not need to comply with SIS Regulation 13.22C and could borrow to purchase the property and use the commercial property as security. Although it won’t be in this case, the trust may be able to carry on a business and hold interests in other entities. Two years have elapsed and David would like to move on from the business and sell the units held by his SMSF. If each of the other three SMSFs purchase an equal share of David’s units, each SMSF will hold one-third of the units in the trust. Assuming nothing else has changed, this would still be an unrelated trust and will not be an in-house asset. stalemates and if one party wanted to exit the arrangement, the remaining SMSF may end up with an investment in a related trust/company unless the exiting party can find another unrelated person or group to sell its interest to. Where an unrelated entity that has borrowed becomes a related entity, it would not comply with SIS Regulation 13.22C and would be subject to the 5 per cent in-house asset limits. Unless the value of the SMSFs investment is less than 5 per cent of the fund assets, selling shares or units, or transferring them outside of the fund may be necessary.

Conclusion Investing through unlisted entities can provide substantial opportunities for SMSF trustees to boost the retirement wealth of their members, however, the rules are complex, and it is easy to run into trouble without expert advice both at implementation and on an ongoing basis. SMSF practitioners should encourage their trustee clients to always seek advice before considering any opportunities and also when other stakeholders in the entity, particularly nonSMSF investors, propose any changes to these arrangements.

COMPLIANCE

Time for a rethink

Instances of individuals looking to access their retirement savings assets early both legally and illegally are on the rise. Mary Simmons suggests the trend indicates the time is right for a review of the rules applicable to these actions.

MARY SIMMONS is head of technical at the SMSF Association.

38 selfmanagedsuper

In the midst of a cost-of-living crisis and evolving societal needs, the debate over early release of superannuation on compassionate grounds is gaining renewed attention. Leaving aside the extraordinary circumstances caused by COVID, allowing temporary limited access to superannuation benefits, the rules governing the early release of super on compassionate grounds have largely remained unchanged since 1997. But evidence is mounting these guidelines may no longer be fit for purpose. There can be no arguing with the ATO figures. Since becoming the approver of all compassionate release requests from 1 July 2018, the regulator’s data shows early release is increasing. Application numbers increased 40 per cent from 53,800 in 2018/19 to 75,600 in 2022/23 and, in dollars terms, withdrawals rose from $456 million to $762 million for the same periods. Where there hasn’t been much movement is in the number of applications approved, dipping slightly from 58 per cent in 2018/19 to 55 per cent in 2022/23. Where the raw data gets even more interesting over this five-year period is the fall in what have traditionally been expenses leading individuals to request early release, being the forced sale of the family home

(down from $35 million to $10 million with less than 6 per cent of applications approved in 2022/23), palliative care, funerals and disability. In contrast, there has been a notable spike in approvals relating to medical expenses. On the dental front, the cost for approved applications has increased almost fivefold, from $66.4 million in 2018/19 to $313 million in 2022/23. Weight loss, too, is another category that has seen a 20 per cent increase in benefits approved from $207 million to $249 million over this timeframe, although the number of applications has remained steady. In the face of these numbers, perhaps the primary focus should be on reforming Medicare and funding of our health system to better support the provision of necessary treatments, rather than shifting the financial burden onto individuals’ retirement savings. Nonetheless, while we wait for reform to our health system, we are left with no choice but to question the principles underpinning the release of superannuation on compassionate grounds to ensure we maintain the integrity of the super system. With detailed data from the ATO on the specific reasons for early release applications, it is hard to avoid Continued on next page

Continued from previous page

questioning whether some of these medical treatments would fall, at the very least, outside the spirit of the law relating to early release. Let’s take dental work as an example to highlight just two significant consequences. Firstly, it sacrifices the compounding effect of super. Withdrawing $20,000 now for dental work will have a long-term impact on how much individuals have in retirement. Using the Australian Securities and Investments Commission’s Moneysmart calculator, with an average 5 per cent annual return, a 30-year-old withdrawing $20,000 today will have about $110,000 less in their accumulation account when they retire at age 65. Secondly, Private Healthcare Australia argues allowing thousands of Australians to drain their superannuation for dental care is driving up the cost of dentistry for all consumers. It wants the federal government to tighten rules for early access to super so it is only used for terminal and life-threatening medical conditions. It concludes: “The benefits of compulsory superannuation in providing a retirement income for millions of Australians are significant. The government must consider what egregious billing is doing to all Australian consumers trying to access healthcare during a cost-of-living crisis.” The SMSF Association has sympathy with these assertions. At the very least it certainly suggests some of these expenses are out of alignment with the policy intent of the compassionate early-release regime, which is based on the principle of last resort. None of this is to suggest the ATO should be stripped of its discretionary powers to approve applications for the early release of super. A level of flexibility should remain a policy feature to ensure genuine

compassionate grounds can be recognised. This was well illustrated by a recent matter before the Inspector-General of Taxation (IGOT), highlighting how the ATO’s discretion can be used without undermining the integrity of the compassionate early-release regime. In 2023, the IGOT intervened in a dispute between a complainant and the ATO over the early release of superannuation on compassionate grounds. The complainant had borrowed money from a family friend to pay for urgent surgery and medical expenses, intending to repay the loan by accessing their super. The ATO initially rejected the application, stating only unpaid expenses were eligible for compassionate release, but the IGOT found the regulator could use its discretion to approve the release in certain limited circumstances, such as when the applicant had difficulties repaying the loan. This resulted in the ATO changing its policy and approving the complainant’s request after obtaining the relevant evidence from them. But the problem remains that ambiguity still pervades early release. This was recognised as far back as 2017 by then revenue and financial services minister Kelly O’Dwyer when announcing a review of the current framework for the early release of superannuation benefits. There was no shortage of submissions, with the SMSF Association being one of many participants. We argued in favour of reform, stating money released early from superannuation should be for genuine claims only. To quote: “We have focused our solution on ensuring that the financial capacity aspect of the legislation is tighter and applied correctly rather than including safeguards or limits on specific releases. “A principles-based approach will ensure that the superannuation system has appropriate policy settings to ensure that

As the gap in accessible and affordable financial advice widens, allowing early access to superannuation for medical treatments raises concerns about health professionals providing financial advice. retirement savings are used in line with the system’s objectives while also providing flexibility for the system to change and adapt to a changing workforce and concept of retirement.” What was notable from the submissions were concerns with the rising trend of releases for medical expenses. Two key issues emerged: doubts about whether the current eligibility criteria are sufficiently targeted and questions regarding the integrity of the medical practitioners certifying these claims, especially in determining which ‘specialist’ should be required for certification. Unfortunately, the review came to naught. Although Treasury initiated a second round of consultations in late 2018, there was little impetus for change. O’Dwyer then left the portfolio in August 2018. From the association’s perspective, the arguments advanced then have even greater validity today. Why? As the gap in accessible and affordable financial advice widens, allowing early access to superannuation for medical treatments raises concerns about health Continued on next page

QUARTER II 2024 39

COMPLIANCE

Continued from previous page

professionals providing financial advice. It’s essential to ensure there are no blurred lines between clinical advice and financial advice. Health professionals should focus solely on providing medical care, avoiding any financial advisory role, which can lead to conflicts of interest and inappropriate financial guidance. Financial decisions involving superannuation require the expertise of licensed financial advisers. This conflict of interest is magnified when third-party providers charge a fee to arrange early access to superannuation on medical grounds. Over the years there has been a strong emergence of thirdparty intermediaries who charge fees to facilitate this process, which can include the establishment of an SMSF. This is not new news. It was highlighted as far back as 2017 in a federal Department of Health submission about early release that noted nearly all medical stakeholders approached expressed concern about the involvement of third parties, particularly if there is financial gain. The surge of exploitative claims for early release goes hand in glove with an even more troubling trend, especially for the SMSF sector – the growth in unauthorised access to super benefits. At our National Conference in Brisbane in February, the ATO did not mince its words explaining illegal early access is a “significant” issue with $381 million in 2019/20 and $256 million in 2020/21 going out the backdoor. As such, it’s hardly surprising the number of trustees being disqualified is at record levels, hitting 751 in 2022/23, a number likely to be exceeded in the 2024 financial year. The fact illegal early release comes with significant consequences, such as additional tax, penalties and even disqualification, is obviously not proving a sufficient deterrent. According to the ATO, these miscreants are being motivated by various factors ranging

40 selfmanagedsuper

from ignorance of the law, a perverse attitude among SMSF trustees in believing it is their money and ignoring the tax benefits that accompany superannuation, to personal issues and financial stress. They are also being encouraged by promoters of illegal early access schemes who pander to their prejudices of believing it is their money, vulnerability such as financial stress, vanity encouraging non-essential medical treatments or simply ignorance in thinking their actions are legal. We want to prevent a scenario where after the ATO rejects an application for the early release of super on compassionate grounds, individuals resort to setting up an SMSF to gain direct access to their funds. We do not want these individuals to fall victim to scams that convince them what was disallowed when a member of a large fund is somehow legitimate in an SMSF, that being a trustee puts them above the law. Not only is that wrong, but the likelihood of being detected is high seeing the ATO oversees SMSFs and all early-release applications. This is an issue requiring government attention. O’Dwyer believed early release was important enough seven years ago to initiate an inquiry and the fact there were 58 submissions would suggest the industry agreed. Since then, as outlined above, the data shows the situation has worsened, whether it’s misusing early release for specious reasons (usually medical) or illegal early access, with no suggestion these trends are in retreat. But we also need to urge government to extend any review of early release of superannuation to include an evaluation of the current tax regime. Right now the taxable component of monies released under compassionate grounds is generally taxed at 22 per cent for anyone under 60 years of age. For anyone over 60, the withdrawal tends to be tax-free. While some may argue the tax rates

We want to prevent a scenario where after the AT O rejects an application for the early release of super on compassionate grounds, individuals resort to setting up an SMSF to gain direct access to their funds. applied act as a disincentive to withdrawing super early, the data suggests otherwise. In fact, by taxing these withdrawals, members are forced to take out more from their super to net enough to cover their eligible expenses, further exacerbating their future financial vulnerability. If we can get the principles underpinning the compassionate release of superannuation right, surely it’s worth asking the question whether it would be more appropriate for these withdrawals to be tax-free to provide the much-needed financial relief, as intended. This would align with the tax-free treatment of withdrawals from super during the pandemic and for terminal illness conditions. The association is certainly not suggesting this is an easy issue to resolve. But the present day provides a perfect opportunity to revisit this in light of the current economic environment and to ensure any reforms are consistent with the overarching Objective of Superannuation. Balancing a genuine compassionate application for early release with the legitimate policy goal of having superannuation provide for retirement will always be akin to walking a tightrope. But that’s no argument for not doing so.

Technical Summit is back this July! 24-25 July 2024 Hyatt Regency Sydney The curated program of the SMSF Association’s premier technical event is designed to elevate the expertise of those already dedicated to delivering quality SMSF solutions to their clients. Come and experience two days of keynotes, technical sessions and interactive workshops designed to challenge, while exploring new strategies from a multidisciplinary perspective. Don’t miss out, register today!

For full event terms and conditions, visit our website https://www.smsfassociation.com/smsf-association-events-terms-and-conditions

STRATEGY

The AI crystal ball

Artificial intelligence is just starting to play a role in many aspects of our lives. Grant Abbott forecasts what its effect will be on the SMSF sector. Let’s start with something a little different, an SMSF poem by Jack Kerouac.

On the SMSF Road to Financial Freedom

GRANT ABBOTT is director and founder of LightYear Docs.

Man, it’s the open road and the open sky, Down under, where kangaroos leap and wild dreams fly. Aussies, man, they got the groove, the beat, Self-managed super funds, that’s where the journey’s sweet. No fat cats, no big-shot suits, Just raw, unfiltered life, man, where freedom roots. It’s the jazz of investment, each note a choice, Riding the highway, hearing your own voice. From Sydney’s rush to the Outback’s hush, They’re carving paths with a steady hush. It’s their stash, their cash, their golden sun, On the road, man, where the SMSFs wild run. You have to love the author and he loves SMSFs. In this body of work he has really nailed all that is important about them – freedom, dreams and control of your

42 selfmanagedsuper

destiny. This is why we have seen a huge increase in SMSF start-ups with millennials, who are by far the most independent of the generations, ready to do their own thing rather than being chained to work like their parents.

Technology changes everything When I first started at KPMG as a tax consultant in 1989, I was lucky enough to be given an Apple Macintosh computer. Having learned to type instead of doing woodwork at school paid off as I could turn around letters of advice faster than my colleagues, including partners and managers who had to wait for the Wang word-processing ladies to go through the queue. Being a junior I held no weight when it came to trying to get work done so I did it on the Mac myself. Of course, I was hauled into the partner’s office and told to stop doing this and all I had to say was: “Do you want your client work out quickly and billed at the same time Continued on next page

Continued from previous page

or wait for weeks until it progresses through the queue?” Game over, the partner was sold on the idea and billable hours went up. The Mac was the first stage of technology and the next was the evolution of the internet. Suddenly everything was at our fingertips, provided we knew how to find it. I remember doing Australia’s first-ever financial video streaming over the internet back in 1998 when the speed was terrible. Then when broadband came online in the early 2000s, recording videos was more viable and working from home was enabled. Basically the internet and broadband freed up my life. And now we have artificial intelligence or AI, which to me is the most amazing development. I did my first AI training in April 2023 for accountants and do regular sessions showing how to use it for blogs, letters of advice, emails, social media, speeches and copy for marketing and videos. It is the great leveller and enables accountants and SMSF advisers who use the right tools to be equal in knowledge and as skilled at writing. But we are only at the very infancy of AI and moving quickly to where it will outperform me, I’m predicting by 2026 at the latest, and then get to superintelligence by 2029 where it will generate strategies and ideas beyond human capabilities. And I want to be there when it does. Can you imagine how fun it will be? In the meantime, I thought to challenge you and myself and take a ride to 2030 to forecast where SMSFs will be and what the industry will look like.

Reflecting on a decade of AI SMSF evolution As we stand in 2030, the evolution of AI in the SMSF industry has been nothing short of revolutionary. AI is now superintelligent and does most of the hard, grinding work SMSF administrators used to do and has evolved into

a personal SMSF manager, bypassing the need for accountants and administration.

Superintelligent agents Superintelligent agents leverage deep learning, natural language processing and advanced data analytics to understand and predict market trends, automate routine tasks and ensure compliance with regulatory frameworks. They will operate for each SMSF and run autonomously in the background, providing a much cheaper ramp for SMSF start-ups. I’m predicting a time when individuals will be able to commence an SMSF for less than $20,000.

Common SMSF tasks now and with super AI agents Before we get into how things are going to change, it is vital to understand that once AI agents are employed, there is no extra cost for having 1 million agents working on a task or one agent. Importantly, there will be different agents doing different tasks and being specialists at that task right down to microdetail. For example, there will be agents that monitor the Australian Securities Exchange and look for all published actions on companies, including dividends, changes in shareholdings, director sales and, well, all company actions. This will happen instantaneously and be transferred to the SMSF accounting agent, the SMSF compliance agent and also the SMSF investment agent, who will analyse the value or perceived value of the stock based on all available and existing investment analysis and adjust the stock weighting accordingly. Here we break down nine common SMSF tasks and illustrate how these super AI agents can revolutionise their execution and more importantly do it on their own without any physical help: 1. Upgrading trust deeds • Current requirements: Regularly updating trust deeds to comply with legislative changes and best practices is mandatory,

As we stand in 2030, the evolution of AI in the SMSF industry has been nothing short of revolutionary. AI is now superintelligent and does most of the hard, grinding work SMSF administrators used to do. particularly if laws, cases and new strategies emerge that extend beyond the thinking of current SMSF deed drafters. • AI agent handling: The super AI agent deployed by a legal firm can monitor legislative updates in real time, draft necessary amendments and automatically update trust deeds in a central repository for all SMSF clients. This process, which currently typically takes weeks in drafting and deploying plus rolling out, can be reduced to mere minutes with a super AI agent. 2. Document management • Current requirements: Maintaining accurate and accessible records of all SMSF-related documents. This can be painful although automation has improved the time handling and document retrieval significantly. • AI agent handling: Superintelligent agents can automate document filing, indexing and retrieval, ensuring all Continued on next page

QUARTER II 2024 43

STRATEGY

We are only at the very infancy of AI and moving quickly to where it will outperform me, I’m predicting by 2026 at the latest, and then get to superintelligence by 2029 where it will generate strategies and ideas beyond human capabilities. Continued from previous page

records are up-to-date and instantly accessible, reducing manual effort and potential for error. This happens on a real-time basis as there is an agent built solely for notifying when a bank or other institution updates its information. 3. Financial accounting • Current requirements: This often happens a year or more after the transaction, but compliance requires the recording of all financial transactions, preparing financial statements and ensuring accuracy and, most of all, compliance with the Superannuation Industry (Supervision) (SIS) Act 1993. • AI agent handling: An AI agent can process transactions in real time, generate financial statements, conduct automated reconciliations and SIS Act compliance analysis, dramatically cutting down the time required for accounting from days to minutes, but in real time.

44 selfmanagedsuper

4. Income verification • Current requirements: Verifying and recording income items such as dividends, interest and rent. • AI agent handling: AI systems can automatically verify income items against market data and update records instantly, ensuring accuracy and compliance. 5. Conducting SMSF audits • Current requirements: Performing annual audits to ensure compliance with SMSF regulations as mandated under the SIS Act. • AI agent handling: There will be specific AI audit agents that can perform continuous auditing by analysing transactions as they occur, flagging discrepancies immediately, and generating audit reports in real time, reducing the audit cycle from months to hours. 6. Making investments • Current requirements: The trustee or their outsourced financial planner needs to research, evaluate and execute investment decisions. • AI agent handling: AI can use any existing investment analysis and take into account vast amounts of market data, predict trends and execute trades at optimal times, ensuring strategic and profitable investments almost instantaneously. 7. Pension strategies • Current requirements: Calculating pension amounts according to ATO guidelines, setting up payment schedules and ensuring compliance with pension regulations, including obtaining the preparation of relevant documents. • AI agent handling: AI can automatically calculate optimal pension amounts based on member data, determine the best tax and transfer balance account report set-ups, calculate the impact of

maintaining a pension or commutating it, set up payment schedules, ensure regulatory compliance and prepare every possible pension document, all within seconds. 8. Fund wind-up • Current requirements: Checking the deed, liquidating assets, reviewing all bank accounts, checking with the fund’s auditors, settling liabilities, distributing remaining benefits and lodging the fund’s final tax and compliance return. • AI agent handling: AI can manage the entire process of winding up a fund and preparing all documentation, plus tasks from asset liquidation to final benefit distribution, efficiently and accurately, reducing a potentially lengthy process to a matter of hours. 9. Managing incapacity or death • Current requirements: Implementing predetermined plans for managing the fund when a member becomes incapacitated or passes away, and if no plan is in place, letting it linger dangerously for a year or more. • AI agent handling: AI can automatically activate industry best practice plans from the moment of death, prepare all necessary documents, deal with the Australian Securities and Investments Commission (ASIC) and the ATO, ensure seamless transition and management of the fund, handling all administrative, accounting, compliance and legal requirements instantaneously.

Complacency: a gift to the ATO All of this is coming so we need to get in front of the wave. But everyone needs to be wary that the ATO and ASIC will also have as many AI super agents as possible to make sure real-time compliance and management is happening.

WE CAN HELP WITH CLIENT EDUCATION Advisers see client education as part of their responsibility but don’t always have the time to fulfil this obligation. A solution can be to white label smstrusteenews. Doing so will keep your clients informed on the major issues shaping the sector and ensure engagement every fortnight. To explore this opportunity further contact us at info@bmarkmedia.com.au | d.tyson-chan@bmarkmedia.com.au

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Gearing down Upon the conclusion of a limited recourse borrowing arrangement, SMSF trustees have certain options as to how the associated structure will subsequently be treated. Michael Hallinan details the courses of action that are available in these circumstances.

MICHAEL HALLINAN is superannuation special counsel at SuperCentral.

Unwinding a limited recourse borrowing arrangement (LRBA) is the process whereby the asset that is held in the holding trust under the gearing procedure is transferred to the SMSF. An LRBA can only be closed down if the borrowing has been repaid. The principal issue arising on taking the action is whether the transfer of the asset to the SMSF gives rise to the charge of a proportionate transfer duty.

What is unwinding? Unwinding an LRBA involves repaying the borrowing under which the asset, typically real estate, was acquired and then transferring it to the SMSF. Closing down an LRBA therefore raises issues as to whether the transfer of the property is a capital gains tax (CGT) event or a taxable supply and whether the transfer is entitled to concessional transfer duty treatment.

When an LRBA can be unwound LRBAs can only be unwound if the borrowing used to acquire the property has been repaid. If the gearing arrangement is unwound before the borrowing has been repaid, the LRBA will not be covered by section 67A of the Superannuation Industry (Supervision) (SIS) Act 1993 as subsection (1)(b) will cease to be satisfied. Consequently, the borrowing made pursuant to the LRBA will cease to fall within an exception to section 67(1) and a breach of that section will occur.

Why unwind? There are a number of reasons why an SMSF trustee would want to unwind an LRBA. The first is recognising the structure has served its purpose. Secondly, doing so would avoid expenses such as the Australian Securities and Investments Commission annual review fee if the holding trustee is a company. Thirdly, the action would more readily identify the property as being an asset of the SMSF. There is also the practical issue that if the LRBA is wound up soon after the borrowing has been repaid, it is more likely the supporting documents necessary to justify the claim for concessional or no transfer duty on the transfer to the SMSF will be readily available. Finally, and most importantly, unwinding means the property will fall within the scope of the ATO’s 2014 46 selfmanagedsuper

SMSF LRBA In-house Assets Exclusion Determination (F2014L00396).

Reasons not to unwind There are three principal reasons not to transfer an asset to the SMSF once the LRBA liability has been satisfied. These are concerns as to eligibility for concessional transfer duty on the transfer, if the acquired property is being sold directly to a third party, or a desire not to incur the expenses of the exercise. Firstly, the doubt over the eligibility for concessional transfer duty may arise because the LRBA was not correctly structured from a transfer duties perspective. Secondly, transferring the asset to the SMSF may not be applicable because the property is to be sold to a third party that will in turn allow the LRBA to be extinguished. The transfer may also be unnecessary in situations where the property will be sold shortly after the gearing liability. Thirdly, the SMSF trustees may not want to commit to the costs of unwinding. This is the least justifiable motivation and ignores the expenses associated with maintaining the LRBA structure.

Is unwinding compulsory? Until the issue of the 2014 determination, the answer to this question was yes. Since the issue of the determination, subject to two exceptions, the answer is no. The reasoning for the position before the issue of the determination is as follows. While the borrowing associated with the LRBA was on foot, the holding trust was not treated as a related trust and consequently the interest of the SMSF in the holding trust was not considered to be an in-house asset. This exception is provided by section 71(8) of the SIS Act. However, this exception ceases to apply once the borrowing is repaid. As such, the interest of the SMSF in the holding trust would then be an in-house asset. However, the determination has made the position radically different. This is because if it applies to the LRBA, there is no legal compulsion to unwind the gearing structure. The determination effectively continues the operation of section 71(8) after the Continued on next page

Continued from previous page

borrowing has been repaid. The 2014 determination will only apply to an LRBA if, assuming the borrowing was still on foot, it would have satisfied all the requirements of section 67A. Should the determination no longer apply to an LRBA, the SMSF interest in the holding trust will be treated as an in-house asset at the first balance date occurring after the determination is no longer valid. This means the SMSF will have to divest its interest in the holding trust If the 2014 determination ceases to apply to an LRBA, then the SMSFs interest in the holding trust will at the first balance date occurring after the determination ceases to apply be treated as an in-house asset and the in-house asset divestment rules will be triggered and the SMSF will have to divest its interest in the holding trust. With regard to the exceptions mentioned above, the first exception relates to LRBAs where the holding trustee was a group company of the lender. Commonwealth Bank of Australia (CBA) preferred an LRBA structure where the purchaser was the SMSF and the contract of sale had an express provision the vendor was to transfer title to a named company that was a group company within the CBA group. This arrangement was chosen to further protect the commercial interests of the lender. On the repayment of the borrowing, it was a term of the arrangement the property would be transferred to the SMSF. Where the LRBA is structured along these lines, then the property must be transferred on repayment of the borrowing due to the applicable contractual terms. The second exception arises if the SMSF intends to undertake actions in relation to the property, for example, redevelopment or substantial renovations, which will result in the property becoming a ‘different property’ for the purposes of the replacement asset rules of SIS Act section 67B. If the redevelopment or renovation results in a different asset, then the holding trust will cease to satisfy the requirements of section 67A with the consequence that the precondition for the

application of the 2014 determination will cease to be satisfied. In this situation the property must be transferred to the SMSF before the next balance date.

The unwinding process LRBAs can be unwound in one of two ways. The first method is to transfer the property to the SMSF. The second is to sell the property to a third party and transfer the net proceeds of sale to the fund. The first approach requires the holding trustee to transfer legal title to the property to the SMSF, while the second calls for the holding trustee, after being duly instructed by the fund, to sell the property to a third party. The sale price must be market value and the sale terms must be the normal conveyancing terms. Reference to a third party means any purchaser other than the SMSF. The purchaser could be an unrelated individual or company or could be a member. If the purchaser is a member of the SMSF, or an entity controlled by the member, then a sale price less than market value will be an improper transfer of value from the SMSF to the buyer and a sale price greater than market value will be an improper transfer of value from the acquirer to the fund. Once the sale has been completed, the net sale proceeds, after payment of items such as conveyancing fees, must be paid to the SMSF. The net sale proceeds cannot be left in the holding trust as the sale proceeds are not treated as a permissible replacement asset of the property. The holding trust will terminate once the transfer of title has been effected or the net sale proceeds paid to the SMSF as there will no longer be any trust property. While no document is needed to effect this termination, it would be prudent for trustee minutes to be prepared to record the means and relevant details as to how this was achieved. As the holding trust is a transparent trust for taxation purposes, the preparation of a final tax return is not required.

Taxation issues of unwinding

Unwinding an LRBA involves repaying the borrowing under which the asset, typically real estate, was acquired and then transferring it to the SMSF. the Income Tax Assessment Act (ITAA) 1997, pertaining to instalment trusts, the taxation issues of unwinding an LRBA were primarily concerned with whether the SMSF was absolutely entitled to the property as against the holding trustee. However, since the enactment of Division 235 the only issue is whether the LRBA is covered by section 67A. If it is, then there are no taxation issues on unwinding. If not, there will be significant taxation issues not only upon unwinding, but also during the existence of the LRBA. The operative provision is section 235-820 of the ITAA, which applies retrospectively from 24 September 2007. The effect of this provision is that: a. the property is treated for income tax and CGT purposes as being owned by the SMSF, b. any act of the holding trustee in relation to the property is treated as being an act performed by the SMSF, and c. the cost base or reduced cost base of the property in the hands of the holding trustee is treated as being the cost base for the SMSF. Accordingly, as long as section 67A of the SIS Act applies then: a. if the LRBA is unwound by transfer of the property to the SMSF, the transfer itself has no CGT consequences and, in respect of any subsequent disposal of the property by the SMSF, will be subject to CGT using the cost base (or reduced cost base) which applied to the holding trustee plus any further cost base adjustments to reflect

Before the enactment of Division 235 of Continued on next page QUARTER II 2024 47

COMPLIANCE

Table 1 Jurisdiction

Concession/exemption

Treatment basis

New South Wales

Section 62 Duties Act 1997 $750

Custodian transfer

Victoria

Section 34(1)(b) Duties Act 2000 Nil

Apparent purchaser

Queensland

Section 130B(1)(b) Duties Act 2001 Nil

Custodian transfer

Tasmania

Section 39(1)(b) Duties Act 2001 or Section 46(1)(b) Duties Act 2001 $50

Apparent purchaser Custodian transfer

South Australia

Section 71(7a) Stamp Duties Act 1923 Nil

Apparent purchaser

Western Australia

Section 117(1)(b) Duties Act 2008 Section 126(2)(b) Duties Act 2008 $20

Apparent purchaser Custodian transfer

Northern Territory

Schedule 2(6)(b) Stamp Duty Act 1978 Nil

Apparent purchaser

Australian Capital Territory

Section 56(1)(b) Duties Act 1999 Section 63(1)(b) Duties Act 1999 $20

Custodian transfer

Continued from previous page

costs incurred by the SMSF since the transfer, and b. if the LRBA is unwound by sale of the property by the holding trustee and payment of the net sale proceeds to the SMSF, the disposal of the property will be treated as a disposal by the SMSF and not by the holding trustee, the cost base (or reduced cost base) that would have applied to the holding trustee is attributed to the SMSF and any capital gain or capital loss is derived by the SMSF, not by the holding trustee, and will be assessable or exempt depending on the circumstances that apply to the fund and whether the interest of the SMSF in the holding trust was a segregated or unsegregated pension asset. The legislation that introduced Division 235 of the ITAA did not amend the goods and services tax (GST) legislation. Consequently, LRBA arrangements must be structured so the

48 selfmanagedsuper

holding trust is a bare trust. If this is the case, then for GST purposes any taxable supply will be treated as having been made by the SMSF.

Transfer duty and unwinding In the absence of an applicable concession or exemption, the transfer of the property from the holding trustee to the SMSF would give rise to normal transfer duty. This is because the transfer is one of dutiable property from one legal entity to another legal entity. All jurisdictions provide either a concession or exemption for transfers from the holding trustee to the SMSF. However, the preconditions for entitlement to the concession or exemption must be strictly satisfied and the onus is on the SMSF to prove these have been satisfied. In the absence of doing so, proportionate duty will apply. As a broad statement, the concession or exemption is based upon either the ‘apparent purchaser’ or ‘custodian transfer’ concession or exemption. The relevant basis for the

LRBAs can be unwound in one of two ways. The first method is to transfer the property to the SMSF. The second is to sell the property to a third party and transfer the net proceeds of sale to the fund. concession, relevant statutory provision and duty amount is set out in Table 1.

Concessional duty amounts as at 1 July 2024 Accessing the various concessions usually depends on the SMSF being a complying superannuation fund, providing documentary proof the entire purchase price of the property was met either directly or via a borrowing, documentary proof of a loan by the SMSF, documentary proof the entire loan proceeds were applied in the purchase of the property and documentary proof the duty applicable to the acquisition of the property by the holding trustee has been paid. Documentary proof is direct evidence, such as the stamped contract of sale, proof duty has been paid in respect of the transfer to the holding trustee, and loan documents and extracts from the fund bank account evidencing the flow of money from the fund into the purchase price of the property. Most revenue authorities will accept PDFs of the various documents, particularly if a revenue authority assessment number is included. Where there is no direct evidence or it is missing or incomplete, secondary evidence may be accepted, such as audited financial statements of the SMSF that show its interest in the property/holding trust as an asset. In jurisdictions that have both apparent purchaser and custodian transfer exemptions, the applicable exemption will depend on the underlying structure of the LRBA, that is, whether it was structured as a custodian acquisition or as an apparent purchase.

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STRATEGY

Seeing through it all

The ability to assess the merits of financial products included in the superannuation system is dependent upon the disclosure of all associated costs. Ben Walsh examines the expenses that should be reported and taken into account.

BEN WALSH is head of research at Padua Solutions.

The Australian superannuation platform industry is a complex and competitive landscape, with numerous product offerings and a variety of fee structures. One of the critical aspects of this industry is the transparency and disclosure of fees and costs, which is governed by Australian Securities and Investments Commission Regulatory Guide 97 (RG 97). Despite the regulatory requirements, many product offers, particularly for pooled investment vehicles, often highlight only the investment management cost in their press releases and advertisements. This selective disclosure can be misleading as it does not provide a complete picture of the total cost of the product.

The importance of total cost disclosure RG 97 mandates all fees and costs associated with superannuation products be disclosed in product disclosure statements (PDS) and periodic statements. This includes not only the investment management fees, but also performance fees, transaction costs and any other associated imposts. The purpose of this comprehensive disclosure is to ensure consumers have accurate and

50 selfmanagedsuper

transparent information to make informed decisions about their superannuation investments.

Investment management fees v total costs Investment management fees are just one component of the total cost of a superannuation product. These fees cover the cost of managing the investments within the fund. However, there are other costs that can significantly impact the overall performance of the investment. These include: • Performance fees: These are fees paid to investment managers based on the performance of the fund. They are typically calculated as a percentage of the returns generated above a certain benchmark. • Transaction costs: These costs are incurred when buying and selling assets within the fund. They include brokerage fees, stamp duty and other related expenses. • Administration fees: These fees cover the cost of managing the superannuation account, including Continued on next page

Continued from previous page

record-keeping, customer service and regulatory compliance. The aggregate of these costs represents the total cost of the product, which is what RG 97 aims to disclose transparently.

Impact on performance Regardless of the disclosure rules, all these costs ultimately hit the performance of the superannuation product. When evaluating the performance of a super fund, it is essential to consider the impact of all fees and costs. A fund with lower investment management fees but higher transaction and performance fees may not necessarily provide better returns than a fund with higher investment management fees but lower overall costs.

Comparability and transparency One of the key objectives of RG 97 is to enhance comparability between different superannuation products. By requiring all fees to be based on the last audited financial statement date, RG 97 enables consumers to make apples to apples comparisons. This comparability is crucial for financial advisers, who need to provide accurate and reliable advice to their clients. However, some product creators may implement investment cost changes off-cycle, which can hinder this comparability. Such practices can hurt the value of the recommendation and the considered alternatives process, making it challenging for consumers to make informed decisions.

Listed pooled investment vehicles v managed funds Another issue in the superannuation industry is the difference in cost structures between listed pooled investment vehicles, such as exchangetraded funds, and managed funds. While RG 97 does not fully reflect the buy/sell spread on listed assets, advisers should consider this

The Australian superannuation platform industry must prioritise transparency and comprehensive disclosure of all fees and costs associated with their products, be they wholesale or retail.

reflecting the impact of all extra costs. This approach ensures advice is based on a comprehensive understanding of the product’s performance and cost structure.

Performance and cost transparency Performance should always reflect the impact of all associated costs. Advice relies on broad asset classes to explain exposure and performance numbers to show how well ‘things’ performed, supplemented by broad asset class return contributions. The combination of both insights would illustrate the value of the asset allocation decision and the marginal utility of particular asset classes in the portfolio.

Consumer understanding and industry practices cost in their evaluation process. The buy/sell spread represents the difference between the buying and selling price of an asset and can add significantly to the overall cost of the product, especially over time due to the compounding effect. The performance impact is very real.

Transaction costs and managed accounts Transaction costs, particularly around managed accounts, is another area where disclosure is often lacking. These costs are sometimes seen as incidental expenses, but their compounding effect can be dramatic. Proper disclosure of these costs is essential for providing a complete picture of the total cost and performance drag of the investment.

The role of financial advisers Financial advisers play a crucial role in helping consumers navigate the complex landscape of superannuation products. However, there is often a focus on making recommendations as cheap as possible rather than making true comparisons based on merit and a comparable data set. Fee disclosure needs to be accompanied by performance disclosure,

While some may view the detailed disclosure of fees and costs as tedious and potentially confusing for consumers, it is essential for ensuring transparency and accountability in the superannuation industry. Industry funds that consistently push performance metrics can benefit from being able to explain why the performance is the way it is, including the impact of various costs. This transparency can build trust and confidence among consumers, who are increasingly looking for clear and comprehensive information about their investments.

Conclusion In conclusion, the Australian superannuation platform industry must prioritise transparency and comprehensive disclosure of all fees and costs associated with their products, be they wholesale or retail. RG 97 provides a framework for this disclosure, but it is up to the industry to implement these requirements effectively. Financial advisers and consumers alike benefit from having a complete understanding of the total cost of superannuation products, enabling informed decision-making and ultimately leading to better financial outcomes.

QUARTER II 2024 51

COMPLIANCE

Recording all of it One of the key components to ensure sound SMSF compliance is thorough record-keeping. Tim Miller details the documentation practices trustees need to take into account.

TIM MILLER is technical and education manager at Smarter SMSF.

Running an SMSF represents a significant responsibility for trustees, demanding meticulous attention to documentation to ensure compliance with legal, regulatory and financial requirements. Proper SMSF documentation is not only crucial for the smooth operation and governance of a fund, but also for protecting trustees from potential legal liabilities and ensuring a fund’s long-term sustainability. This article summarises key aspects of SMSF documentation, including the necessity of regular reviews, essential documents, governing rules, best practices and the documents that frequently cause conflicts.

The significance of documentation Documentation within an SMSF serves multiple purposes. It provides a clear framework for the fund’s operations, ensuring all actions are compliant with the Superannuation Industry (Supervision) (SIS) Act 1993 and associated regulations. Additionally, it safeguards trustees by documenting decisions and processes, thus providing evidence in case of disputes or audits. Comprehensive documentation also ensures the fund’s strategies, especially regarding investments and estate planning, are clear and executable.

Key documents Key documents every SMSF must maintain include: • Trust deed: The trust deed is the foundational document of an SMSF. It establishes the fund’s framework, detailing trustee powers, member rights and operational guidelines and it must comply with the SIS Act. Regular updates are necessary to align with legislative changes. • Investment strategy: A comprehensive plan detailing the fund’s investment objectives, risk management strategies, diversification strategies and liquidity needs taking into consideration the personal circumstances of the members. This document must be reviewed regularly to ensure it remains relevant. • Minutes of meetings and resolutions: Records of trustee meetings and decisions made that are crucial for transparency and accountability. • Financials statements: These include the operating statement, statement of financial position and notes to the accounts. They provide a snapshot of the fund’s

52 selfmanagedsuper

financial health and performance. • Tax returns and audit reports: Annual returns submitted to the ATO and independent audit reports verifying the fund’s compliance with regulatory requirements. • Member statements: Annual statements that provide details of each member’s account balance, contributions and benefit payments. • Death benefit nominations – binding or otherwise: Documents directing how a member’s benefits should be distributed upon their death. These need to be regularly reviewed and compliant with the trust deed to be valid. • Pension documents: Formal details pertaining to the commencement and management of pensions, including terms and conditions agreed upon by the trustee and member.

Trust deeds The governing rules of an SMSF are encapsulated within its trust deed, a legal document that outlines the powers, duties and obligations of the trustees. The trust deed must be appropriately drafted and updated to reflect any changes in legislation or fund circumstances. The trust deed sets out how the fund is to be operated and managed. It must align with superannuation laws, including the SIS Act and the SIS Regulations 1994. The deed should cover essential provisions such as: • Establishment date and definitions: An official record of when the fund was set up and clear definitions of common terms used throughout the deed and within the SMSF sector to assist trustees in their understanding. • Compliance clause: A clause stipulating the deed must be read in conjunction with superannuation laws and, in case of inconsistencies, the law takes precedence. • Trustee and member details: Procedures for appointing and removing trustees and members. • Operational rules: Guidelines for fund operations, including how meetings are conducted, voting procedures and how decisions are made. Continued on next page

Continued from previous page

Statutory obligations Key statutory covenants under sections 52B and 52C of the SIS Act are taken to be included within the governing rules, whether stated or not and include: • acting honestly in all matters concerning the fund, • exercising skill, care and diligence in managing the fund, • acting in the best financial interests of members, • formulating and giving effect to an appropriate investment strategy, and • keeping accurate and accessible records. Further, it is incumbent upon the trustees to inform the ATO of significant changes and events as required by law.

Trustee liability Trustees can be held personally liable for any loss suffered by the fund due to breaches of trust or negligence. Therefore, it is crucial to ensure all actions are well documented and compliant with the governing rules and superannuation laws. In the event of a legal dispute, comprehensive documentation serves as evidence of the trustees’ adherence to their duties.

Effective estate planning is critical for SMSFs, particularly concerning BDBNs and reversionary pensions. Trustees must ensure these documents are valid, up to date and aligned with the fund’s trust deed.

• Commutability and reversionary rules: Guidelines on whether the pension can be ceased and the rules governing reversion actions.

Product disclosure statement A product disclosure statement (PDS) is an essential document for SMSFs, particularly when a member transitions from the accumulation phase to the pension phase. The Corporations Act 2001 mandates a PDS must be issued under specific circumstances to ensure members are fully informed about the products and services they are receiving.

Pension documents

PDS exemptions

Pension documents are critical for outlining the terms and conditions of income streams paid from the fund. Proper documentation ensures pensions are managed in compliance with legal requirements and fund rules. Pension documents should cover: • Start date and reversionary status: Clear information on when the pension starts and if it reverts to another individual upon a member’s death. • Terms and conditions: Detailed terms agreed upon by the trustee and member, ensuring alignment with the trust deed.

A limited exemption exists if there are ‘reasonable grounds’ to believe the member has received, or has access to, all the information the PDS would typically contain under section 1012D of the Corporations Act. This exemption applies if the member is already sufficiently informed about the pension product and its terms. One of the significant risks is making decisions for the client without issuing a PDS. The default position should be that the client’s understanding, as a member, is typically Continued on next page

Document conflict: The following table outlines some of the SMSF documents that can create conflict for trustees. Deed and legal documents

• Outdated or ineffective deeds: Deeds that are not updated to reflect legislative changes can lead to compliance issues. • Inconsistent constitutions: Differences between the SMSF deed and the constitution of a corporate trustee can create conflicts.

Investment strategies

• Generic strategies: Investment strategies that are too generic may not meet the specific needs of the fund and its members. Regular reviews and updates are necessary to ensure they remain relevant and effective.

Related-party transactions

• Compliance with SIS: Ensuring transactions with related parties are conducted on commercial terms and in compliance with SIS regulations. • Valuation issues: Accurate valuations following market value guidance are essential, particularly for related-party transactions.

Pension and estate planning documents

• Invalid BDBNs: Binding death benefit nominations (BDBN) must follow the procedure outlined in the trust deed to be valid. The Hill v Zuda case emphasised the importance of compliance with the deed’s requirements. • Inadequate pension documentation: Proper documentation is essential to avoid issues such as circular arguments or inconsistencies with the trust deed. QUARTER II 2024 53

COMPLIANCE

Continued from previous page

insufficient without a PDS. Therefore, it is generally recommended a PDS be provided to ensure full compliance and transparency.

Contents of a PDS To be effective and beneficial, a PDS should include comprehensive information that helps the member understand how a pension will operate. Key elements to be covered include: • type and term of the pension, • administrative, tax, legal and actuarial considerations, • advantages and disadvantages, • commutability and reversionary status, and • estate planning implications. The final point above is critical as it is important to know how the pension integrates with the member’s overall estate planning strategy, including details on binding death benefit nominations (BDBN) and reversionary pension provisions.

Practical considerations There are a number of practical considerations when drafting pension documents. • Agreement before commencement: Trustees and members must agree to the terms and conditions of the income stream before it commences. • Flexibility in documentation: Pension documents should allow flexibility in dealing with benefit payments, ensuring compliance with pension standards.

Best practices for SMSF documentation The following is a non-exhaustive guide to having good SMSF documentation. Regular reviews and updates Given the dynamic nature of superannuation laws, it is essential to regularly review and update the trust deed and other governing documents. Over time, circumstances and details may change, necessitating updates to ensure all records are accurate and complete. Regular reviews help identify and mitigate potential risks associated with outdated or incomplete documentation.

54 selfmanagedsuper

Accurate record-keeping Maintaining accurate and accessible records is fundamental. Using SMSF administration software can help streamline the recordkeeping process and ensure all documents are stored securely and are easily retrievable. Electronic documentation The Electronic Transactions Act 1999 allows certain SMSF documents to be signed and stored electronically. However, some laws, like the SIS Act, still require paper forms or wet-ink signatures for specific documents. Trustees must ensure electronic records are verifiable, accessible and compliant with ATO requirements. Document retention The ATO mandates specific retention periods for SMSF documents to ensure all records are available for audit and compliance checks. Key retention requirements include: • Five years: Applicable to accounting records, annual returns and documentation related to benefit payments. • 10 years: Relevant for minutes of trustee meetings, records of changes in trustees, trustee declarations and member consent forms. Failure to retain documents for the required periods can result in penalties and compliance issues. Consistency and clarity Consistency in documentation is key to avoiding conflicts and misunderstandings. All documents should be clear, concise and aligned with the fund’s governing rules. For example, investment strategies should explicitly state the objectives and risk management policies of the SMSF, avoiding generic or vague statements. Professional advice and support Engaging professional services for legal, financial and compliance advice can help trustees navigate the complexities of SMSF documentation. Legal professionals can assist in drafting and updating the trust deed, while accountants and financial advisers can provide guidance on compliance and investment strategies. Estate planning considerations Effective estate planning is critical for

Trustees must be prepared for more rigorous audits and inspections, emphasising the need for comprehensive and accurate documentation. SMSFs, particularly concerning BDBNs and reversionary pensions. Trustees must ensure these documents are valid, up to date and aligned with the fund’s trust deed. The High Court decision in Hill v Zuda emphasised the importance of adhering to the trust deed’s requirements for BDBNs, underscoring the need for meticulous documentation.

Conclusion Regulatory bodies, including the ATO and the Australian Securities and Investments Commission, are placing increased scrutiny on SMSFs, particularly regarding compliance and documentation. Trustees must be prepared for more rigorous audits and inspections, emphasising the need for comprehensive and accurate documentation. Advancements in technology, particularly in SMSF administration software, offer significant opportunities for improving documentation practices. Automated document generation, digital signatures and secure cloud storage can enhance efficiency and accuracy. Effective SMSF documentation is the cornerstone of a well-managed and compliant fund. Trustees must prioritise the maintenance of accurate, comprehensive and up-to-date records to ensure compliance with superannuation laws, protect themselves from possible legal actions and facilitate the smooth operation of the fund. By adopting best practices in documentation, engaging professional advice and staying abreast of legislative changes, trustees can safeguard their SMSF’s future and ensure it meets the needs and expectations of its members.

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Contribution entitlement

Employment arrangements can sometimes be unclear as to whether an individual is entitled to having superannuation contributions made on their behalf. Daniel Butler reviews a recent legal case addressing this issue. This article covers the topic of whether an individual is regarded as an employee or a contractor. It focuses on the ATO’s recent decision impact statement (DIS) regarding the full Federal Court in Jamsek v ZG Operations Australia Pty Ltd (No 3) [2023] FCAFC 48. DANIEL BUTLER is director at DBA Lawyers.

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Background By way of background, we have extracted some paragraphs below concerning the facts of Jamsek: “Mr Jamsek and Mr Whitby were initially employed as drivers directly by ZG Operations from 1977. However, in 1985/86 the company negotiated a new arrangement with each driver and their wife as separate partnerships. Each partnership purchased a truck from the company and thereafter maintained their own equipment. Each partnership was paid for

the delivery of goods via an invoice. Each driver argued they were placed under pressure to enter into these arrangements. “Each truck driver on departure from the company in 2017 claimed they should be paid their employee entitlements that they had missed out on, including annual leave and superannuation guarantee (SG) contributions. This is not an uncommon claim for a departing purported contractor where the person may consider they missed out on these entitlements — thus, employers need to be mindful of this risk when considering the apparent advantages of hiring a contractor, in contrast to an employee. “The primary judge of the Federal Court concluded Continued on next page

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the drivers were independent contractors. However, the full court overturned this decision and held that, having regard to the ‘substance and reality’ of the relationship, they were employees. “The High Court unanimously held that Mr Jamsek and Mr Whitby were not employees within the ordinary meaning of that term.” The High Court subsequently remitted back to the full Federal Court the issue regarding whether the drivers fell within the meaning of employee under section 12(3) of the Superannuation Guarantee (Administration) (SGA) Act 1992. Relevantly, section 12(1) of the SGA Act states the terms ‘employee’ and ‘employer’ have their ordinary meanings. However, section 12(3) provides for an expanded definition of an employee for SG purposes, namely: “If a person works under a contract that is wholly or principally for the labour of the person, the person is an employee of the other party to the contract.”

Full Federal Court decision The full Federal Court unanimously held Jamsek and Whitby did not fall within the expanded definition of employee under SGA Act section 12(3). Importantly, the court concluded section 12(3) only applies if the party providing the labour or services is a natural person who entered the contract in their individual capacity and not in any other capacity, for example, as a partner in a partnership. The court also found Jamsek and Whitby failed to adduce sufficient evidence to establish they fell within the scope of section 12(3).

ATO view The ATO highlighted several aspects of section 12(3) that were clarified by the court, including: • the application of section 12(3) requires an analysis of the content of a bilateral exchange of promises (regardless of the

number of parties on each side of the contract), • the SG regime cannot be circumvented by forming a contract that names more than two parties, and • only natural persons entering contracts in such capacity can be deemed an employee for the purposes of section 12(3). Further, section 72(1) of the SGA Act does not operate to deem a partnership or other entity to be a natural person for the purposes of section 12(3). The ATO also reiterated the considerations that apply in determining whether a contract is for labour with regard to the terms of the relevant contract, including: • a contract designed for the provision of a result is not a contract for labour, • remuneration calculated on a per hour basis points against a contract being for the provision of a result, while remuneration calculated with reference to a number of hours worked per day is inconsistent with a contract being for a result, • a substantial capital asset being required to provide services points towards the contract not being wholly or principally for labour, • the existence of a right to delegate under a contract means the performance of the contract is not personal to the individual engaged to provide the service (that is, the contract will be for the provision of a service, not for the labour of the individual), and • it may not be appropriate to divide the contract into components when determining whether the contract is wholly or principally for labour where a contract is for a single integrated benefit (that is, a delivery service). The DIS also provides guidance on whether an analysis of a contract should be quantitative or qualitative. Broadly, the court found quantitative evidence from Jamsek and Whitby regarding the market value of components

We recommend individuals who engage contractors should ensure they have comprehensive written contracts that are appropriately worded to reflect the latest guidance from the AT O.

of the delivery service was required to show the contract was at least principally for labour. However, the tax commissioner has clarified in the DIS there will be instances where a qualitative analysis of components of a service should be used. However, no further guidance was provided as to circumstances that would warrant a qualitative review.

Conclusion We recommend individuals who engage contractors should ensure they have comprehensive written contracts that are appropriately worded to reflect the latest guidance from the ATO. Further, the DIS notes the commissioner is considering whether changes are required to a range of ATO material, including Superannuation Guarantee Rulings 2005/1, 2005/2 and 2009/1 and ATO Interpretive Decision 2014/28. Therefore, individuals and entities seeking to rely on these ATO materials should be mindful they are subject to potential change. There is considerable complexity in ensuring that a true contractor relationship exists especially after recent changes to the Fair Work Act 2009, which, in essence, seeks to reverse the High Court decisions that focus on the primacy of the contract.

QUARTER II 2024 57

SUPER EVENTS

SMSF PROFESSIONALS DAY 2024

SMSF Professionals Day 2024 was held across three locations in May with around 400 practitioners in attendance. The Sydney leg of the event was held at Rydges Sydney Central. 1

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1: Matthew Richardson, Melanie Dunn, Lee-Anne Hayes, Mark Ellem and Anthony Cullen (all Accurium). 2: Lisa Palmer (Hostplus). 3: Harris Argeetes (Questra Financial Services), Morris Addamo (ANZ) and Goran Gorgievski (Finance and Risk). 4: Alan Greenstein (Zagga). 5: David Goldsmith and Carolyn O’Brien (both Class). 6: Dane Stephenson (Accountancy Insurance). 7: Mark Ellem, Matthew Richardson and Anthony Cullen (all Accurium). 8: Lee-Anne Hayes (Accurium). 9: Stephan Mekertichian and Erica Tsang (both Zagga). 10: Anthony Cullen (Accurium). 11: David Edgar and Lisa Palmer (both Hostplus). 12: Mark Ellem, Melanie Dunn, Lee-Anne Hayes, Matthew Richardson and Anthony Cullen (all Accurium). 13: Ky Wilson and Natasha Panagis (both Institute of Financial Professionals Association). 14: Melanie Dunn (Accurium). QUARTER II 2024 59

“ I NEVER THOUGHT I’D BE HOMELESS.” 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.

Visit salvationarmy.org.au or scan the QR code *Name changed for privacy