Self Managed Super: Issue 47

QUARTER III | ISSUE 047 | THE PREMIER SELF-MANAGED SUPER MAGAZINE

CURRENT HURDLES CONFRONTING

2024 smsf roundtable

FEATURE

COMPLIANCE

STRATEGY

COMPLIANCE

SMSF roundtable Significant issues considered

New tax ruling Minimum pensions

Disability benefits Best tax results

Asset valuations Correct approach

COLUMNS Investing | 28 Outlook for markets.

Investing | 32 Benefits of high-yield bonds.

Compliance | 36 New tax ruling regarding pensions.

Strategy | 39 Time for a complete fund review.

Compliance | 42 Getting asset valuations right.

Strategy | 46 Optimising disability benefits tax position.

Compliance | 50 NALI issue still requiring attention.

CURRENT HURDLES

CONFRONTING

2024 smsf roundtable

Strategy | 54 Estate planning involving blended families.

Compliance | 58 Related-party loan complexity.

Strategy | 61 When bigger is not always better.

Compliance | 64 Revisiting a landmark estate planning case.

Compliance | 66 SMSFs and the Design and Distribution Regime.

REGULARS 2024 SMSF ROUNDTABLE INDUSTRY DISCUSSES CURRENT SECTOR HURDLES Cover story | 12

What’s on | 3 News | 4 News in brief | 5 SMSFA | 6 CPA | 7 IFPA | 8 CAANZ | 9 IPA | 10 Regulation round-up | 11 Super events | 70 QUARTER III 2024 1

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

Reflections on a political career It was announced this month Bill Shorten would be stepping down from his position as a member of the House of Representatives. A decision like this often prompts reflections on the individual’s career so I thought I’d join this chorus. However, unlike the platitude-only assessments this habit usually triggers, I’m going to throw a few brickbats as well as bouquets I feel the Member for Maribyrnong has earned.

His role is significant as he was the first financial services minister and politician with whom I had direct contact when I began covering the SMSF sector.

Let’s start with some of his less glorious moments. I first encountered Shorten at a Selfmanaged Independent Superannuation Funds Association event where he was outlining the government’s position on SMSFs and speaking alongside his Liberal Party counterpart, Mathias Cormann.

I remember noting never before seeing a politician with such poor body language during a presentation. Why? Because for a lot of the time he was at the lectern, and especially when he was taking delegate questions, he had his chin resting in the palm of his hand as if to reflect on the chore of having to be there.

Next came his appearance at the SMSF Association National Conference, I think in 2011, held in Brisbane that year. Of course, the media was told he would be attending and addressing conference attendees shortly after the formal sessions had ended for the day. As such, all journalists in attendance were prepared for his appearance to see if he would reveal any nuggets of policy information.

But alas his arrival was delayed, delayed and then delayed again. By the time he got to the event, the networking function was well underway – hardly an ideal situation for a politician to engage with their audience.

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His speech took on further farcical proportions as he had to deliver it on what could be described as a maintenance walkway above the exhibition hall. Proof of how badly the exercise unfolded was evidenced by the reaction of some of the delegates.

The function had a casino theme and a good number of practitioners were playing blackjack and just continued on with their games throughout Shorten’s speech.

I suppose if you treat an audience with perceived disrespect, you’ll get it back in spades.

Now to the positive side and really one initiative in particular of which the current government should sit up and take note.

While in office, Shorten introduced the limited licensing regime for accountants wanting to provide restricted financial advice.

Now we all know the initiative didn’t work out, but I don’t think poor execution should prevent us from recognising the spirit of what he was trying to achieve.

I remember when the policy was announced, Shorten claimed it would mean an additional 10,000 accountants would be in a position to provide financial advice – a good result if achievable, I thought.

Fast forward to the current day and we’re seeing shrinking adviser numbers and the implementation of the Quality of Advice Review recommendations. I’m of the firm belief accountants are the critical element to release more advisers into the industry and enable the delivery of advice to more Australians. But the review has categorically ignored the important role these professionals can play here. It would have been nice if the review had taken a leaf out of Shorten’s book to enable greater industry participation from the accounting community. In encouraging this approach, originally, I think the Member for Maribyrnong should be applauded in the assessment of his parliamentary achievements.

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 c.oyoung@bmarkmedia.com.au Publisher Benchmark Media info@bmarkmedia.com.au Design and production AJRM Graphic Design Services

WHAT’S ON

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

Accurium

Auditors Institute

SuperGuardian

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

Inquiries: (02) 8315 7796 or email awan@ awan@auditorsinstitute.com.au

Inquiries: 1300 787 576

Incorporating estate planning into our practice

Sole purpose testing in SMSFs

9 October 2024 Webinar 3.00pm–4.15pm AEDT

TRIS strategies and pitfalls 23 October 2024 Webinar 2.00pm-3.00pm AEDT

CPI and fund deductions 26 October 2024 Webinar 2.00pm–3.00pm AEDT

SMSF hot topics 26 November 2024 Webinar 2.00pm–3.00pm AEDT

SMSF live Q&A 28 November 2024 Webinar 2.00pm–3.00pm AEDT

DBA Lawyers Inquiries: dba@dbanetwork.com.au

SMSF online updates 4 October 2024 12.00pm–1.30pm AEDT 8 November 2024 12.00pm–1.30pm AEDT

15 October 2024 Webinar 1.00pm–2.00pm AEDT

Auditors Day VIC 8 November 2024 Crowne Plaza Melbourne 1–5 Spencer Street, Melbourne

Update on the ATO SMSF compliance 26 November 2024 Webinar 1.00pm–2.00pm AEDT

Heffron Inquiries: 1300 433 376 or email events@heffron.com.au

Super in 60 17 October 2024 Webinar 2.00pm–3.00pm AEDT

2024 year-end accountants & auditors update 21 October 2024 Webinar 11.30am–1.00pm AEDT

SMSF clinic 12 November 2024 Webinar 1.30pm–2.30pm AEDT

SMSF expenses under the microscope 12 October 2024 Webinar 12.30pm–1.30pm AEDT

Institute of Financial Professionals Australia Inquiries: 1800 203 123 or email info@ifpa.com.au

Has your client really retired?

3 October 2024 Webinar 12.30pm–1.30pm AEDT

2024 super quarterly update 5 December 2024 Webinar 12.30pm–1.30pm AEDT

SMSF industry update – legislation, policy and trends 3 December 2024 Webinar 11:00am–12:00pm AEDT

National Conference 2025 VIC 19–21 February 2025 Melbourne Convention and Exhibition Centre 1 Convention Centre Place, Melbourne

The Tax Institute Inquiries: 1300 829 338

National Superannuation Conference NSW 31 October–1 November 2024 Crown Sydney 1 Barangaroo Ave, Sydney

SMSF Association Inquiries: events@smsfassociation.com

In practice webinar series 15 October 2024 Webinar 12.00pm–1.00pm AEDT 19 November 2024 Webinar 12:00pm–1:00pm AEDT

QUARTER III 2024 3

NEWS

TR 2013/5 brings SMSFs in line with APRA funds

By Darin Tyson-Chan

The update to Taxation Ruling (TR) 2013/5 Income tax: when a superannuation income stream commences and ceases appears to have aligned SMSFs with Australian Prudential Regulation Authorityregulated funds when addressing pensions that have failed to meet the payment standards.

The TR now dictates if SMSF trustees fail to satisfy their minimum pension, it must be commuted and a new income stream started for the members

to continue to enjoy the associated tax benefits, such as exempt current pension income.

In years prior to the update, an income stream where the minimum pension had not been met for an income year could be automatically restarted in the subsequent fiscal year, with the same value, if the payment obligation was met in that 12-month period.

Colonial First State head of technical Craig Day noted the new approach is one public offer funds have taken when payment standards, due to an error, have not been fulfilled in a particular year.

“We had one situation

[where this issue arose]. It was during COVID [and occurred] because the client had an excess transfer balance cap determination and the ATO sent a physical letter to our offices that nobody was in,” Day told delegates at the ASF Audits Technical Seminar 2024 held in Adelaide recently. “[So] it sat there for longer than the specified period and then there was an autocommutation authority [issued] that once again no one got, so therefore the pension stopped.

“We worked on that and the legal view from our guys was we need to stop that pension straightaway and restart it.

“So that was the view from large fund land from the beginning that [in these situations] there’s no pension that continues.

“I know what the industry view from SMSF land is, but that’s quite different from what our lawyers think.”

Craig Day

SMSF specialists increasing technology use

By Darin Tyson-Chan

Recent Investment Trends sector research has shown advisers who are SMSF specialists have significantly changed the approach their practices are taking with regard to servicing clients and developing professional relationships.

“What we’ve seen is that SMSF specialists have been way more active in the sense they have changed a lot of things when servicing their SMSF clients in the last 12 months,” Investment Trends analyst Yigit Gunhan told selfmanagedsuper.

To this end, the most significant area of differentiation this cohort undertook in delivering advice was accelerating the adoption of technology in their practices.

Here 37 per cent of SMSF specialists,

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defined as practitioners servicing more than 20 funds, who took part in the survey said they had pursued this path.

In comparison, only 12 per cent of study participants who service fewer than 20 SMSFs, classified as generalists, indicated they had done the same.

In addition, 21 per cent of respondents who are SMSF specialists indicated they have adopted an increased focus on reviewing and updating the risk profiles of their clients. Conversely, only 2 per cent of SMSF generalists had focused on this type of activity.

Further, 24 per cent of specialist practitioners admitted they are providing SMSF advice to a wider range of client types.

According to the research, there was also a significant shift in the attitude of all SMSF advisers with regard to relationships with other professionals.

“One thing that all SMSF advisers have done less of is deepen relationships with accountants and accounting firms compared to last year. The trend looks like it is going to worsen even more because when we asked SMSF advisers how they anticipate their relationship with accountants will change in the next 12 months, a lower proportion compared to last year said that it will increase,” Gunhan said.

When examining this trend, 15 per cent of SMSF specialists indicated they improved their connections with accountants in the past 12 months, whereas 33 per cent of respondents in this group expressed such sentiment in the previous year.

The analysis examined data collected from an online survey that 652 accountants and 177 advisers took part in during February and March.

NEWS IN BRIEF

Fix for legacy pensions The federal government has announced plans to allow people to exit legacy pensions over a five-year period by relaxing commutation restrictions and allocating reserves to SMSF members where those funds supported an income stream to that member.

The proposed changes have been released for consultation and are contained within the draft Treasury Laws Amendment (Self-managed superannuation funds – legacy retirement product conversions and reserves) Regulations 2024.

The explanatory statement to the regulations stated “the regulations relax commutation restrictions so that legacy products can be exited with the resulting capital used to commence an account-based income stream, left in an accumulation interest account or withdrawn from superannuation entirely”.

“The commutation must occur in full within a designated five-year grace period beginning on the day the regulations commence,” it said.

“The regulations also provide more flexible pathways to make allocations from a reserve by providing that where a reserve supported an income stream that is ceased, and the reserve is allocated to the former recipient of that income stream, it will be exempt from both contribution caps.”

Work test change boosts NCC Non-concessional contributions (NCC) by older SMSF members have increased sharply recently, while similar contributions from younger trustees have declined, according

to the latest research conducted by Class.

The Class “2024 Annual Benchmark Report” found the amount of NCC made by trustees aged between 66 and 70 increased from $555 million in the 2022 financial year to $899 million a year later, while contributions made by those over 70 had risen from $232 million to $936 million in the same time frame.

Class operations general manager Kate Anderson noted the rise in the level of NCCs made over the past year can be largely attributed to the removal of the work test in 2022.

“They don’t need to meet a work test, they don’t need to say they’ve been gainfully employed for the 40 hours and 30 consecutive days and they can put money in. That’s definitely one of the reasons why older members are making non-concessional contributions,” Anderson told selfmanagedsuper.

Public inquiry into Dixon failure The Financial Advice Association Australia (FAAA) has been successful in its efforts for a public inquiry to be held into the collapse of Dixon Advisory, with the terms of reference based on its key areas of concern.

The association announced the inquiry would go ahead after a motion calling for an examination into the collapse and its potential impact on the Compensation Scheme of Last Resort (CSLR) was moved in the Senate and gained cross-parliament support.

The inquiry will be undertaken by the Senate Economics References Committee and will address the causes of the collapse of the advice group, the role of the internally run US Masters Residential Property Fund, the actions of key individuals and the Australian Securities and Investments Commission, the impact of the administration and

insolvency issues, and the potential implications for future advice matters.

QAR reforms tabled Treasury has tabled regulations to support the first tranche of reforms in the Delivering Better Financial Outcomes package, which address the government’s initial response to the Quality of Advice Review (QAR).

The Treasury Laws Amendment (Delivering Better Financial Outcomes) Regulations 2024 contains five parts, with the first four parts in effect as of 17 September, while the fifth commences on 9 July 2025, allowing a 12-month transition period for related measures in the Treasury Laws Amendment (Delivering Better Financial Outcomes and Other Measures) Act 2024.

The first amendment updates the Electronic Transactions Regulations to reflect changes in the Superannuation Industry (Supervision) Act, enabling superannuation documents, such as written consents or requests, to be electronically sent, received and stored.

The second change removes the requirement for fee disclosure statements and ensures clients provide consent when entering or renewing ongoing fee arrangements.

The third modification allows financial advisers to either give clients a financial services guide directly or make the information available online.

The fourth adjustment revises the rules on conflicted remuneration by banning benefits from product issuers that could influence advisers’ recommendations, while benefits from retail clients remain unaffected.

The fifth alteration clarifies financial advisers can continue receiving commissions on general insurance products, provided they obtain informed consent for personal advice.

When general advice is provided, no consent is required.

QUARTER III 2024 5

SMSFA

New tax on super far from done deal

PETER BURGESS is chief executive of the SMSF Association.

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When the federal government announced its decision in late February 2023 to introduce a new tax on total super balances above $3 million, it’s fair to assume it believed selling this proposal to the electorate would not be politically difficult.

After all, it was estimated to only affect about 80,000 superannuation members and most of those would be in SMSFs – in other words, so the implicit message went, the wealthy.

But almost from day one this measure, which if passed will apply from the 2026 income year, has encountered difficulties. Eighteen months later, and with the current parliament having less than a year to run, this legislation is far from certain to become law, at least in its current form.

As we all know too well, nothing is ever certain in politics, but at this very moment the likelihood of the government getting this bill through the Senate without amendments is receding as crossbench opposition grows (the Greens are likely to support the measure and the coalition oppose it).

So how did it come to this? How did a measure that would seemingly only affect a financially secure tiny cohort become such a legislative minefield?

Although there have been many factors at play, to my mind two stand out. Firstly, with the decision not to index the $3 million cap, it was quickly estimated of those entering the workforce today under age 30, half a million would have super balances breaching the cap on retirement. The reality is inflation will ensure that for today’s 30-year-old, a $3 million cap will be worth about $1 million when they leave the workforce.

Secondly, there has been mounting concern the decision to tax unrealised capital gains, an implicit feature of this proposal, will set a dangerous precedent for tax law. Despite Treasury’s protestations this is nothing new, with the only example of it happening is the taxing of capital gains on investments (excluding property) where an individual or company ceases being an Australian tax resident, the fact is for almost 40 years our tax system has clearly delineated between income and capital gains tax (CGT), with the latter only payable when an asset is sold.

So this measure turns existing tax policy on its head by treating the increase in the price of an asset as income received during the income year. Furthermore, when the asset is eventually sold, the capital gain will still be subject to CGT, effectively subjecting taxpayers to a form of double taxation. The inequity is self-evident.

For this past 18 months, this issue has dominated the SMSF Association’s advocacy agenda. Rightly so too, considering the unfairness this policy represents for the many SMSF members. It has entailed numerous press releases, opinion pieces, background briefings and innumerable visits to Canberra to see legislators of every political shade in a bid to convince them this proposed tax is bad policy.

To this end, I think we can claim a level of growing influence that has even surprised me, considering where we started on this issue in early 2024. We are increasingly finding the politicians are wanting to get our input, to the degree where we were tasked with drafting amendments to the proposal to address the most egregious elements.

What we have also discovered on this journey is just how many people will potentially be affected by this proposal. Farmers and small business owners, who are often asset rich and cash-flow poor, are obvious examples, so we have had many discussions, such as with the National Farmers’ Federation, to determine how best to oppose this legislation. Using 2021/22 fund data, it’s been conservatively estimated more than 3500 SMSFs own family farms that are likely to be impacted by this tax.

Earlier this year we received an email detailing how it would affect venture capital by taxing unrealised capital gains prior to an initial public offer. It provided the background for a media opinion piece that certainly helped kick-start a debate on an issue which seemed to put this government proposal on a direct collision course with its stated ambition to attract more capital into start-ups.

It should be noted, while we oppose this legislation in principle, arguing that excessively large balances are a legacy issue and contribution caps and the transfer balance cap will address it over time, we are certainly cognisant of the fact politics is the art of compromise. In this vein, we have proposed indexation and the use of a proxy rate for actual taxable earnings as a substitute for taxing unrealised capital gains. It’s not perfect, but it will certainty reduce the severity of this tax for many impacted members and remove the very real prospect of erratic swings in their tax liability from one year to the next.

Throughout this process we have always been open to working with the government to find common ground between its revenue needs and SMSFs’ legitimate aspirations for an equitable tax system. What we have never accepted, and will never accept, is the current proposal that not only makes the superannuation system more complex and costly to administer, but, importantly, introduces more of the very thing the government is claiming to address – inequities.

Let me end by making one final point. Throughout this process we have been heartened by the support and feedback we have received from our members. It’s also apparent our efforts are being recognised, not just in Canberra, but across the sector. Over the years our member survey has revealed an increase in the value members place on our advocacy efforts. This is reflected not only in our growing membership numbers, but also in the strong and consistent attendance at our conferences and webinars. Our members’ heightened engagement underpins the importance of our advocacy work and its impact on shaping the future of the SMSF sector.

CPA

Time to focus on valuations

RICHARD WEBB is superannuation leader at CPA Australia.

The proposed arrival of the Division 296 tax in 2025 marks a significant shift in the regulatory landscape for members of superannuation funds in Australia. But more specifically, this new tax regime will impose stricter requirements on how SMSFs manage the valuations of their assets and comes at a time when the ATO has acknowledged asset valuations as an area of heightened interest for it. What this all means is trustees of SMSFs need to revisit how they undertake valuations of their fund assets to ensure compliance, avoid inaccurate taxation and safeguard the best financial interests of fund members.

The importance of careful asset valuation cannot be overstated, but with the introduction of the Division 296 tax, valuations are looming as a high priority for trustees. However, this is not something they should have paid any less attention to in the past: accurate asset valuations are essential to ensure SMSFs meet extant regulatory obligations and avoid potential penalties. As has always been the case, trustees must remain diligent in maintaining accurate records and ensuring valuations are both current and justifiable, with the Division 296 tax being the latest incentive to get this critical job done correctly.

Regardless of what trustees’ past approaches have been to valuations, the Division 296 tax is likely to occupy a large amount of their attention, with a view to its impact on potential future liquidity problems facing funds with members who have large balances. The needs will vary from fund to fund. For example, funds primarily holding assets in the pension phase, where the tax rate on income and capital gains is zero, and where the liquidity needs are currently mainly focused on income payments, may find the new tax more of an adjustment than SMSFs, which mainly service members in the accumulation phase and where liquidity is assisted by regular contributions.

And, given the main rationale for the new tax is to satisfy the federal budget bottom line, collecting revenue is likely to be prioritised by the ATO. Existing guidance around asset valuations is revised by the regulator frequently, but a recurring theme is that valuations must reflect market conditions and be supported by appropriate documentation.

Understandably, it is reasonable to expect the ATO will scrutinise the valuation methodology and documentation of SMSFs more closely to determine future tax liabilities, given the amounts at stake.

So how might this affect your clients’ funds?

The most immediate concern is compliance. The

ATO has made it clear accurate asset valuations are essential for determining a fund’s tax obligations.

Trustees must ensure they have robust processes in place for valuing assets, particularly those not traded on public markets, such as business real property or private equity. The Division 296 tax will be assessed on changes in fund values over a year and any suggestion valuation inaccuracies may be used by trustees to reduce member tax liabilities is likely to be investigated.

However, accurate asset valuations are also crucial for ensuring correct tax outcomes for SMSFs. Under Division 296, the tax treatment of changes in fund values is likely to vary significantly based on the valuation of assets. For instance, if an asset is presently overvalued, the future introduction of the measure may see more tax assessed than is accurate, while undervaluation of an asset could lead to a lower tax liability but increased ATO scrutiny. By ensuring valuations are accurate and reflective of market conditions, trustees can ensure correct tax outcomes and enhance the overall financial performance of the fund.

But a disciplined approach to asset valuations is not only a practice that should be undertaken in the interests of tax and compliance.

It is a fundamental responsibility of SMSF trustees to act in the best financial interests of members.

Accurate asset valuations are essential for providing trustees with a true picture of how their fund’s portfolio is performing. Trustees need to assess the performance of their investments regularly to determine whether to hold, sell or acquire new assets. Inaccurate valuations can distort this assessment, leading to poor investment choices that could negatively impact the fund. By prioritising accurate valuations, trustees can ensure they have a clear understanding of the investment performance of fund assets and better meet the best financial interests duty.

With the increased focus on transparency in the financial services sector, SMSFs need to demonstrate their commitment to sound governance practices. Accurate asset valuations ensure funds meet their tax and compliance requirements, contribute to the overall transparency of funds and provide members with confidence in the SMSF’s financial reporting and investment strategy. This transparency is particularly important as the Division 296 tax looms, where the ATO will be closely monitoring compliance and may ultimately require additional disclosures related to asset valuations.

QUARTER III 2024 7

IFPA

Changes to pension ruling cause concern

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

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The ATO’s recent update to its Taxation Ruling (TR) 2013/5, which provides guidance on when a superannuation income stream commences and ceases, will have a significant impact on SMSF trustees who fail to meet the pension standards in a financial year.

As the ruling was released back in 2013, it needed to be updated to reflect the legislative amendments that have occurred since the original publication.

This update included the introduction of the transfer balance cap provisions, the concept of retirement phase for superannuation interests and the ATO’s view on when a super income stream ceases and a new one commences under a successor fund transfer. The draft update published on 27 September 2023 included these elements.

It’s hard to believe there is no change to the ATO’s fundamental views expressed in the original ruling as the regulator has in fact changed its position on the consequences for an SMSF that has failed to pay the minimum pension payment requirement. This is because the finalised ruling includes an important update regarding the differentiation between when a superannuation income stream ceases for tax purposes versus super purposes.

The original ruling stated at paragraph 20 “if the requirements are again met in the following year, this results in the commencement of a new superannuation income stream”. The commencement of a new superannuation income stream for tax purposes meant a client was automatically taken to have commenced another pension for tax purposes with exactly the same settings as the original income stream on 1 July of the financial year.

However, in the final ruling, paragraph 20 now says if a superannuation income stream ceases for income tax purposes it “cannot recommence meeting the SISR (Superannuation Industry (Supervision) Regulations) requirements in a future year. This means it will not be a superannuation income stream for income tax purposes from the time of cessation, even if the member remains entitled to receive payments from the superannuation fund. For the member to receive a superannuation income stream, any income stream payable from the superannuation interest must cease (for example, by commutation) and a new superannuation income stream must commence”.

This new ATO view implies on the start of the financial

year, the pension ceases for tax purposes and can no longer generate exempt current pension income (ECPI).

The only way to fix the failed pension and claim ECPI is for the member to cease/commute the pension and commence a new one. This is evident in example 6 of the tax ruling.

Industry agrees that where the minimum pension is not paid, there are a range of tax consequences, including transfer balance account (TBA) implications.

What industry is questioning is the ATO’s view on having the failed pension cease by way of commutation and restarted as a new pension in order to claim ECPI in future years.

This differing view may have significant implications for SMSF trustees as it can impact the ongoing treatment and reporting of retirement-phase income streams within the fund. For example, although the failed pension will end for TBA purposes on 30 June of the relevant income year, it will only recommence when the member realises the pension failed for that income year.

It may be months before they realise there is a problem.

It can also cause another timing issue as, although the TBA debit arises on 30 June, the TBA credit arises when the member restarts their pension, which is likely to result in different amounts and potentially lead to an excess TBA amount.

The stopping and starting of a pension also means new documentation will be needed to perform the tasks. To date, there has not been a need to draw up and lodge new paperwork for the restart of a failed pension as the member has not requested their pension to be fully commuted nor have they requested to restart their pension. From a member’s perspective, it’s the same pension as per the original terms and they are owed the pension shortfall. Rather, trustees have been recording circumstances surrounding the underpayment in a trustee minute/resolution and acknowledging the terms and conditions of the pension haven’t changed. This change may also see members needing to seek advice and obtain a statement of advice to commute and restart a new pension. The end result is more documentation and costs incurred in order to rectify the failed pension.

The implications of getting it wrong can be disastrous. As such, it’s crucial SMSF trustees understand the ATO’s position to ensure the proper management and compliance of retirement-phase income streams within their funds.

CAANZ

A significant investment strategy assessment

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

An Administrative Appeals Tribunal (AAT) decision was handed down in May this year regarding a disqualified SMSF trustee that aired many significant compliance issues. So what can we learn from it?

At one level, the AAT decided the trustee’s disqualification status should be set aside, but a number of other matters came to light as a result of the proceedings.

The case involved Gordon Merchant, who established the Billabong surf clothing brand in the 1970s. The business was very successful and was originally privately owned before it was listed on the Australian Securities Exchange in August 2000 and then delisted in April 2018.

The proceedings concerned Merchant and a number of related entities. Of particular interest here was a discretionary trust – the Merchant Family Trust or MFT. The trust owned shares in a company called Plantic that became subject to a potential takeover in 2014. A sale of these shares would generate a significant taxable capital gain.

Merchant’s tax advisers suggested one way to reduce this potential tax bill would be to transfer Billabong shares to Merchant’s SMSF, of which he was the sole member and sole corporate trustee director.

At the time, Billabong was trading for a lot less than the price MFT had acquired the shares for, thereby creating a capital loss on disposal. That loss could then be used to offset the capital gain on disposal of Plantic shares.

An added benefit was it would mean Merchant and his related entities would retain significant shareholdings in Billabong.

This plan was put into place. In time, the ATO decided to investigate these and other transactions and determined the income tax general anti-avoidance provisions under Part IVA of the Income Tax Assessment Act should apply to the Billabong share sale.

The regulator administratively rejected Merchant’s objection to this decision. He appealed to the Federal Court and lost. At the time of writing he had appealed to the full Federal Court. He was also suing his tax advisers in the Queensland Supreme Court. Only time will tell if there are any flow-on consequences from these other court cases and any potential further appeals.

Some of the investment strategy matters that flow from the AAT decision are as follows:

• Over a number of years, Merchant’s SMSF had purchased Billabong shares, however, in March 2012 the fund executed an investment strategy document that said the SMSF’s primary objective was to achieve an after-tax rate of return at or above the rate of inflation and permitted a 0 per cent allocation to property and up to a 40 per cent allocation to listed securities. However, the 2012 year-end accounts show the fund owned commercial real estate and had more than 40 per cent of its total assets in Billabong shares.

The AAT said that when making investment decisions, a trustee does not have to consider all the regulatory issues required to formulate the fund’s investment strategy. However, the fund’s investment strategy document required the trustee to consider a range of matters when making investment decisions, including the marketability of an asset, as well as realisation costs and the risk involved in making, holding or realising assets and the likely return from those assets.

The AAT found that any decisions made without considering the points listed in the strategy document would represent a failure to give effect to the fund’s investment strategy and hence would be a regulatory breach.

Merchant had sought to argue he had adjusted the fund’s investment strategy, but the law didn’t require this to be put into writing. The AAT said it had no information to justify this statement and no information showing this revised investment strategy had been formulated in accordance with the regulatory requirements.

• In November 2015, Merchant’s advisers recommended the fund’s investment strategy needed to be updated; the advisers provided a pro-forma document that was similar to the 2012 document with different permitted percentages for a range of asset classes to reflect the fund’s actual asset holdings.

The AAT used this revised document, and the manner in which it came into existence, as another reason to reject the claim that the 2012 investment strategy document had been amended.

The AAT found the SMSF had breached the operating standards of the Superannuation Industry (Supervision) Act because it had failed to comply with the regulatory investment strategy requirements.

QUARTER III 2024 9

IPA

AML/CTF expansion needs more examination

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

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Australia’s anti-money laundering and counter-terrorism financing (AML/CTF) regime is undergoing significant reforms by the Attorney-General’s Department, with the changes having far-reaching implications for the nation’s professional financial and accounting sectors.

The proposed expansion of the AML/CTF regime to include more professional service providers emphasises the importance of safeguarding Australia’s financial system from illicit activities.

However, one key challenge finance sector professionals face is the lack of clear recognition of what an accountant is within Australian law. This ambiguity creates difficulties in determining which services should be considered high risk under the AML/CTF regime.

The accounting bodies proposed a competitively neutral approach that ensures the designated services under the regime apply to all providers and not just professional accountants.

This approach is crucial to prevent the displacement of AML/CTF risks to unregulated service providers.

Harnessing existing regulatory frameworks rather than duplicating them is essential to effectively implement tranche two of the AML/CTF regime with minimal disruption to businesses.

Accountants are already subject to stringent statutory and professional obligations, which should be acknowledged and leveraged within the AML/CTF regime.

Another area requiring immediate attention is the lack of clarity in the AML/CTF Act guidelines, particularly in cases where an accounting practice operates as a partnership firm. The current guidelines do not explicitly identify the reporting entity in such scenarios, creating a significant need for clear and unambiguous regulations.

The legislation governing the AML/CTF regime should be structure-agnostic, allowing firms to enrol with AUSTRAC in a similar way to how they register with other regulators like the Tax Practitioners Board. This approach would provide the necessary flexibility and adaptability, reducing the potential for

confusion during the regime’s implementation.

Including services such as ‘correspondence’ or ‘administrative’ can create further complications for accountants.

Professional accountants often act merely as conduits for their clients, receiving and forwarding correspondence without exercising control over how the clients respond. Including these services under the AML/CTF regime would impose an unnecessary regulatory burden on accountants without addressing real risk.

Furthermore, the proposed requirement for independent reviews of AML/CTF compliance programs raises questions about their effectiveness.

Currently, such reviews can be conducted by anyone and the findings are only shared with the reporting entity. This does not constitute meaningful regulation and contradicts AUSTRAC’s stated approach of “regulation for a purpose”.

The reform process must also include appropriate information-sharing mechanisms between AUSTRAC and professional bodies, especially in cases where enforcement decisions are made. This would enhance the effectiveness of the regime by preventing individuals who have been sanctioned by one professional body from simply moving to another.

While the Institute of Public Accountants supports the overarching goals of the AML/ CTF regime, there is an urge for a thoughtful and balanced approach to its implementation.

By leveraging existing regulatory frameworks, providing clear guidance and allowing sufficient time for compliance, Australia can strengthen its financial system without imposing unnecessary burdens on its professional service providers.

However, given the significant workload these reforms will impose on professional accountants, an extended 24-month implementation period is necessary for practitioners to become familiar with new obligations.

This timeframe would also allow AUSTRAC to develop comprehensive guidance materials and toolkits to assist the industry in navigating the new regulatory landscape.

REGULATION ROUND-UP

NICHOLAS ALI is SMSF technical service director at NEO Super.

Deferral of tax agent code of conduct Slated to commence on 1 August 2024, the Tax Agent Services (Code of Professional Conduct) Determination 2024 has been postponed to 1 July 2025 for firms with fewer than 100 employees and 1 January 2025 for those with more than 100 employees.The hiatus is due to concerns raised by the industry peak body around eight new conditions for tax practitioners not previously seen by industry in the original exposure draft of the determination published by Treasury. Two of the new obligations that have caused most consternation are the requirement for practitioners to report clients to the ATO where they do not change misleading information in their tax returns, which raises concerns about client confidentiality, and fears that personal matters relating to the practitioner, such as mental health, would need to be disclosed to clients. The Tax Practitioners Board, which would administer the determination, has outlined a planned release of guidance on the eight obligations by November. The coalition announced a decision to move disallowance, but this was defeated. Independent Senator David Pocock has said he is prepared to consider voting to get rid of the determination if the government does not amend it to take into account the concerns of professional bodies.

Successor fund changes for CDBIS The Income Tax Assessment Amendment (Superannuation) Regulations 2024 have now been registered with a commencement date of 6 July 2024.

The regulations specify changes to the treatment of the transfer balance cap for successor fund transfers and will ensure individuals with a capped defined benefit income stream (CDBIS) are not adversely impacted in the event of a successor fund transfer between superannuation funds. Previously, the balance of the transfer balance account for some recipients of CDBIS was unintentionally affected by the original income stream being treated as ceasing and a new one commencing. From 6 July 2024, for the purposes of the individual’s transfer balance account, an income stream that is a CDBIS just before the successor fund transfer will have the credit value equal to the debit value of the CDBIS that arises as part of the successor fund transfer. The changes will be applied retrospectively from 1 July 2017.

NALE legislation becomes law Legislation that includes the non-arm’s-length expenditure (NALE) changes has become law almost five years from the date the Treasury Laws Amendment (2018 Superannuation Measures No 1) Bill 2019 first received royal assent on 2 October 2019.The Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Act 2023 includes a limit on NALE related to general SMSF expenses. Royal assent was granted on 28 June 2024 with the NALE changes commencing on 1 July 2024, with retroactive application from 1 July 2018.

Financial advice regulation bill receives royal assent The Treasury Laws Amendments (Delivering Better

Financial Outcomes and Other Measures) Act 2024 has received royal assent. The Delivering Better Financial Outcomes (DBFO) Act implements financial advice regulation as part of the government’s response to the Quality of Advice Review. Reforms under the DBFO Act include: • clarifying the legal basis in the Superannuation Industry (Supervision) Act 1993 for fund trustees to charge individual members for financial advice from their super account and clarifying associated tax consequences under the Income Tax Assessment Act 1997, • streamlining ongoing fee renewal and consent requirements, including removing the need to provide a fee disclosure statement, • providing more flexibility in how financial services guide requirements can be met, • simplifying and clarifying the provisions governing conflicted remuneration, and • introducing new standardised consent requirements for life risk insurance, general insurance and consumer credit insurance commissions.

Changes to tax ruling for pensions The ATO recently released the final updated version of its Taxation Ruling (TR) 2013/5: when a superannuation income stream commences and ceases. The public advice and guidance compendium to TR 2013/5 includes a summary of issues raised and responses from the ATO. It clarifies its stance on when a pension ceases where the trustees have failed to comply with the pension or annuity standards. This stance means the following applies where trustees fail to meet the pension payment standards and are unable to use the shortfall discretion: • the failed pension will end for transfer balance account (TBA) purposes on 30 June of the relevant income year and only recommence when it is known the pension failed for that income year (sometime after 30 June), • the TBA debit arising on 30 June and the TBA credit arising when the member starts their new pension are likely to be different amounts and may give rise to an excess TBA amount, • in addition to the fund not being entitled to claim exempt current pension income (ECPI) for the income year the pension failed, it would potentially also not be entitled to claim ECPI in respect of the pension until it was commuted and restarted by the member sometime later in the next financial year, • there will be a requirement to recalculate tax components for the restart of the failed pension, and • there will be a requirement for each benefit payment to be reclassified.

Practitioners must be aware recommendations to commute an existing income stream and and commence a new one will be product advice and a statement of advice may be required. It is also unclear at this stage how this clarification will impact transitionto-retirement pensions or non-commutable income streams.

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FEATURE

CURRENT HURDLES CONFRONTING

2024 smsf roundtable

Developments in the SMSF sector in the past year around the Division 296 tax, non-arm’s-length expenditure and pension payments have created new hurdles for advisers and trustees to clear and provided the framework for the selfmanagedsuper 2024 SMSF Roundtable, which considered the impact these issues are creating now and into the future.

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FEATURE ROUNDTABLE

Participants

Division 296 tax

Shelley Banton (SB) ASF Audits head of education

Peter Burgess (PB) SMSF Association chief executive

Meg Heffron (MH) Heffron managing director

Liam Shorte (LS) Sonas Weath director

Moderators Darin Tyson-Chan (DTC) selfmanagedsuper editor

Jason Spits (JS) selfmanagedsuper senior journalist

DTC: What better way to start than with a discussion about the Division 296 tax. There have been quite a few recent developments, but where are we at right now and where do we see this headed?

PB: The SMSF Association is doing everything we can to get the relevant schedules removed, or at least amended, to address some of the egregious aspects of this legislation.

We’ve been having discussions with the Senate crossbenchers and I’m yet to meet one of them that supports this tax. The bill is still in the parliament.

It hasn’t passed the lower house and there’s been no indication from government they’re prepared to consider amendments. It would be difficult for the government to walk away as it has $2.3 billion in revenue attached to this measure baked into the forward estimates. I suspect they are in negotiation with the Senate crossbench and are aware this is going to be a difficult bill to get through the Senate and to expedite that are having discussions on possible amendments.

I hope those amendments are not just about indexation as there are some other aspects of this bill which lead to unintended consequences and unfair outcomes that need to be addressed.

MH: Half the reason we’ve got this legislation is because we haven’t had compulsory cashing for so long. It used to be compulsory and once you got to a certain point you had to start taking your super out, but it’s kind of too late now. The horse has bolted. I don’t think the government is going to shy away from imposing extra tax on people with more than $3 million.

Every method has its flaws, but the one they’ve come up with is probably about as bad as you could possibly think of. They’ve quite successfully come up with the dumbest approach.

If we had compulsory cashing all the way through, it would have needed some tweaking when we got the limit on pensions and for compulsory cashing to be in a form that recognised some other forms of pension and didn’t give you any exempt current pension income or something like that.

It’s such a shame we’ve ended up here because of a problem created years ago when the government took away compulsory cashing.

SB: There’s nothing fair or equitable or even simple about this particular approach. I don’t think anybody really opposes the philosophy of taxing those higher balances within super, but it’s the methodology they have taken which has left the industry reeling because it’s unprecedented. We will be one of the first countries in the world to be adopting the taxation of unrealised capital gains and it hasn’t worked over in the US. They looked at it and walked away from it. How it’s going to play out for us remains to be seen, but I don’t think this is the way forward. There are other methods and what the SMSF Association has come up with in regards to a deeming rate rather than the current methodology is at least better than nothing or better than what we’ve currently got.

MH: Liam, as an adviser, is this starting to impact the types of assets you recommend people hold in their SMSF as opposed to elsewhere? I would see anything that is volatile is not going to be attractive in an SMSF anymore for somebody impacted by Division 296.

LS: Almost definitely. We’re seeing people involved in venture capital or cryptocurrency or any of those very volatile sort of arrangements looking to exit. They have no choice because anybody investing in crypto knows they can get a huge uplift in one year and the next year could see an 80 per cent Continued on next page

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FEATURE ROUNDTABLE

Division 296 tax (continued) Continued from previous page

drop and they don’t want to get caught with capital gains one year and not having enough then to pay the tax the next year. The issue I’m worried about is the older SMSF trustee who has a difference in balance between them and their spouse and they have $3 million or $4 million in their super, but most of it is in one name and they never took the opportunities to do a recontribution strategy and rebalance.

They also tend to be the same people where a property hasn’t been revalued for three or four years and the husband has got $3 million and the wife has got $1 million, but when they revalue the property, it’s probably going to be $6 million and they are going to be totally affected by this. I don’t blame them because they were concentrating on working with what they had and inside the rules, while some small accountants and auditors who don’t do many SMSFs are letting through stuff like this that they should not let through.

SB: This is where valuations are becoming more critical, especially for those around that $3 million mark, because we’re going to see a lot of focus and pressure on valuations over the next couple of years. People are going to increase the valuations over the next two years and then take a massive

drop and looking at using different methodologies to suit their purposes, depending on how the assets are going. For auditors it places additional pressure, especially on those complex assets, which are difficult enough to value without having these sorts of additional complications added to the equation.

DTC: Peter, do you ever get the feeling too much weight is being put on the SMSF sector to fight this tax and get a better resolution or perhaps the best resolution of all of not having this tax introduced?

PB: Given the SMSF sector is the area that’s going to be impacted mostly by this tax, I don’t think it’s a surprise that it has been left to us to go hard on this, but it’s been encouraging that other bodies have come forward and support the push against this tax. We’re not the only ones involved and other associations have voiced their concerns and we saw the Joint Associations Working Group come out with a statement opposing this tax so we’re not the only voice out there. It’s been a hard slog and nothing’s been achieved yet, but we’re encouraged by the fact the bill is not being debated in this sitting of parliament and that’s a clear indication there are some negotiations going on behind the scenes. The surprising thing for us was that Treasury had not considered any other option. It was pretty clear when this consultation paper came out they hadn’t considered or modelled any other way in which

this tax could be introduced. There are other ways they could have gone about clawing back these concessions for people with high balances and that’s why we’re fighting as hard as we can to get these schedules out of the bill so that we can have consultation with government on other ways which don’t involve things like taxing unrealised capital gains.

SB: It may well be the thin end of the wedge because we don’t know if this gets accepted as the new norm within superannuation where it’s going to end up within the tax community.

PB: The precedent that this sets for future tax reform has been a concern for the Senate crossbenchers. Things like negative gearing are things which the government is reluctant to touch, but it’s not out of the question that they start to tax unrealised gains on investment properties. That’s the concern some have as to what’s next if we have this type of tax in the super environment.

LS: It’s also stopping small business owners thinking about putting their business premises into super. When we talk to them in terms of protection for bankruptcy, the superannuation fund has been a very good way for small business owners to protect their premises in case their business doesn’t go well. Now if they keep the property outside of super, that’s going to become available to creditors, so it has a knock-on effect throughout the whole Continued on next page

We’ve always maintained that if we’re going to have a tax on earnings, the only way you can avoid taxing unrealised capital gains is to base it on actual taxable earnings.

– Peter Burgess, SMSF Association

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FEATURE

Continued from previous page

industry.

PB: How do they fix the problem? The government and Treasury can address indexation, but what about fixing the taxation of unrealised capital gains?

We put forward some amendments which would be the simplest way to take some of the severity away, but the only way you can address it is to go back and start again. We’ve always maintained that if we’re going to have a tax on earnings, the only way you can avoid taxing unrealised capital gains is to base it on actual taxable earnings and because we’re moving away from that, we are seeing these unintended consequences and unfair outcomes emerging. So we’ve been trying to get the conversation back to actual taxable earnings.

DTC: If we went to an actual earnings model, I’m sure other parts of the superannuation sector wouldn’t find that palatable because SMSFs have got the information at hand, whereas Australian Prudential Regulation Authority (APRA)regulated funds would have to reconstruct that information.

MH: It would impose an administrative burden on other funds that is greater than the burden that would be placed on SMSFs. Would it incentivise people to have an SMSF over another fund? I don’t know that it would because it’s the same concept. If every fund is treated in the same way, then whether you have

your portfolio of shares in your SMSF or in your retail fund won’t make any difference. The biggest barrier to having an actual taxable earnings model is administrative complexity because that’s just not how large funds work.

PB: Treasury made it quite clear in their consultation paper as to why they’ve gone with the unrealised gains approach because large APRAregulated funds are not able to track actual taxable earnings at the member level. So either a proxy for actual taxable earnings, which is a deeming rate, would apply to all funds, or those funds that can report actual taxable earnings should be able to use actual taxable earnings. I’m not sure it’s an option that would be considered seriously by government and Treasury because they may feel it gives SMSFs an advantage over APRA-regulated funds and they don’t want a different approach for different sectors.

MH: To be fair, we’re usually the ones arguing for not having different systems for different sectors so you can understand why they wouldn’t want one system for SMSFs and a different system for APRA-regulated funds.

PB: At our national conference in February, David Barrett from Macquarie presented a session where he modelled the use of actual taxable earnings versus the Treasury’s proposed approach over the life of someone in a fund, and found you actually pay more tax under an actual taxable earnings approach, but the big difference is you will always

have liquidity to pay the tax on capital gains. That’s another reason why we have put forward this proxy rate because you pay less tax under that modelling.

That could be a problem for Treasury and government if they do move to a proxy as they will get less revenue from this measure. However, we’ve always maintained the government should be prepared to give up some of that revenue in order to address the egregious aspects of taxing unrealised capital gains and take some of the heat out of the discussion. It’s also the reason why we would not want a deeming rate any higher than the 90-day bank bill.

If it’s going to be the 90-day bank bill plus three or seven percentage points, that’s not something we would support.

In fact, our modelling suggests people will be worse off under that model than they would under the current model. So we agree to a proxy, but it can’t be any more than the 90-day bank bill because what we’re trying to achieve with the deeming rate is it’s supposed to be a proxy for actual taxable earnings. We’ve made that point very clear to the teal independent members of parliament and to the Senate crossbench that if it is going to be a proxy rate, it has to be for actual taxable earnings, not something any higher.

DTC: We’re getting closer to the proposed start date for the Division 296 tax, so are you seeing distinct ways SMSF trustees are responding Continued on next page

Every method has its flaws, but the one they’ve come up with is probably about as bad as you could possibly think of. They’ve quite successfully come up with the dumbest approach.

– Meg Heffron, Heffron

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FEATURE ROUNDTABLE

Division 296 tax (continued) Continued from previous page

to this issue?

LS: They are looking for solutions and at options. We’re looking at the options of whether property comes out of a fund, whether part of a property comes out of the fund and what do we do with accumulation balances. A lot of the talk now with older clients is do we start the intergenerational wealth transfer now because of this rather than waiting till later or doing it within their estate. For a few clients in their late 80s we’re taking money out and making non-concessional contributions into the fund for their children, so that more and more the fund becomes owned by the children. In most cases, we’re making sure that whatever happens, the parents have got more than enough to live comfortably and rather than waiting and leaving the money inside super, we start moving it onto the next generation.

A lot of the next generation are hitting 60, so we’re taking it out of pension or accumulation in their parents’ name, and we’re only one or two years away, in some cases, from getting it into pension phase in their children’s name, so it’s working pretty well.

SB: Liam, are these going into new

funds or you’re adding the kids into the mum and dad’s fund?

LS: Where there’s a small business or a business property in mum and dad’s fund, or if it’s a family business, then we are adding them into the fund. What’s happening then is, over time, more of the value of the property is held in the kids’ names. These are people who see it all as family wealth and the parents were struggling to find a way to pass money to the next generation because they’re not too sure they wouldn’t blow it, but they love the idea of taking it out and putting it back in and owning part of the business premises.

MH: What I’m hearing more is about death benefit taxes and estate planning and those things have always been a big issue. The challenging part of that conversation was saying to mum and dad if you want to start moving wealth to the next generation, or taking it out of super, you are deliberately making yourself poorer during your own lifetime because investing in super is so much more attractive than investing outside super. If the Division 296 tax is introduced in its current form, I don’t think we will see investing outside super as massively more attractive than inside super. They will be neutral for that bit over $3 million. For all these 80 year olds not taking $1 out of super because of its 15 per cent tax rate, we can say to them whether you have it inside super or outside super it’s all the

same. We may find that unlocks a very useful conversation about that it’s not a bad idea to start taking money out in some kind of steady, regular, sensible fashion as you sell things and because of the form of the Division 296 tax we see them taking that steady process to winding down their super, which they might not have done in the past. Given that we’ve not had compulsory cashing for ages, and since 2017 we’ve had a cap on what they can put in in pension phase, they’re not even taking 5 per cent of their whole balance. The rest is just sitting there, building up, and there’s been no driver to take the money out, but now there might be because they’re going to pay some extra tax, but it may not be any worse than it would be if they took the money out and invested it outside.

LS: This is the first generation that’s really living a lot longer than their parents so they’ve always been afraid of funding the later years if they live longer.

We’re trying to have this estate planning conversation with them, saying you may not have inherited much from your parents, but when you did, they were around 75 and you were around 40.

Now, however, if you live into your 90s, your children will be in their 60s before they inherit your money and do you think that’s the right time for them to be receiving the money? So it’s just having that conversation about whether to do that intergenerational transfer first.

It may well be the thin end of the wedge because we don’t know if this gets accepted as the new norm within superannuation where it’s going to end up within the tax community.

– Shelley Banton, ASF Audits

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NALE JS: Moving onto the issue of nonarm’s-length expenditure (NALE), are there any ongoing concerns around the general expenditure provisions rules that came into effect on 1 July of this year as well as the retrospective nature of it going back to 1 July 2018?

LS: One of the problems is most financial planners know nothing about non-arm’slength income (NALI) or non-arm’s-length expenditure and are caught off guard. I also hear from accountants that clients have usually done these things before the end of the financial year and they only find out with hindsight about what’s happened and some of them let people get away with things they should not be doing as trustees. So it’s not just retrospective to 2018, but things people have done 10 to 15 years ago and got away with are now going to be caught under these new rules and it’s going to be a big wake up for a lot of people. As an adviser I think the financial planning side needs to learn more about it because it’s not something that’s been on the radar for most financial planners.

MH: With NALE there are specific and general expenses and many of us have been focused on the general because the original position was going to be infinitely worse where a small underpayment of your accounting fees could taint all of the fund’s income, which was crazy. The final wrap-up of that penalty being much

smaller made sense and because we’ve all been focused on general expenses, people forget the treatment of specific expenses goes all the way back to 2018 and is often a bigger problem.

PB: We are in a much better position now than before the amendments were introduced where with general expenses all the fund’s income was being taxed as NALE and now we just have a bill of two times the shortfall, which in many cases is just a nuisance. The good thing about these amendments was it was made clear the rules don’t go back beyond 1 July 2018, unlike the original proposals that brought in the NALE rules where you could have a situation of an expense incurred prior to 1 July 2018 that could give rise to NALI even today. It was made clear in amendments that’s not the case for general expenses, but also for specific expenses, which is good, but the issue with NALE on specific expenses is still a live issue and we’re doing what we can to get Treasury back to the table because the job is not done. The most blatant example is the way NALE is applied to capital expenses. It doesn’t seem right to us that you could have a property that’s been held by an SMSF for many years and prior to being sold there was some renovations and for whatever reason they weren’t done on an arm’s-length terms, and therefore all the capital gain is taxed as NALE. How is that possible? This is the new frontier in the battle with NALI and how can we deal with these type of issues

because that is still punitive and needs to be addressed.

JS: Given the time it took to get the general expense rules settled and into law, what’s the likelihood the specific expenses and the capital gains issues are going to get dealt with in a timely manner?

PB: It’s going to be a long, hard road for sure and it doesn’t seem like this is an issue that is on the priority list for Treasury at all.

When we’ve raised it with them, they did not see this as an issue in terms of specific expenses. Until such time we start to see some real cases coming through, it’s going to be difficult to get the attention of Treasury and government.

JS: Going back to this idea of a lack of awareness around NALI and NALE, are we going to see some retrospective bookkeeping to go back and identify some of these issues in the past?

SB: With general expenses, in terms of when it starts, how are we going to know what is arm’s length and what’s not in terms of a general expense? It’s not our job to sit there and really scrutinise every single expense and ask is this on a commercial basis or not simply because there’s so many other factors that can be brought into that equation. There could be a discount policy. It could be somebody who’s offering services from their home that doesn’t have the same Continued on next page

Often the issue is that accountants have already made a commitment to the client and so they’re trying to implement it any way possible, and that’s squeezing the auditor to try and fit a square peg into a round hole, which just doesn’t happen.

– Liam Shorte, Sonas Wealth

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NALE (continued) Continued from previous page

sort of expense from someone who’s renting an office in the CBD. It’s not up to us to be across those particular issues.

So by and large, if it’s not reported in the financials, and it stands out so there are no accounting expenses, we might ask that question. Then again, it could well be that the fund hasn’t had their returns lodged for a couple of years and you don’t see those expenses within those particular accounts each and every year. So there are a whole lot of practical issues that need to be put into place here and thought about in terms of general expense NALE. Specific expense NALE hasn’t stopped either and we’re seeing a lot of focus from the ATO in the areas of property and property development. One of the things which provides confusion is how general expense NALE applies when you’ve got a contract or an invoice that’s in the fund’s name and it’s acquired an asset, such as property, but the fund has only paid a portion of that and there’s been an in-specie contribution made personally by the member. We’re not saying that is not a contribution. What Law Companion Ruling (LCR) 2021/2 says, and also the amendments made to Taxation Ruling (TR) 2010/1, is that a particular issue triggers the NALI provisions because that invoice being in the name of the fund, which has not paid the full amount, means an asset has been acquired at less than market value. To get around that there needs to be additional documentation put in place which states you can either have that listed on the purchase contract or you can have a separate document, which is a minute or a resolution, stating you know what the split out is, and then you can see the contribution being taken up by the fund.

There is a lot of confusion because people are asking does that mean if a member

18 selfmanagedsuper

pays an accounting fee personally, they can or can’t take that up as a contribution?

Well, that’s not the case and we’re talking about a very specific situation here in the examples in the LCR, about property contracts, but we’ve still got a lot of confusion. We need more clarification and more guidance from the ATO to make sure that people aren’t doing the wrong thing unintentionally.

DTC: Shelley, do you have any indication the ATO has recognised this and might come out with more guidance if that’s what’s really necessary?

SB: They’re certainly aware of it and we’ve raised it in our professional stakeholders meetings, and that’s been registered in the minutes published on the ATO website. We’re waiting to hopefully get some more guidance from them to help us navigate through this so that we’re not unintentionally missing something or our clients are unintentionally finding themselves in a situation where they are triggering NALE when otherwise they shouldn’t be.

PB: From what we understand, the ATO will be coming out with some updated guidance and have to update LCR 2021/2 because that still talks about the legislation prior to it being amended. We hope there’ll be some extra examples as to how some of these things will apply, including the material use of business assets, as those type of things can be quite subjective. Whether we do see any more examples I’m not sure, but from what we understand, later this year, we should see some updated guidance coming out. It might be in draft form and I’m not sure whether it will be made available for public or industry consultation, but the word we’re getting is there will be some updated guidance, which they have to do anyway because the law has been amended. In regards to that ruling on the contribution Shelley was talking about, that will probably come out, but we’re not

expecting it to be retrospective in terms of the way they’re going to apply that in-specie contribution strategy Shelley mentioned. There was some concern this new position the ATO has taken as a result of these changes to legislation could be retrospective where you’ve purchased a property partly by an in-specie contribution and partly as an acquisition, but from what we’re hearing it won’t apply prior to the rule being finalised.

SB: It is strange they’ve put a draft version of the new ruling on contributions out, but nothing’s been done on LCR 2021/2. The timing of that, once again, just leaves us with a little bit more confusion than what we what we need to have really.

LS: We definitely need those examples to take to the trustees because when you talk now it just goes right over their heads unless you can actually give them those specific circumstances and examples they can grasp. We need a multitude of them to cover as many things as possible so that we can say, ‘look, this is a case similar to what you’re trying to do and you can’t do it’ or ‘if you do it, this is what will happen’.

Otherwise it just doesn’t sink in for the average person. They don’t understand the jargon. They don’t understand the way the legislation works. We’ve got to put it into plain English for trustees.

SB: I’ve already had conversations with accounting clients who respond they don’t know what the problem is. They’ve just made a personal contribution and they are allowed to do that and I’m not saying they can’t do that, but just please give me this other bit of documentation which is going to help everybody out. They don’t understand and more material from the ATO as soon as possible would be better than the situation we’re currently in.

LS: Often the issue is that accountants have already made a commitment to the client and so they’re trying to implement it any way possible, and that’s squeezing the auditor to try and fit a square peg into a round hole, which just doesn’t happen.

FEATURE

Taxation Ruling 2013/5 DTC: There was a recently released update to TR 2013/5, dealing with the operation of income streams where the minimum pension for one particular income year was not satisfied, but complied with in the following financial year, that was significantly different to its draft version. Was that a big surprise?

MH: It certainly was to me. Did you have advanced warning, Peter, that the final version would be very different to the draft?

PB: No, no, we didn’t have advanced warning.

MH: And that’s pretty profound, I think, and certainly raises an awful lot of questions for me.

SB: I was taken aback by the update because it’s just put a whole new layer of complexity on what we have to check during audit, thanks very much.

We’ve come the full circle. Pensions used to operate like this and then they didn’t so we have to drag out those old skills again and we’ll have to oil those old wheels to get them moving again, but we’ll do it.

MH: And I wonder why the ATO has chosen this course of action. The way it used to work is if you failed your minimum pension obligation, you lost your ECPI (exempt current pension income) for that year, but as

long as you did everything right the following year, that income stream automatically restarted. So it was bad for that year and you got punished for the compliance breach, but there was no lingering problem. Whereas my read of what we have now is you’ll basically lose your ECPI until you realise you failed last year’s minimum pension requirement, which could be nearly 12 months into the following year, and then you will have to formally end and restart your pension and that creates a whole lot of other problems.

So I wonder who thought this was an important change to make.

LS: I wonder if it revolves around the integrity of the TBAR (transfer balance account report) because if you’ve got to restart the pension or stop the pension, then there has to be a TBAR to say the pension stopped on 30 June of the previous year and then a new TBAR will have to be submitted within the first quarter. But if somebody hasn’t done their accounts till March or April the following year then they will be well behind.

MH: So why not just impose penalties for late lodgement of TBARs? LS: Right. Now we’re going to have to say to our clients if you don’t make your minimum pension payments, not only will you lose a year of ECPI, but because your managed fund holdings

don’t provide financial reports until October or November each year, it’s probably going to be February or March before we discover you haven’t covered the minimum pension.

DTC: Peter, do you have any idea as to why this change was considered to be so important?

PB: From what we understand, it was because of the transfer balance cap rules which were introduced in 2016/17 and they had to update this ruling to accommodate the new cap and the new debits and credits. I think that was the reason for it.

MH: But we already have rules that say if you fail your minimum pension obligation, you’ve got to submit your TBAR again. So why did we feel the need to have this extra step of you’ve got to formally commute and restart the pension in order to get your ECPI back, which is the thing that creates the complexity in my view.

SB: Well the new requirements are just penalising members further because then they’ll be mixing their taxable and tax-free super components together for no apparent reason apart from aligning with the TBAR rules. So I’m not sure where it’s going to end up.

LS: Well I think I’ll end up getting clients to write a memo to their trustee on 30 June every year saying I want to move my entire balance from accumulation into pension phase, Continued on next page

The legislative changes make our job more difficult every single year, but that doesn’t mean we should be monitoring trustee behaviour – what they’re doing and why they’re doing it. Our role is very black and white.

– Shelley Banton, ASF Audits

QUARTER III 2024 19

FEATURE ROUNDTABLE

Taxation Ruling 2013/5 (continued) Continued from previous page

regardless of whether their SMSF assets are already all in pension phase, just in case an income stream has to be cancelled and restarted in the event of not satisfying the minimum pension obligation.

MH: Do you think that’ll work, Liam?

I would have thought you’ve still got to formally commute your old pension because at that moment it isn’t in accumulation phase. It’s being treated like it is for tax purposes, but it isn’t until you stop it and restart it.

LS: As far as I could read it, it was saying you can’t start the new pension until the trustees request it. So if you’ve got a request on file, it can act as a safety measure that might be just something we put in place for clients.

SB: So I’m assuming it’ll be along the lines of the member stating if I don’t meet my minimum pension and if I don’t do this, then make sure my pension is commuted as of this date and restarted on this date and I’ll put the paperwork in at a later time. The more interesting question is how the administration software advisers are

using is going to deal with this.

DTC: So will this create a significant additional administration burden for SMSF trustees and increase the cost of running their funds?

LS: It will because trustees are going to need an extra set of financial statements for the date you restart the pension as, in a lot of cases, it won’t be 1 July. They’ll also have to revalue all the assets and that means getting new valuations. So there will be considerable costs and time involved not only for trustees, but for each of the professionals advising the fund.

SB: More unnecessary red tape is what we’re looking at here.

MH: It makes you wonder how it will affect things like grandfathering for the Commonwealth Seniors Health Card or the age pension. For social security purposes an income stream is not considered to be terminated just because the SMSF hasn’t met the minimum pension, it is considered terminated if no drawdowns have been made. So one of the saving graces of the approach we had before was you could underpay the minimum and lose

your ECPI, but you didn’t necessarily lose grandfathering because technically the pension continued.

So if we have to forcibly stop it, then people will lose any associated grandfathering as well.

LS: No doubt, and look grandfathering is becoming less and less important as time passes, but still for some people not being able to receive the Commonwealth Seniors Health Card is really important because they love it.

PB: That’s what has really caught us off guard. We didn’t expect that we had to formally cease the failed pension before we could start a new one. So what the ATO is saying is once you’ve failed the pension standards, that pension can never again be a retirement income stream. It’s like those SIS (Superannuation Industry (Supervision)) regulation 13.22C unit trusts where once you blow it up, it can never be a 13.22C unit trust again. We have raised these issues with the ATO and what we’re really pushing for here is to confirm if this is the interpretation moving into the future, that’s okay, but let’s not make it retrospective. If it was applied retrospectively, I think Continued on next page

There have been some big increases in the number of trustees being disqualified. But I think what has us more concerned at the moment it how many SMSFs are being set up without professional advice.

– Peter Burgess, SMSF Association

20 selfmanagedsuper

FEATURE

Continued from previous page

that would cause a lot of issues for the industry. We don’t have any decision on that request, but hopefully the regulator will agree to it.

DTC: So what sort of effect will TR 2013/5 have on the way advisers operate with regard to compliance procedures?

LS: It means advisers will have to prepare a new pension agreement that is standard if we have to restart an income stream. But if it does happen, I’ve got to prepare a SOA (statement of advice) to move into pension because the restarted income stream will be considered to be a new product. So I’d have to put together a full SOA for it and I’m sure my clients are not going to pay for that. They’re going to think I’m the professional and I should have made sure this didn’t happen to them. There are many knock-on effects. For example, who is going to tell Centrelink the individual’s social security status has changed?

MH: Also, what if the trustees do put in place the automated request we were talking about before, but as it happens they made contributions expecting to claim a personal tax deduction for

them? By following your proposed procedure you’ve got them back into pension phase, but you’ve ruled out their chances to claim a tax deduction for the contributions because they started a pension before lodging an Income Tax Assessment Act section 290.170 notice. So even the solutions we might come up with will potentially create other problems. I just wish this was not the interpretation used and I don’t really understand why it has changed. I take your point, Peter, that it was for TBAR requirements, but we had these obligations even under the old interpretation where for SIS purposes there was still a pension in place, but for tax purposes there wasn’t. I thought that fitted okay with TBAR requirements.

JS: So will advisers now have to make a greater effort to ensure SMSF clients meet their minimum pension obligations?

LS: It’s something we’re definitely going to have to take a look at. In the past I’ve never forced clients to use a bank account that I could view, like the Macquarie Cash Management Account, meaning a lot of them were able to use a facility of their choice, such as a Sydney Credit Union

account, for their SMSF. As financial planners it’s a lot harder to get access to those accounts that are not fed into Class, SuperConcepts or BGL software. It meant in some situations I was flying blind. So a change like this means I’m going to have to tell clients I don’t care what bank accounts you use, but I want to be able to access the one you pay the pensions from so I can check you’ve paid the minimum pension. I know a lot of administrators are building in a system of alerts where, towards the end of the financial year, advisers will be informed as to the amount of money the member has drawn down from the fund in relation to their minimum pension. I think that’s going to provide the solution to allow us to trigger a warning to clients to take their minimum pensions.

SB: This could also see an increase in the number of accountants and administrators adopting the practice of performing daily reconciliation of those data feeds instead of using a weekly or monthly cycle simply to overcome this issue.

LS: It will make quality data feeds even more important.

Continued on next page

We did think having the ATO bring out their new education programs might make a real difference in helping people decide whether an SMSF is appropriate for them. But it’s being delivered in a very ordinary way.

– Liam Shorte, Sonas Wealth

QUARTER III 2024 21

FEATURE ROUNDTABLE

Taxation Ruling 2013/5 (continued) Continued from previous page

DTC: Will the updated TR 2013/5 result in improved compliance with minimum pension requirements due to the severity of the consequences of not doing so?

MH: I don’t think so because

compliance with this obligation was already pretty good. Some instances of non-compliance in SMSFs happen because people don’t pay enough attention to the rules. But I think people who have pensions try to take their obligations seriously, but sometimes just make an honest mistake. I think the consequences of

not satisfying the payment standards, even before this change, were already pretty severe – you lost your ECPI for a whole year and given how valuable that is, it was already a very strong disincentive. So if this change in interpretation was all about providing a stronger disincentive, I don’t think we needed it and I don’t know this will suddenly make people more compliant.

I wonder why the ATO has chosen this course of action. The way it used to work is if you failed your minimum pension obligation, you lost your ECPI for that year, but as long as you did everything right the following year, that income stream automatically restarted.

– Meg Heffron, Heffron

22 selfmanagedsuper

FEATURE

Auditor responsibilities JS: Is too much responsibility being placed on SMSF auditors whereby they are now expected to detect and guard against improper actions outside of their legal or professional remit?

SB: Trustees need to take responsibility for their obligations in terms of maintaining a fund and operating a fund and making sure that it’s compliant at the end of the day. From our point of view, we’re there to check compliance with SIS and make sure that we undertake an independent and objective audit. All of our processes and procedures, and what we do during the audit is outlined in our terms of engagement letter. So if we look at NALI and NALE, for example, while we might find a fund has a compliance issue of this nature, it’s a Part A qualification at the worst because the tax calculation has been materially misstated. That’s the extent of it. It may be included as a management letter comment, but we don’t actually inform the ATO about something like that. It’s up to the tax agent to include the item in the tax return and we don’t audit the SMSF tax return. We’re very happy to perform an audit without the tax return so from our point of view there’s a limit to what we can do from a compliance perspective and we’re trying to do the best we can.

The legislative changes make our job more difficult every single year, but that doesn’t mean we should be monitoring trustee behaviour – what they’re doing and why they’re doing it. Our role is very black and white. If it’s a compliance issue, we either have sufficient appropriate audit evidence on file or we don’t, and if we’ve got conflicting evidence, then we’ll undertake further procedures and go back and ask more questions. We’ll evaluate that and we’ll come up with our logical conclusions

and our audit findings as a result. It’s not up to us to determine what the trustees are doing and why they’re doing it. We need for the trustees to tell us that and to provide us with that evidence. So even though it seems these separate responsibilities are merging together, I still see it as being very separate and distinct lines. Trustees need to take responsibility for their obligations in terms of maintaining and operating an SMSF and making sure it’s complying.

DTC: Some recent court rulings seem to have placed more onus on auditors to detect all SMSF compliance issues. Is this an attitude being reflected by sector stakeholders in general?

SB: With everything there are varying degrees. We’ve always had clients who use us as the reviewer from an accounting perspective, which is not our job. Auditors and any SMSF professionals who are not doing the right thing should be held accountable and have the applicable penalties applied to them. We’re seeing a lot of change in the audit industry and auditor numbers reducing. That’s not necessarily a bad thing, especially when you look at a reduction in the number of practitioners who previously were undertaking a small number of audits, but there are still a lot of them out there. The legislation is making it harder and harder for auditors to keep on top of all the rules and for individuals who just perform audits for one or two funds it would be a very difficult situation to manage.

We’re at a point where serviceability is still absolutely being maintained and I don’t think that’s an issue from an audit perspective. It also means we’re starting to rely more and more on technology to fulfil the more mundane tasks within the SMSF audit so we can focus on the compliance aspect more fully.

JS: Some auditors are expressing concerns they feel their professional judgment is increasingly being

questioned. To eliminate this perception should the ATO provide a formal template as to what an audit should include and cover or are SMSFs too bespoke for something like that?

SB: The ATO already provides on their website a fairly comprehensive auditor checklist from both the compliance perspective and the auditing standards.

If you have an ATO review, you’re going to be scrutinised from a compliance perspective, but also in the context of satisfying the auditing standards. So that sort of information is already available on the ATO website. In terms of professional judgment, a lot of auditors just have the audit evidence on file, but they don’t actually draw their logical conclusion from this evidence. So then it’s not just enough to have the audit evidence on file. In these situations you’d have say, for example, I’ve looked at the rent for this lease that’s been renewed, it’s a lease for a related party, I have this market valuation of rent online and it is being charged at arm’s length and I’m okay with this arrangement. In contrast you can’t just say it’s a new lease and just put the lease agreement on file and the process is finished. You actually should have a logical progression in your audit file which will give someone else, who is an independent third party, the ability to have a look at that file, understand where you’ve got to with your audit findings and the associated conclusions without that person having any knowledge of the fund in the first place. So I’m not too sure where the professional judgment issues are arising from.

JS: Is the audit contravention report (ACR) a good default mechanism?

Should the auditor file one where for instance they have doubt over a fund’s compliance?

SB: I don’t think any auditor would be issuing an ACR without Continued on next page

QUARTER III 2024 23

FEATURE ROUNDTABLE

probable cause and sometimes it is just the auditor opinion at the end of the day. An ACR does not make the fund non-complying and it’s not penalising the fund in any other way. It’s just a mechanism to inform the ATO about a

24 selfmanagedsuper

potential compliance issue. Also, the ATO does not necessarily have to agree with the opinion recorded on an ACR. For example, we might lodge an ACR because we don’t have sufficient audit evidence. There may be a situation where an SMSF asset has been acquired from a related party, but we can’t establish if it is business real property because we can’t gather enough information. Here we’re not saying that it’s not business real property in our ACR, but rather we can’t confirm the transaction is in compliance

with the SIS Act. We’re supposed to be reporting a contravention as to where it may have occurred, is occurring or may be occurring in the future. We also have to inform the ATO about anything it needs to be aware of in its role as the sector regulator. So we’ve got a very broad sphere as to what we need to report to the ATO that means we may have to lodge an ACR, not flippantly, but certainly from the point of view that we can’t confirm compliance with regard to a certain area.

FEATURE

Health of the sector DTC: There has been a significant increase in trustee disqualifications recently, with the number increasing from 252 in 2021/22 to around 750 in 2022/23. Is this a trend we should be worried about or is it just evidence the ATO is being more effective in its compliance activities?

PB: I think there is a greater focus of the ATO nowadays than perhaps it has been in the past, but you’re right, there have been some big increases in the number of trustees being disqualified. But I think what has us more concerned at the moment it how many SMSFs are being set up without professional advice. We saw some figures released from Investment Trends recently indicating establishments of this sort are at an all-time high.

Worryingly, new trustees seem to be getting their advice from the internet, family and friends, and so forth. Perhaps there is a joining of the dots there as to the number of SMSFs set up without professional advice and why we are seeing more trustees being disqualified.

Perhaps it’s happening because these people are setting these funds up without having an understanding of what’s involved. That’s a concern for us and something we are really trying to address is to make it easier for people to access specialist SMSF advice because it is obviously important they get that advice.

So that situation probably has us more concerned at the moment.

DTC: Are we seeing any situations of buyer’s remorse from individuals who have received specialist advice before establishing an SMSF? LS: There are certainly people that come to us and say running their own super fund is all too hard and I think there is a COVID effect with regard to a greater number of people coming to this

realisation. That’s because there were a lot of young people who set up SMSFs online using a low-cost provider just to invest in bitcoin or participate in market trading as they were at home for 24 hours of the day and controlling their super was something they had time to do. Two years later a lot of those individuals have never answered an email from those online SMSF administrators, meaning they’ve got themselves to the stage where the ATO is classifying the fund as noncomplying and shutting them down. But the latest thing we’re seeing is the fallout from the UCG, or United Global Capital, case. Around 1247 SMSFs were affected.

It involved cold callers who contacted individuals and offered a superannuation review. If the offer was accepted, they were passed on to another general advice company and eventually they were encouraged to establish an SMSF that in turn invested in a property fund associated with UGC. As a result, you’ve probably got 1200 people there that should never have been in an SMSF in the first place. So I am attracting trustees who have got themselves into trouble and my practice is trying to fix it. In many cases it just entails approaching the ATO and admitting the individuals should never have started an SMSF and we’re going to exit them from the fund, but we just need time to do so. I have to say from my point of view it cost me a fortune in time, but you don’t want to leave people stranded where they will ignore the situation for four or five years and face a bigger problem that will result in severe penalties.

SB: So what’s the solution to this problem? There will always be a percentage of bad actors out there, but it just seems like a lot of people are looking for the short-term quick return and will believe the first charlatan that really might come along.

LS: The ATO is carrying out checks and about 27 per cent of SMSFs and a fair

few of the funds set up by people who were not appropriate to do so have been stopped now. But a lot of it comes down to the fact people should be getting advice from an SMSF specialist.

In the case of the UGC, individuals were being told the advice was coming from a superannuation specialist, but when I made the complaint on behalf of the client I was told he was only a practitioner providing general advice with no financial planning qualifications at all. So he actually couldn’t give them the advice to roll their benefits over into an SMSF. PB: It’s unlicensed advice in many cases and that’s a real problem. We need to get on top of that because unlicensed advice is an issue.

DTC: Should it give the industry any comfort the Australian Securities and Investments Commission has declared poor SMSF advice will be one of its areas of focus for the coming year?

PB: Well we’d like to see the regulators stamping out unlicensed advice. As I said, that is an issue. As you know, from our perspective, it is important that people get advice from an SMSF specialist. This is a specialist area. It’s the important decision they’re making and they should be getting advice from a specialist practitioner.

LS: We did think having the ATO bring out their new education programs might make a real difference in helping people decide whether an SMSF is appropriate for them. But it’s being delivered in a very ordinary way. It really is designed for the punishment of people who have broken the rules – in other words the rectification.

The regulator did such a good job on the video series it produced, but I think this initiative doesn’t hit the mark. In this day and age you have to engage with people and almost gamify the way you do it and this I think was the total opposite. It’s just rote learning a document so I think the ATO needs to step up on that side of it.

QUARTER III 2024 25

FEATURE ROUNDTABLE

Impact of INFO 274 DTC: In December 2022, ASIC eliminated the suggested minimum balance threshold of $500,000 for SMSF establishments in Information Sheet (INFO) 274, replacing it with the ability for advisers to use their professional judgment as to whether an individual is appropriate to be a trustee of this type of fund. Investment Trends research has found this change has not made any difference to fund set-ups. Is this a surprise?

MH: That makes sense if establishment is moving away from advisers and is becoming more informed by the internet. In that scenario what ASIC says in that information sheet won’t tend to make any difference.

LS: When someone comes to me the one thing I have to consider is whether it is in their best interest to set up an SMSF. I spoke to people recently who had $270,000 in super who were told they could acquire a property in an SMSF. When I assessed the situation I told them they would be far better off buying their first investment property outside of super where they could get some negative gearing

26 selfmanagedsuper

benefits. Further, I said we could then build up their knowledge levels of superannuation and their contributions before committing to owning a property in an SMSF. They had almost been completely pre-sold on the internet to buy a property in Townsville using an SMSF. PB: Realistically we were never expecting to see the removal of the thresholds ASIC previously had in place was going to open the establishment floodgates. All we were doing, from the SMSF Association’s perspective, was challenging the $500,000 threshold the regulator had included in its material previously. But it was never a matter of removing the threshold with a view doing so would open the floodgates to setting up SMSFs. As we know there are many other factors to consider besides an individual’s super balance before it can be deemed appropriate for that person to establish an SMSF. LS: You’re right, Peter, it isn’t about their superannuation balance. I’ve got some SMSF clients with between $170,000 and $200,000 in super, they only invest in broad and sector-specific exchange-traded funds and they use a low-cost administrator. As such, the fees for their fund is competitive with any industry or retail fund in the industry and they’re engaged, meaning they’re making higher

contributions at an earlier age and as a consequence they’re doing really well.

DTC: Is professional indemnity (PI) insurance also neutralising the impact of INFO 274 on fund establishments, seeing some policies will not cover advisers if their SMSF clients have super balances that are below $500,000?

LS: I know with our PI if the client has a lower balance, I have to justify their situation. I’ve got to complete a suitability questionnaire and explain why they have an SMSF. But like we discussed earlier, the amount of money they have in super is not really an issue.

The important thing is what they’re trying to do with their retirement savings and what they’re trying to achieve. Those factors are much more important than their current balance.

PB: It’s all about best practice at the end of the day. We can’t control what the PI insurers have in their policies, but we can control best practice and putting material out promoting that.

MH: I think one of the things that is quite significant about ASIC’s change of direction there is at least we no longer have a firm statement from such an important regulator implying a magic number that was quite high. So I think the change to INFO 274 is still important.

PB: I’d agree with that.

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The global markets picture

The US share market suffered a sizeable drop in August. Brent Puff analyses the reasons for this event and what is likely to happen in the months ahead.

BRENT PUFF is vice president and senior portfolio manager at American Century Investments.

28 selfmanagedsuper

After an extended period of strong performance, global stock markets fell hard at the beginning of August when the Chicago Board of Trade’s VIX Volatility Index, Wall Street’s ‘fear gauge’, hit 65 – a level not seen since the early days of the COVID-19 pandemic.

Global markets were rattled by a combination of geopolitical and economic concerns, overshadowing what arguably would have been a period of optimism fuelled by strong earnings from tech giants. Earnings were largely overlooked as negative sentiment surrounding the potential outcome of the United States election took centre stage, particularly the possibility of a Trump presidential election victory fuelled by the recent assassination attempt. Trump’s polarising

comments on Taiwan, suggesting the island nation should pay for US military defence, added to growing concerns about US trade restrictions on China.

Meanwhile, the Bank of Japan (BoJ) made an unexpected move by raising short-term interest rates by 0.25 per cent at the end of July, a significant shift after years of ultra-loose monetary policy. This led to an unwinding of the carry trade, where investors borrow in a low-interestrate currency to invest in higher-yielding assets elsewhere. The market reaction was swift with Japan’s Nikkei 225 Index falling more than 12 per cent in a single day, marking its largest one-day Continued on next page

There is no doubt this is a challenging environment for investors, with contradictory messages to digest. There remain multiple areas of uncertainty that contribute to risk aversion and volatility.

Continued from previous page

drop since 1987. Although the BoJ has since backtracked on its aggressive stance, the damage was already done, highlighting the fragile state of global investor sentiment.

The VIX has since dropped back to under 20 as the S&P 500 recovered, but this dip in shares should not be ignored as the economic outlook for the US, and the global economies that depend on it, becomes increasingly uncertain.

The beginnings of a market rotation?

To some investors the volatility in early August may have come out of the blue.

Through July, the market seemed steady,

with US stocks as measured by the S&P 500 rising 1.22 per cent and the index reaching a high of 5667.

The US Labor Department’s inflation measure came in lower than expected in July, which was seen as good news for the prospect of interest rate cuts and a catalyst for rate-sensitive asset classes. It seemed like an indication of a soft landing.

Beneath the surface, however, there was a significant rotation from mega-cap technology stocks to small caps and other areas of the market that have been lagging in recent years.

And sentiment around artificial intelligence (AI) was shifting. Investors started to question how much was being spent on this technology and whether there’s any return on investment on the horizon.

While hyper-scale companies such as Microsoft, Meta and Amazon have continued to guide for increased capital expenditure growth around AI, much of this spending is going toward data centres – vast, unglamorous facilities filled with rows of powerful computer servers, routers and cooling systems. The sheer scale of these investments has led some analysts to question whether the AI hype justifies the costs, especially in a market environment increasingly focused on tangible returns and cost efficiency.

This may all be the beginnings of a regime change for earnings growth.

Profit growth for the largest tech stocks is projected to fall from 68 per cent in the fourth quarter of 2023 to 20 per cent in the fourth quarter of 2024, marking a significant deceleration. Meanwhile, analysts predict earnings for the rest of the

S&P 500 Index companies will grow from just 1 per cent to 11 per cent.

Mixed messages At the same time as this rotation in the market, the US economic data presented a more subdued picture.

Unemployment ticked up to 4.3 per cent in July, from 4.1 per cent in June, which was higher than expected. Initial jobless claims for the beginning of August were also higher than expected. While we had been hearing anecdotal evidence about consumers pulling back and manufacturing slowing, this was the first bit of hard data showing the economy is slowing.

The Sahm rule, which says when the three-month unemployment moving average rises by 0.5 percentage points or more relative to its low during the previous 12 months, then a recession is underway, started to flash warning signs.

The July ISM report, or purchasing managers’ index, also indicated US manufacturing activity had fallen deeper into contraction territory, raising further concerns about the sustainability of economic sentiment.

And the yield on the 10-year US Treasury bonds also fell sharply. In July, lower rates were viewed positively as an indicator of declining inflation. Now recession fears are driving lower rates.

Other issues in early August included a big drop in Intel’s stock price, its announcement of 15,000 job cuts and Amazon’s cautious comments about consumer spending.

Continued on next page

QUARTER III 2024 29

INVESTING

Continued from previous page

What’s next?

There is no doubt this is a challenging environment for investors, with contradictory messages to digest. There remain multiple areas of uncertainty that contribute to risk aversion and volatility.

Geopolitical risk continues to be high, especially in the Middle East, where the situation is far from certain, as well as in Ukraine.

Likewise the US election situation is adding to uncertainty with more recent developments making it harder to predict an outcome than perhaps initially thought.

Markets are also going back and forth with regard to the US Federal Reserve’s next steps, although this has become a little clearer as the result of recent data points and chair Jerome Powell’s comments around the likelihood of a cut at its next meeting.

Additionally, there is increasing evidence of US consumer spending stalling. The resiliency of the US economy has hinged on the strength of the US consumer, but we are starting to see weakness in what were areas of strength, such as travel and leisure spending, auto sales and other large discretionary spending. During the most recent earnings season the results from several airlines disappointed and forward guidances were subdued. It seems clear the US consumer is under increasing pressure, particularly as the job markets soften. Before the pandemic, consumer

30 selfmanagedsuper

savings were sitting around 6 per cent, but this has now fallen to 3 per cent at a time when fiscal deficit spending is weakening.

At the same time, however, there are also positive signs for investors.

We believe markets will be supported by continued strength in corporate earnings, especially in the large-cap space. This is driven by sustained growth in certain areas such as: • large-cap tech – driven by themes such as AI-related capital expenditure spending, cloud computing and the recovery of semi-conductor (non-AI) production, • healthcare – driven by innovation and commercialisation of new drugs and treatment, as well as a recovery in procedure volumes, which were negatively impacted by the pandemic, and • utilities – driven by the rising need to invest in electricity generation and distribution, which in turn is driven by rising AI computer intensity, adoption of green energy and modernisation of an ageing infrastructure.

Another positive signal is the falling interest rates across many developed economies, including the US, which will be supportive of valuations. We expect growth, as an investment approach, to benefit as rates fall and normalise across many areas. Lower rates have historically been a tailwind for many parts of the investable universe, such as housingrelated names and real estate investment

There is increasing evidence of US consumer spending stalling. The resiliency of the US economy has hinged on the strength of the US consumer, but we are starting to see weakness in what were areas of strength.

trusts.

If the market gains greater confidence that the risks outlined above are diminishing, and if earnings remain resilient, markets should continue higher.

And we will be watching for stabilisation in the unemployment rate. We expect a gradual increase in claims, which would indicate normal slowing, but another spike would be viewed as a bad sign. We believe market dislocations like this create opportunities for active managers ready to capitalise on unwarranted moves.

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High-yield bond optimism

An allocation to high-yield bonds can enhance the income a portfolio can generate and improve asset class diversification, writes Jack Stephenson.

JACK STEPHENSON is US fixed income investment specialist at Axa Investment Managers.

The most common point of discussion around the outlook for fixed income, for bonds, is yields and whether they’re rising or falling.

A bond’s yield describes the return an investor gets from a bond, considering the coupon, the principal and how much an investor paid to invest.

Bond prices and yields have an inverse relationship – as the price goes up, the yield decreases, and vice versa. In other words, falling yields are good for investors, as it means the value of their portfolio is rising.

The three primary drivers of bond prices, including high-yield bonds, are credit risk (determined by an issuer’s financial profile), interest rates and duration.

Credit risk Independent bond rating agencies assign credit ratings to companies and governments based on their financial strength, that is, their ability to repay debt. A high credit rating, such as BBB and above from S&P, is labelled investment grade, while a low rating is considered noninvestment grade, that is, high yield (see table below).

Financially sound bond issuers are seen as more reliable than smaller, less well-known ones. Developed market government bonds, for example, those issued by the United States, major European economies and Japan, are seen as most reliable of all. But their

32 selfmanagedsuper

perceived safer status means they also offer very conservative yields.

High-yield bonds typically come with greater risk and are generally more volatile with higher default risk among underlying issuers versus investment-grade bonds. But high-yield issuers need to pay higher interest to incentivise potential investors.

Interest rates outlook If investors think rates will rise, then bond prices typically fall in value as new bonds coming to the market will offer higher coupons, reflecting the higher interest rate.

Equally, if interest rates fall, the reverse is true – a bond’s value will rise, but its yield will drop. Bear in mind falling yields are good news for bond investors because it means the value of their portfolio is rising. Similarly, rising yields are bad news as the value of the bonds they hold is falling.

Duration A bond’s lifespan, or how long until the bond matures, is always a major consideration. Bonds with longer maturities, such as 10 to 20 years, are considered riskier as long-term interest rate movements are unpredictable.

Continued on next page

Table 1: Credit agency investment ratings Credit risk

Moody’s

S&P

Fitch

Highest quality, minimal risk

Aaa

AA

AAA

High quality, low risk

Aa

AA

AA

Upper medium grade

A

A

A

Medium grade

Baa

BBB

BBB

Lower media grade

Ba

BB

BB

Low grade, high risk

B

B

B

Poor quality, very high risk

Caa

CCC

CCC

Highly speculative

Ca

CC

CC

Near default

Ca

C

C

In default

C

D

D

Investment grade

Sub-investment grade (high yield)

Source: Mood’ys, S&P, Fitch, Credit risk definations are not verbatim and vary slightly between agencies

Continued from previous page

Their prices are also more sensitive to changes in interest rates. The price of a 30-year bond will move more for a 1 per cent change in interest rates than the price of a three-year bond. So duration measures the sensitivity of bond prices to changes in interest rates.

Additionally, inflation will have an impact on the principal. An amount of $100 million today will be worth more than $100 million in 25 years’ time. High-yield bonds come with shorter maturities than many investment-grade bonds, typically less than 10 years, and as such tend to have relatively lower duration.

This means high-yield bonds can potentially be less exposed to interest rate risk than most investment-grade strategies.

Why investors should consider highyield bonds High-yield bonds are among the higher income investment offerings. They are

generally issued by companies that could be more capital intensive and may have higher levels of debt and therefore could be seen as a higher credit risk.

While they’re riskier than government and corporate investment-grade bonds, they offer investors the potential for much higher rates of income. This higher income stream has the potential to offset the higher risk of principal loss. Active strategies that can minimise principal loss while still maintaining a higher income stream can potentially lead to outperforming results.

The performance of high-yield bonds also tends to have lower correlation to other sectors within the fixed income market so can provide important diversification to a broader bond portfolio and, as highlighted, they can be less sensitive to interest rates. In addition, there is also the potential for capital growth.

Like equities, high-yield bond prices can increase because of the issuing firm’s improved performance or a wider

High-yield bonds typically come with greater risk and are generally more volatile with higher default risk among underlying issuers versus investment-grade bonds.

But high-yield issuers need to pay higher interest to incentivise potential investors. economic upturn. In addition, the typically higher income component of these types of bonds means they are generally less volatile than equities, but their performance is more correlated with stocks than that of longer-duration, less risky investment-grade corporate fixed income offerings.

The high-yield bond market was born in the US and the world’s largest economy remains the largest and most liquid market.

But today there is a wider global market offering potential benefits, such as the diversification of Europe or the stronger growth potential of emerging markets.

Is there still room to run for US high-yield bonds?

Looking at previous cycles, the high-yield market tends to bounce back strongly after a sell-off. This is because as bond prices recover and coupons reset at higher levels, the level of income bondholders receive increases. This is reflected in the all-in yield, which in the US high-yield market moved from around 4 per cent in 2021 to 9 per cent at the start of 2023 and is now around 8 per cent.

Continued on next page

QUARTER III 2024 33

INVESTING

Continued from previous page

This most recent sell-off, however, was unusual compared to previous ones. The one in 2022 and the rise in yields was driven mainly by interest rate increases, not by credit spreads widening. This means bond prices today remain discounted as the outlook for interest rates has been uncertain. That could now be all about to change as we expect the US Federal Reserve to start moderately easing policy in the second half of 2024.

This means there is still significant upside potential for the high-yield market through a combination of higher income and continued bond price recovery. It is worth bearing in mind that rallies in high yield can happen very quickly. For example, in the fourth quarter of 2023, the US high-yield market delivered a 7 per cent total return as the market priced in rate cuts, with the average high-yield market dollar price increasing from $88 in September to $93 by year end, where it currently remains.

Timing such market moves can be challenging so, we believe, being invested is important to ensure participation in rallies while also benefiting from the higher carry now on offer.

We expect high-yield spreads to continue to be supported by broadly healthy corporate fundamentals. We also expect any potential spread widening to be met with buyers, providing further technical support.

That said, dispersion is increasing as

2024 outlook Maintaining a diversified bond portfolio for the remainder of 2024 may be prudent due to increased macroeconomic uncertainty and geopolitical risks that continue to play out.

Ausiex adviser trading data has shown the net traded value, that is the buy value less the sell value,

34 selfmanagedsuper

Over the long term, the high-yield bond asset class has proven its ability to outperform other parts of the fixed income market.

This is principally due to the attractive carry component that compounds through time.

high-yield companies adjust to a higher rate environment. This is reflected in how little of the US High Yield Index is trading at its average yield to worst (YTW) level. As at 12 June 2024, 70 per cent of the index had a YTW between 0 per cent and 7.5 per cent and 20 per cent had a YTW greater than 8.5 per cent, leaving just 10 per cent of the overall market with a YTW between 7.5 per cent and 8.5 per cent – the index’s average YTW range for the past year or so.

We believe active management and prudent fundamental analysis are critical to identify companies that are well positioned to pay coupons on a timely basis and pay back, or refinance, principal.

Over the long term, the high-yield bond asset class has proven its ability to outperform other parts of the fixed income market.

This is principally due to the attractive carry component that compounds through time.

High-yield bonds also have the potential to compete with equities from a return perspective, but with less volatility.

Since the global financial crisis 15 years ago, the high-yield bond asset class has matured significantly in terms of the quality and diversity of companies that make up the market. Many of these companies are household names and global leaders in their lines of business that feel very comfortable using the high-yield market to access capital.

Due to these characteristics and

developments, high-yield bonds have become much more of a core part of investor portfolios, attracting a wide range of participants across institutional, wholesale and retail segments.

As well as the high income available relative to other asset classes, investors are also attracted by the diversification qualities that high-yield bonds can offer within a balanced portfolio. With a risk/return profile that sits somewhere between the fixed income and equity markets, high yield can be used in a variety of different ways to suit different investor risk appetites and outlooks.

of Australian dollar fixed income exchange-traded funds (ETF) has more than doubled from January to April 2024, while inflows into global fixed income ETFs have also increased steadily from January.

Australian dollar fixed income ETFs listed on the Australian Securities Exchange (ASX) include the iShares Core Composite Bond ETF (ASX: IAF), Betashares Australian Bank Senior Floating Rate Bond ETF (ASX:

QPON), Vanguard Australian Fixed Interest Index ETF (ASX: VAF) and Russell Investments Australian Select Corporate Bond ETF (ASX: RCB).

Global fixed income ETFs on offer include the Vanguard Global Aggregate Bond Index (Hedged) ETF (ASX: VBND), Global X US Treasury Bond ETF (ASX: USTB) and Betashares Sustainability Leaders Diversified Bond ETF – Currency Hedged (ASX: GBND).

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COMPLIANCE

One that flew under the radar

The failure to meet minimum pension obligations will now have significant consequences for SMSF members. Mark Ellem examines the implications of the ATO’s new approach to this occurrence.

MARK ELLEM head of SMSF education at Accurium.

In the run-up to 30 June 2024, while industry focus was on end-of-financial-year matters, the ATO released on 26 June the final updated version of its Taxation Ruling (TR) 2013/5: when a superannuation income stream commences and ceases. While the expectation, based on the draft version, was the final updated ruling would include nothing surprising or controversial, it did include an interesting, and some may say concerning, concept.

So does this updated version of the pension ruling change the obligations and costs for SMSFs failing to meet the minimum pension rules and the approach taken by those who prepare financial statements and the annual return? I think it does.

Purpose of the draft ruling It was generally understood the update to this ruling was to simply: • incorporate the legislative amendments flowing from the 2016 budget announcement of the transfer balance cap, which limits the superannuation interests a person can have in retirement phase, • clarify how the general principles in this ruling apply in the context of successor fund transfers, and • remove practical compliance approaches that are no longer current.

36 selfmanagedsuper

The draft update, published on 27 September 2023, included these items. In the main, from an SMSF perspective there was nothing new and nothing that would require a change to the approach when dealing with pensions paid from an SMSF. However, it’s one particular paragraph in the final version that gives pause to consider the potential implications where an SMSF fails to pay the minimum pension for an income year.

Prior to the publication of this updated version of the ruling we knew if the minimum pension was not paid in an income year and the tax commissioner’s general powers of administration (GPA) did not apply, the consequences were: • the pension ceased for income tax purposes from the start of the income year in which the minimum pension was not paid. Consequently, the fund was not able to claim exempt current pension income (ECPI) in respect of the failed pension, and • the pension ceased to be a retirement-phase income stream at the end of the income year in which the minimum pension was not paid. This gives rise to a reportable transfer balance account (TBA) event, which in turn gives rise to a TBA debit equal to the Continued on next page

Continued from previous page

value of the pension at 30 June.

The original version of the ruling further stated at paragraph 20 that: “If the requirements are again met in the following year, this results in the commencement of a new superannuation income stream.”

Generally, the approach for an accountbased pension (ABP) that failed the minimum pension payment requirement was: • not to claim ECPI in respect to the failed ABP for that income year, • allocate the failed ABP’s share of fund net income to the taxable component of the pension, • report the TBA event of the ABP ceasing to be in retirement phase as at 30 June for the value at that date as a TBA debit, and • restart the ABP on 1 July of the following income year, applying the proportionate rule to determine the tax components of the ABP. Report the ABP becoming a retirementphase income stream from 1 July using the value at this date. The credit would be equal to the debit on 30 June, meaning no net effect on the member’s TBA. Start claiming ECPI from 1 July, provided the minimum ABP amount was paid for that income year.

The draft version of the updated ruling merely removed the word ‘again’ from paragraph 20 – no change to the approach generally taken, as outlined above.

Release of final version of the ruling In the final version of the updated TR, released on 26 June, paragraph 20 now states: “If a superannuation income stream ceases for income tax purposes for the reasons outlined in paragraph 18 of this ruling, it cannot recommence meeting the SISR (Superannuation Industry (Supervision) Regulations) requirements in a future year. This means it will not be a superannuation income stream for income tax purposes from the time of cessation, even if the member remains entitled

to receive payments from the superannuation fund. For the member to receive a superannuation income stream, any income stream payable from the superannuation interest must cease (for example, by commutation) and a new superannuation income stream must commence under the principles in paragraphs 9 to 13 of this ruling.”

Paragraph 18 refers to a superannuation income stream ceasing for income tax purposes if any of the SIS requirements are not met, such as failure to pay the minimum pension.

My view of this extended revised paragraph 20 is the ATO is making it quite clear that for the failed pension to be fixed, the member must consciously commute the pension and commence a completely new pension. If this is the case, then there are potential implications, such as: • while the failed ABP will end for TBA purposes on 30 June of the relevant income year, it will only effectively recommence when it is known the pension failed for that income year. This could be sometime after 30 June, • the TBA debit arising on 30 June and the TBA credit arising when the member starts

The AT O is making it quite clear that for the failed pension to be fixed, the member must consciously commute the pension and commence a completely new pension.

If this is the case, then there are potential implications. their new ABP are likely to be different amounts and potentially give rise to an excess TBA amount or may even create some transfer balance cap space, • in addition to the fund not being entitled to claim ECPI for the income year the ABP Continued on next page

Table 1 Roger

Emma

Age at 1 July 2023

77

73

ABP balance at 1 July 2023

$1,277,780

$601,004

Tax-free percentage of ABP

23.59%

16.52%

Accumulation balance at 1 July 2023

$Nil

$520,109

Tax-free amount of accumulation interest

N/A

$110,000

Minimum ABP percentage for 2023/24

6%

5%

Minimum ABP amount for 2023/24

$76,670

$30,050

ABP paid for 2023/24

$20,000

$31,200

ABP balance at 30 June 2024

$1,343,822

$610,923

Accumulation balance at 30 June 2024

$Nil

$558,711

failed, it would also not be entitled to claim ECPI in respect of the pension until it was commuted and a new one started by the member, • there will be a requirement to recalculate tax components for the replacement of the failed pension, as well as for each benefit payment from the failed pension, and • there may be a requirement for a new statement of advice in respect of the member ceasing their (failed pension) and commencing a new pension.

Let’s consider the following example.

The Century Super Fund is an SMSF with two members, Roger and Emma Century.

Details of their respective interests held in the SMSF and what takes place in 2023/24 are as in Table 1.

As the minimum pension is not paid in respect of Roger’s ABP and the ATO’s GPA do not apply, it fails for the 2024 income year.

Consequently, the SMSF can only claim ECPI in respect of Emma’s ABP for 2023/24. Using the proportionate method to calculate and claim ECPI, the actuarially determined ECPI percentage is 24.594 per cent.

Approach pre-update to TR 2013/5 Generally, where Roger intends for his ABP to continue in 2024/25, it would so continue provided the minimum pension was paid in that financial year. Effectively the ABP would be treated as recommencing on 1 July 2024.

However, the following implications would result for Roger: • the tax components of his ABP would be recalculated as at 1 July 2024. As Roger had no accumulation interest, his ABPs would be altered due to the earnings allocated to the ABP in 2023/24 being allocated to the taxable component, • the ABP ceased to be in retirement phase as at 30 June 2024. This is a reportable TBA event and will result in a debit to Roger’s TBA of $1,343,822, and • the ABP would re-enter retirement phase on 1 July 2024. This is a reportable TBA event and will result in a credit to Roger’s TBA of $1,343,822.

However, as the debit and credit are the

38 selfmanagedsuper

same amount, there’s no net effect on Roger’s TBA. The SMSF has only lost claiming ECPI for Roger’s ABP in 2023/24, but can claim ECPI in respect of the ABP for 2024/25 provided he is paid the minimum pension as calculated for that income year.

Approach post-update to TR 2013/5 Generally, it will be discovered Roger’s ABP failed to have the minimum pension paid when the fund’s financial statements are being prepared, usually well after the end of the 2024 income year. As the updated ruling states the pension cannot recommence but instead has to be commuted and a new pension started, this will change the approach to the treatment of the ABP as it will not just apply to the 2024 income year. Let’s say it was late November 2024 when the SMSF’s accountant discovered the minimum pension was not paid in respect of Roger’s ABP for 2023/24 and that Roger consciously commuted the offending income stream and started another one on 1 December 2024 for an amount of $1,388,616. Following the updated ruling the implications below would result: • Roger’s ABP cannot regain SIS Regulations compliance until he consciously commutes the ABP and commences a new one, • the fund’s ability to claim ECPI in respect of Roger’s ABP would not be possible until after it has been commuted and a new one started. This means the fund will be unable to claim ECPI not just for 2023/24, but also from 1 July 2024 until 1 December 2024, • from a TBA perspective, the debit will arise on 30 June 2024 for $1,343,822. However, the TBA credit will arise on 1 December 2024, the date the new ABP is commenced for $1,388,616. There will be no TBA debit when Roger consciously commutes his ABP as it is not in retirement phase at that time, having ceased being in retirement phase back on 30 June 2024, • the effect of the TBA transactions is a net increase to Roger’s TBA of $44,794.

Depending on Roger’s TBA balance prior to these actions, he may end up exceeding his personal transfer balance cap, and • when Roger commences his new ABP on 1

This new version of the ruling is likely to see additional administrative, and perhaps advisory, costs borne by the member and the SMSF. December 2024, the taxable components will need to be calculated using the proportionate rule.

Let’s consider that during the period 1 July to 30 November 2024, Roger received pension payments equal to the minimum pension for 2024/25. As the pension cannot be meeting the SIS Regulations requirements until he commuted the old pension and commenced a new one, he would still be required to be paid a pro-rata minimum pension for the period 1 December 2024 to 30 June 2025, regardless of what he may have received prior to the new pension commencing.

This new approach may be further exacerbated where the SMSF has a number of outstanding returns to be prepared and it is the earliest of the outstanding years in which the pension failed to meet the minimum pension requirement. There could be a number of years where the fund cannot claim ECPI in respect of the failed pension as it cannot be consciously commuted and a new one started until after it has been discovered the minimum pension was not met. This is despite the minimum pension being paid in the years after the income year in which the pension failed, but prior to when it is commuted and a new one established.

Will this mean additional costs?

This new version of the ruling is likely to see additional administrative, and perhaps advisory, costs borne by the member and the SMSF. Finally, for now, this is just looking at the potential implications for an ABP. We also need to consider what effect this will have on other pensions, such as transition-to-retirement income streams and legacy pensions.

STRATEGY

Time for an SMSF spring clean

The proposed introduction of a new tax on total super balances over $3 million has provided a good opportunity for trustees to review many critical aspects of their SMSF, writes Andrew Yee.

ANDREW YEE is a director at HLB Mann Judd Sydney.

The federal government’s proposed Division 296 tax on total super balances above $3 million has given many SMSF trustees and members pause for thought.

The measure is slated to come into effect on 1 July 2025 and means an additional 15 per cent tax will be levied on superannuation earnings, including unrealised capital gains, where a member’s account balance at the end of the financial year is over $3 million. This is on top of the existing 15 per cent tax on fund income and realised gains.

While the tax has yet to pass through parliament, this hasn’t stopped people worrying about its impact, causing many to wonder what they could or should do now with their SMSF to minimise their potential tax liability.

It is always risky to start pre-emptively making changes to superannuation, or indeed any investment, when any new rules haven’t yet been finalised. SMSF trustees and members should not be making tax on super their primary consideration as superannuation is about building savings for retirement and the investment strategy is more important than just taxes. Regardless of whether the tax on super balances over $3 million comes in or not, superannuation will still be the most

tax-effective investment vehicle available. The first $1.9 million in superannuation, that is the pension cap, upon retirement is highly tax-effective and the balance between $1.9 million and $3 million is very tax-effective.

Nonetheless, it could be a good trigger for an SMSF ‘spring clean’. To this end, there are certain identifiable matters worthy of consideration as part of this exercise.

Revaluation of assets SMSF trustees by law are required to report the SMSF assets annually at market value. Obtaining valuations of unlisted assets, such as unlisted trusts, commercial property assets or collectable assets can be a costly or an onerous exercise and trustees can sometimes ignore or defer obtaining a proper price assessment of these assets. Some SMSF trustees like to stick with the old notion of carrying out a property valuation once every three years.

The introduction of a $3 million tax will provide trustees the impetus to review the SMSF asset portfolio and identify assets to be revalued prior to the introduction of the new tax. If they do so, they can better Continued on next page

QUARTER III 2024 39

STRATEGY

Continued from previous page

plan their affairs prior to its introduction.

A proper valuation of SMSF assets may lead to different outcomes in respect of the new tax.

Some asset values may be revised downwards, which may have the effect of excluding certain members from the new regime. Conversely, an increased valuation may have the effect of including a fund member in the $3 million net, which may spur them into taking action to avoid this from happening by withdrawing assets from their SMSF provided they have met a condition of release and are eligible to do so.

If it is expected an SMSF member’s balance will be over the $3 million threshold as at 1 July 2025, then trustees should ensure all SMSF assets, in particular unlisted assets, are fully revalued to their market value on 30 June 2025. Overdue mark-to-market valuations on unlisted assets undertaken post 1 July 2025 may lead to a greater tax impost under Division 296 as it will be applied only on earnings post 1 July 2025 and only on income accumulated on balances above $3 million on 1 July 2025.

Hence it is critical all unrealised gains on SMSF assets are fully accounted for on 1 July 2025.

Many private equity and early-stage investment funds like to report their assets at cost or at a conservative value due to the private and confidential nature of the industry.

However, SMSF investors will need to lobby these fund managers to revalue their assets and unit prices pre-1 July 2025 so there are no nasty Division 296 tax surprises down the track.

Moving fund assets to one’s own name People may find, following a valuation, their total super balance has exceeded the $3 million cap. While we wouldn’t recommend liquidating assets purely to avoid the new tax,

40 selfmanagedsuper

there could be other reasons for selling assets held within the SMSF. For instance, self-funded retirees who have been retired for some time may no longer hold many assets in their own name and pay zero or very little personal income tax. Therefore, it could be a good opportunity to move some assets out of the superannuation environment and into their own name or into a different investment vehicle – such as an investment company – without triggering a significant tax liability.

Estate planning For older SMSF members, another benefit of moving assets from the super fund to hold them personally or within another structure, is to avoid the ‘super death tax’.

While Australia doesn’t have an inheritance tax per se, there are still a number of taxes that are triggered when someone dies. These include the superannuation death benefits tax, which is becoming a more frequent issue as people live longer and have more wealth.

Most commonly super death benefits are paid to a dependant, including a spouse or a child under the age of 18, and are therefore tax-free. In most cases the deceased member’s remaining superannuation is paid to a surviving spouse and there is no tax liability. Likewise any super benefits withdrawn by the member themselves, while alive and over age 60, are not taxable.

However, if the super balance is to be paid upon death to a non-dependent beneficiary, such as an adult child, then a tax liability arises.

In such situations, beneficiaries will need to pay a tax of 15 per cent on the ‘taxed component’ of the amount they receive. This could be up to $150,000 per $1 million paid out plus a Medicare levy of a further 2 per cent.

As people get older, they may be less interested in running their own super fund or start to doubt their own abilities to manage the rules and regulations, or the investments, even with the help of an adviser.

In light of the introduction of the Division 296 tax, SMSF members in their later years should consider bringing forward their estate planning. For example, they should be asking whether reducing their superannuation assets and passing them onto the next generation ought to be done now if that is their intention upon their death. They should also consider if some super assets can be housed in a family trust or family investment company for the benefit of successive generations.

Review SMSF approach An SMSF spring clean is also a good time for members to assess whether the fund is still the right retirement vehicle for them. As people get older, they may be less interested in running their own super fund or start to doubt their own abilities to manage the rules and regulations, or the investments, even with the help of an adviser.

If this is the case, then it might be time to Continued on next page

Continued from previous page

wind up the SMSF and move into another type of super fund.

As a general rule, if the SMSF balance falls to $300,000, this may also be a trigger to close down the fund as the costs associated with running the SMSF mean it may no longer be financially worthwhile.

Investment companies As mentioned earlier, it could make sense to consider alternative investment structures to an SMSF. In particular, we have seen renewed interest in private companies as an investment vehicle.

A key benefit is these companies pay tax at 30 per cent so for those SMSF members who are still working and paying tax at the top marginal rate, it can be a good wealth-holding structure.

Another benefit of investment companies is asset protection. Because companies are a legal entity, they are liable for its debts and any creditors cannot make a claim against the personal assets of the shareholders.

In addition, investment companies can be useful for estate planning. Companies operate in perpetuity, meaning they continue to exist when the original shareholders die. Shares can be transferred according to the deceased shareholder’s wishes and daily control can be replaced. Furthermore, companies offer a flexible structure in terms of the types of shares issued and rights thereon. Lending money to a company for it to invest is simple, as is reinvesting future profits.

Family trusts Another option is a family discretionary trust, although this structure can have some

disadvantages. For example, a trust must distribute its taxable income to beneficiaries who then have to pay tax on that income at their marginal tax rate, which can be as high as 47 per cent for individuals and 30 per cent for company beneficiaries.

Like companies, trusts can live on past the death of key individuals, but they are usually not perpetual. Most have a vesting date of 80 years after formation.

One area where family trusts have an advantage is with capital gains. Capital gains earned by a company are subject to the company tax rate of 30 per cent. Trust distributions, however, may be entitled to the 50 per cent reduction applying to assets held for more than 12 months. This reduction is only available to individual beneficiaries, but not companies.

Investment bonds Investment bonds are often considered a bit staid and old-fashioned, but can offer individuals significant tax advantages.

Investment bonds can work well running alongside an SMSF. These types of bonds invest in a range of different asset classes and have access to specific tax advantages. Most significantly the income earned by the investment bond is taxed within the instrument at the company tax rate of 30 per cent.

Investment bonds also have a ‘10-year tax rule’, which allows income earned to be taxed at 30 per cent and paid for within it. This means investors do not need to include the income in their personal tax return. Furthermore, if they don’t make a withdrawal from the investment bond for 10 years, they also don’t need to pay tax on income from their withdrawal.

However, to access the 10-year tax-free

The proposed tax on total super balances over $3 million serves as a timely reminder for SMSF trustees to review their current strategies and ensure their funds are well-positioned for the future. earnings, investors must meet the 125 per cent contribution rule, that is, while the amount of the contribution in the first year of the bond is uncapped, any subsequent contributions must be less than 125 per cent of the previous year’s contribution.

Conclusion In summary, the proposed tax on total super balances over $3 million serves as a timely reminder for SMSF trustees to review their current strategies and ensure their funds are well-positioned for the future. While the uncertainty around these changes means drastic actions should be avoided, conducting a comprehensive ‘spring clean’ of an SMSF can help identify areas for improvement and potential opportunities for optimising tax efficiency and investment performance.

By considering asset revaluation, alternative investment vehicles, estate planning and the overall suitability of the SMSF structure, trustees can make informed decisions that adapt to evolving legislative landscapes and align with their long-term financial goals.

QUARTER III 2024 41

COMPLIANCE

Critical nature of valuations

SMSF asset valuations are a current area of ATO focus. Shelley Banton details the relevant compliance rules and the penalties breaches will bring.

SHELLEY BANTON is head of education at ASF Audits.

42 selfmanagedsuper

Is near enough good enough when valuing SMSF assets at market value? Not according to Superannuation Industry (Supervision) (SIS) Regulation 8.02B, which requires SMSF trustees to value all assets at market value when preparing financial statements.

The problem is getting it wrong because the true cost of non-complying market valuations has financial and operational implications for an SMSF. What is market value?

The first rule is the market dictates the value of an asset and not the trustee. Adopting a Goldilocks pricing strategy whereby the trustee has different values depending on their SMSF goals will result in a compliance breach.

The next logical step is to use the market value definition in section 10(1) of the SIS Act. It refers to the amount for which a willing buyer could reasonably be expected to acquire the asset from a willing seller given the following assumptions: 1. Both parties dealt with each other at arm’s length in relation to the sale.

2. The sale occurred after proper marketing of the asset.

3. The buyer and seller acted knowledgeably and prudentially in relation to the sale.

For clarity, the definition covers all types of property, including money. It essentially expects SMSF trustees to make valuation decisions using careful consideration and sound judgment, resulting in a fair and reasonable sale.

Auditing standards SMSF auditors are equally responsible for meeting their professional obligations under the auditing standards as those detailed in the SIS rules.

ASA 500: Audit Evidence is relevant for market valuations as it requires auditors to design appropriate procedures to obtain sufficient audit evidence.

ASA 540: Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures requires auditors to assess whether the trustee’s estimates are reasonable and whether there is a risk of material misstatement in the financial statements.

SMSF trustees are not typically experts or independent valuers. To that extent, auditors must ensure trustee estimates have been prepared appropriately by reviewing factors such as whether a reputable data source was used, their assumptions, trustee bias and subsequent events that can affect Continued on next page

In short, auditors need to understand how trustees came to a valuation by assessing the logic, information and evidence of how they got there.

Continued from previous page

values.

In short, auditors need to understand how trustees came to a valuation by assessing the logic, information and evidence of how they got there.

The standards do not require SMSF auditors to obtain an independent annual valuation. They need sufficient appropriate audit evidence on file that substantiates the methodology used by trustees to value assets.

ATO general valuation principles The ATO is aligned with the auditing standards because it also says an annual independent valuation is not required.

A valuation is fair and reasonable if it takes into account all the relevant factors and considerations likely to affect the value of an asset while using a fair and reasoned process.

Trustees, however, must provide objective and supportable data as evidence to support the reasons for their valuations. They must be able to explain the valuation in terms of the methodology and evidence to an independent third party.

It means trustees are obliged to document what value has been adopted and how that value has been determined.

It is not the SMSF auditor’s job to value the asset.

The ATO has stated if trustees follow its guidelines, the valuation will generally be

accepted where: 1. It does not conflict with its general valuation guidelines or market valuation for tax purposes guide.

2. There is no evidence a different value was used for the corresponding capital gains tax event.

3. It is based on objective and supportable data.

same market value of assets for at least three income years.

The ATO reminded SMSFs with more complex assets, such as residential and commercial properties and unlisted investments in companies and trusts, to report assets at market value every year or they may be subject to additional tax and administrative penalties.

Trustee decisions SMSF trustees must decide whether to pay for an independent qualified market valuation report. If they do, the fund will be ready for audit.

Alternatively, they must provide objective and supportable data annually for SMSF auditors to confirm compliance with SIS regulation 8.02B. Trustees, or their SMSF advisers, need to allocate time and effort to obtain sufficient appropriate audit evidence for the audit.

Where trustees cannot provide evidence, the SMSF auditor may be unable to confirm compliance and the fund may breach regulation 8.02B. Where the ATO disagrees with a trustee valuation, it will apply an appropriate method to an amended value, which can impact transfer balance caps, non-arm’s-length income (NALI), a member’s total superannuation balance and the potential Division 296 tax.

It means an SMSF may be worse off if there are potential tax or compliance issues.

Compliance breaches Acquisition of assets from related party Some exceptions allowed under section 66 of the SIS Act enable an SMSF to acquire assets from a related party, such as listed shares, business real property, SIS regulation 13.22C entities, widely held trusts, insurance policies, in-house assets up to 5 per cent of the total asset value of the fund, acquiring an asset from another fund as a result of a relationship breakdown or a merger of super funds.

To ensure compliance with section 66, related-party assets must be acquired at market value, with an independent formal valuation undertaken as close to the transaction as possible where relevant.

Acquiring assets not at market value triggers the NALI provisions, whereas rectifying a breach of section 6 requires the trustees to sell the asset.

Administrative penalties A breach of regulation 8.02B comes with administrative penalties. While not explicitly mentioned in the regulation, it is a breach of the operating standards, attracting 20 penalty units and currently worth $6260 per trustee.

Where a fund has a corporate trustee, the penalty applies once, whereas it applies separately to each individual trustee. Yet another reason to have a corporate trustee.

Through its market valuation campaign earlier this year, the ATO identified a high-risk category of 16,500 SMSFs that reported the

Case study 1 Scott decides to transfer listed shares to his SMSF as an in-specie contribution. He transfers $100,000 worth of listed shares using the 15 June 2024 share price and fills in the off-market share transfer form.

Life gets in the way and Scott finally signs the form on 25 August 2024. He sends it to the share registry that day. Does the transaction comply?

While Scott planned to transfer the shares on 15 June 2024, the form was dated and signed on 25 August 2024. Given that the share price is different on 25 August, the fund has breached section 66, which is reportable Continued on next page

QUARTER III 2024 43

COMPLIANCE

Continued from previous page

yearly until the shares are sold.

The NALI provisions are also triggered because the transfer form specified an incorrect purchase price and the parties are not dealing with each other at arm’s length.

The market value substitution rules apply to modify the cost base, but do not affect the application of the NALI provisions. Disposal of the shares will result in a capital gains tax (CGT event taxed at the top marginal tax rate along with any income incurred before the sale.

NALI Law Companion Ruling (LCR) 2021/2 discusses how purchasing an asset at less than market value triggers the non-arm’s-length expenditure (NALE) provisions relating to general expenses and in turn the associated NALI penalties.

Where an asset is purchased under the terms of a contract in the fund’s name and not through an in-specie contribution, any difference between the amount paid by the SMSF and the market value is not an in-specie contribution.

As a result, the fund will trigger the NALI provisions, and all income from the asset will be treated as non-arm’s length, as well as any capital gains on disposal.

Case study 2 Scott decides to purchase business real property from an unrelated party. He personally pays the deposit of $60,000, which is correctly treated as a non-concessional contribution. The SMSF pays the remaining $540,000 out of its bank account. Does this transaction represent a compliance breach?

The purchase contract is in the fund’s name, which paid for part of the asset ($540,000), and the member paid for the other part ($60,000).

Effectively, the fund has paid for an asset at less than market value by paying $540,000 for a $600,000 property.

As such, it has triggered the NALI provisions because the asset was acquired under the terms of a contractual agreement and not 44 selfmanagedsuper

through an in-specie contribution. All income from the property will be considered as nonarm’s length in nature, as well as any capital gain from disposal.

If Scott, as trustee of the SMSF, recorded the acceptance of the contribution in writing and reported the market value of the contribution in the fund’s account and to the ATO, the NALI provisions would not be triggered as per LCR 2021/2 Example 5.

Collectables and personal-use assets There is no requirement to have an annual independent valuation undertaken for collectables and personal-use assets as long as the trustee provides objective and supportable evidence to show how they value the asset.

However, when an asset is transferred to a related party, the trustee must have the sale price at a market value determined by a qualified, independent valuer.

Each breach of SIS regulation 13.18AA, such as the asset being leased to a related party or stored in a related-party’s private residence, is worth 10 penalty units per instance, or $3130. In this example, the fine would amount to $6260 per trustee.

Loans Loans are considered high risk within an SMSF primarily because of recoverability. The evidence required is the loan agreement and whether it is on commercial terms by reviewing factors such as the interest rate, if it is secured or unsecured and whether it is being repaid.

Where the terms of the loan agreement are not met, the question of recoverability and the market value of the loan must be raised, which may result in a breach of regulation 8.02B. Complex assets Complex assets, such as property and investments in unlisted entities, do not require an annual independent market valuation.

Regarding property, the cost of property purchased during the audit year at arm’s length is acceptable audit evidence. Where the value remains the same in subsequent years, the trustees must be able to provide evidence each year to show how and why they have

Auditors must ensure trustee estimates have been prepared appropriately by reviewing factors such as whether a reputable data source was used, their assumptions, trustee bias and subsequent events that can affect values. continued to rely on that valuation.

It dispels the industry myth that a property valuation is required every three years.

Unlisted entity investments, on the other hand, require the consideration of several factors, such as the most recent sale price between unrelated parties or a property valuation when a property is the only asset of the entity.

Issues arise when a different accountant prepares the financials. The reports could be challenging to obtain and there is no requirement for any other entity apart from an SMSF to value their assets at market value.

Apart from the penalty units that can apply for a breach of SIS regulation 802B, all parties waste significant time trying to obtain objective and supportable data.

Conclusion The complexities surrounding market valuations will mean more onerous obligations and responsibilities for all SMSF professionals.

With market valuations now one of the emerging risk areas, advisers should be aware SMSF auditors will be increasingly vigilant when reviewing documentation and valuations.

The SMSF landscape has changed yet again.

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STRATEGY

Maximising disability super benefit payments

Members who become permanently disabled have the ability to receive benefit payments from an SMSF. Craig Day details how this can be done in the most taxeffective manner.

CRAIG DAY is head of technical services at Colonial First State.

In times of personal crisis involving a client becoming permanently incapacitated and unable to work, their super can provide a critical financial lifeline, especially where insurance is also held through super. However, the taxation of disability-related super payments is complicated. Therefore, it is important to understand the tax implications, as well as the strategies available to reduce tax and ease financial stress for a client and their family during this most difficult of times.

Lump sum invalidity benefit payments Where a member has become permanently disabled and can no longer work, they can generally access their super under the permanent incapacity condition of release. However, where they withdraw a lump sum from a taxed fund, such as an SMSF, tax will apply to the payment depending on the member’s age at the time of receiving the benefit payment and Continued on next page

Table 1 Age

1

46 selfmanagedsuper

Under 60

60 and over

Tax component

Tax-free

Taxable

Max tax rate

Tax-free

22% 1

Including Medicare levy

Tax-free

Taxable Tax-free

Continued from previous page

the tax components of the payment. This is summarised in Table 1.

Insurance proceeds Where a fund held a total and permanent disability (TPD) insurance policy for a member and the fund received an insurance payout for the member, the trustee will be required to allocate those proceeds to the member’s account from which the premiums were deducted. From a tax component perspective, the insurance proceeds are then treated in the same way as investment returns and are generally added to the member’s taxable component. Those insurance proceeds are then taxed in the same way as the member’s accumulated benefits when paid out as a lump sum (that is, as per Table 1).

Lump sum disability benefit payments However, where a member’s lump sum withdrawal also satisfies the definition of a disability superannuation benefit under the Income Tax Assessment Act 1997 (ITAA), a special formula can apply to uplift the amount of tax-free component included in the lump sum benefit payment.

A disability superannuation benefit payment is defined in section 995-1 of the ITAA as: • a benefit payment paid to a person because they suffer from ill health (whether physical or mental), and • two legally qualified medical practitioners have certified that, because of the ill health, it is unlikely the person can ever be gainfully employed in a capacity for which they are reasonably qualified because of education, experience or training.

While this definition is very similar to the super permanent incapacity condition of release, a key difference is that for a benefit

to qualify as a disability super benefit, the trustee must be provided with two medical certificates confirming the member satisfies the above definition. In comparison, the super permanent incapacity condition of release only requires the trustee to be reasonably satisfied the member meets the above definition.

Therefore, while most trustees will generally require medical certificates to satisfy themselves the member has met the permanent incapacity condition of release, where the trustee considers they are not required to maybe due to the severity of the member’s disability, a member may wish to consider providing two medical certificates anyway to ensure any lump sum payment will qualify as a disability super benefit payment and that the tax-free uplift will apply.

Disability lump sum tax-free component The formula to calculate the tax-free component of a disability lump sum is: Tax-free = Existing tax-free + Days to retirement Service days + Days to retirement

where: Existing tax-free component is the sum of the tax-free component included in the lump sum worked out apart from using the disability formula.

Amount of benefit is the amount of the lump sum disability benefit being paid, including any insurance proceeds.

Days to retirement is the number of days from the day on which the person stopped being capable of being gainfully employed to their last retirement day (generally age 65).

Service days is the number of days in the service period for the lump sum.

After calculating the tax-free component of the payment, the taxable component is simply the balance of the payment.

Case study Bob is a member of an SMSF and was a qualified carpenter, but after a workplace accident he has become permanently incapacitated. His details are the following: • age 53 • date of birth: 01/06/1971 (date he will turn 65: 01/06/2036), • date of permanent incapacity: - 6/07/2024: - days to retirement: 4349, - service days: 12819, • accumulated super: $450,000 (100 per cent taxable/fully preserved), and • insurance proceeds: $1.1 million.

Bob needs to withdraw $200,000 from his fund to extinguish debt and pay for some expenses. Assuming the above details, the tax components of the $200,000 payment

Table 2: Tax components and tax payable Tax component Tax-free

$50,664

Tax at 22% (max) $0

Taxable

$149,336

$32,854

Amount

would be calculated as follows (also see Table 2): Tax-free = $0 + 4349 4349 + 12,819 In relation to the formula, there are two important things to note. These include: • the larger the ‘amount of benefit’ and the larger the existing tax-free component, the larger the tax-free uplift, and • the earlier the service date of the fund, the bigger the denominator and the smaller the tax-free uplift. In this case, service date relates to the date the member first joined the fund or the date the member Continued on next page

QUARTER III 2024 47

STRATEGY

Where the strategy involves making a large NCC and then immediately withdrawing the member’s entire balance, it may be deemed tax avoidance under the Part IVA provisions of the ITAA if the sole or dominant reason the member made the contribution was to obtain a tax benefit.

Continued from previous page

commenced employment with an employer who has contributed to the fund. In addition, where a member rolls over a benefit from a different fund that had an earlier service date, the receiving fund adopts that earlier services date.

Therefore, a fund could have a service date that predates the member’s membership of that fund.

Understanding these issues can then allow an adviser to implement a range of strategies to try and maximise the tax-free component and therefore reduce the amount of tax the member may be required to pay on a withdrawal.

Making large non-concessional contributions Under the above formula, the tax-free component of the withdrawal is calculated by adding together the existing tax-free

48 selfmanagedsuper

component included in the benefit payment plus the relevant proportion of the total amount of the payment, which also includes the tax-free component. Therefore, making a non-concessional contribution (NCC) prior to withdrawing a lump sum will increase the amount of tax-free component by more than may otherwise be expected.

For example, if Bob made a $360,000 NCC prior to withdrawing the $200,000 lump sum, his tax-free component would be calculated as 19% x 200,000 + 25% x $200,000 = $88,360 (44%). Therefore, by making a $360,000 NCC prior to withdrawing the $200,000 lump sum, Bob increased the tax-free component included in the lump sum from $50,664 to $88,360, and therefore reduced the maximum tax on his withdrawal from $32,854 to $24,560.

Please note making a large NCC would generally be considered a valid strategy where the member did it for reasons other than obtaining a tax benefit, such as to reduce their assessable assets for Centrelink purposes (see below). However, where the strategy involves making a large NCC and then immediately withdrawing the member’s entire balance, it may be deemed tax avoidance under the Part IVA provisions of the ITAA if the sole or dominant reason the member made the contribution was to obtain a tax benefit.

For example, if Bob changed his insurance arrangements by taking out a new life and TPD policy via an insurance-only super fund two years ago and then funded the premiums with concessional contributions instead of rollovers, his service period in the new fund would only be 730 days, instead of 12,819 days. As a result, if he took the $200,000 lump sum benefit from that fund and rolled over the remainder, the tax components of the $200,000 payment would be as follows (also see Table 3): Tax-free = $0 + 4349 4349 + 730

Insurance held in a separate newly established fund Arranging for insurance to be held separately in a newly established fund or account, such as within an insurance-only SMSF, can also assist to maximise the tax-free uplift as it minimises the days in the service period. However, this will only be effective where the member finances the insurance with contributions to that SMSF rather than with rollovers, as the fund holding the insurance would otherwise adopt the same service date as the rollover fund.

Withdrawing lump sums over time Where a member becomes permanently incapacitated, any benefits they hold within the accumulation phase are exempt for Centrelink means-testing purposes. Therefore it is a common strategy for these members to retain benefits within the accumulation phase to maximise any means-tested benefits, such as the disability support pension, and only withdraw lump sums as required.

However, in this situation it’s important

Table 3: Tax components and tax payable Tax component Tax-free

$171,254

Tax at 22% (max) $0

Taxable

$28,746

$6324

Amount

This would result in a tax saving of $26,530.

Please be aware this strategy could result in a higher untaxed element calculation, which could result in a larger proportion of any death benefit, which includes insurance proceeds, paid to a non-tax dependant being taxed at rates of up to 32 per cent.

Continued on next page

Where a member’s lump sum withdrawal also satisfies the definition of a disability superannuation benefit under the Income Tax Assessment Act 1997, a special formula can apply to uplift the amount of tax-free component included in the lump sum benefit payment.

Continued from previous page

to note the trustee cannot continue to rely on the original medical certificates to apply the tax-free uplift to all future lump sum payments.

For example, ATO Interpretive Decision 2015/19 confirmed a trustee could rely on the original medical certificates to apply the tax-fee uplift to a number of different lump sums payments as they were paid over a ‘short period of time’ (in this case November 2007 for the first and April 2008 for the last) and there was nothing to suggest the individual’s circumstances had changed in some relevant way.

Therefore, where a member retains their benefits in super, they need to be aware they may be required to obtain updated medical certificates to enable the tax-free uplift to be applied to future lump sum payments. This may not always be possible especially where the member has retrained and returned to work.

To avoid this situation, a member could

Table 4 Benefit amount

Tax-free component

Taxable component

$1.91m

$843,841 (44%)

$1,066,159 (56%)

Table 5 Age

Under 60

60 and over

Tax component

Tax-free

Taxable

Max tax rate

Tax-free

Included in assessable income and taxed at marginal rate.

consider rolling over their entire benefit to a different fund within a reasonable period as this would also constitute the payment of a lump sum for tax purposes. In this case, the trustee could then apply the tax-free uplift to the member’s entire benefit on rollover.

For example, if Bob made a $360,000 NCC to his SMSF prior to rolling over his entire balance, the tax components included in his rollover would be as in Table 4.

This would then effectively ensure Bob would get the benefit of the tax-free uplift applying to any future lump sums without needing to provide updated medical certificates at that time. This also shows the benefit of making a large NCC prior to rolling over, instead of making the NCC to the new fund. For example, in this situation, Bob’s tax-free component in the new fund would only have been $752,646, approximately $91,000 less.

Disability benefit income streams Where a member instead decides to commence a pension within the same fund due to becoming permanently incapacitated, their pension payments will be taxed as in Table 5.

However, where the pension payments qualify as disability super benefit payments

Tax-free

Taxable Tax-free

(see above), a member under age 60 will be entitled to a 15 per cent tax offset on the amount of taxable component included in the pension payments.

In this case it’s important to note the ATO has confirmed the tax-free uplift will not apply where a member uses their benefits to commence an account-based pension in the same fund, even where the pension payments would qualify as disability benefit payments. This is because the tax-free uplift only applies on the payment of a lump sum and commencing a pension within the same fund does not qualify as a lump sum payment.

However, as above, where a member under age 60 rolled over their benefits to a different fund, the rollover would qualify as a lump sum benefit payment for tax purposes and the tax-free uplift could apply. Where the member then provided the required medical certificates to the receiving fund for their pension payments to qualify as disability super benefit payments, the member would get the benefit of both the tax-free uplift applying to increase the tax-fee component of the pension payments, as well as a 15 per cent tax offset to reduce the tax on the taxable component included in the benefit payments.

QUARTER III 2024 49

COMPLIANCE

NALI not over yet

The government is likely to believe the recent passing of legislation regarding non-arm’s-length income and expenditure has effectively addressed this contentious issue. Mary Simmons outlines why additional examination and legal amendments are still required to achieve more optimal outcomes.

MARY SIMMONS is head of technical at the SMSF Association.

50 selfmanagedsuper

From the perspective of Treasury and the ATO, it’s fair to assume the recent passing of amendments to the non-arm’s-length income (NALI) rules has finally put our issues with the 2019 amendments to bed.

NALI and its bedfellow, non-arm’s-length expenditure (NALE), have been a bugbear of the SMSF sector since the NALE rules were introduced back in 2019, so the passing of the Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Bill 2023 surely is the end of the matter.

The end of the matter? The SMSF Association would beg to differ and so would our members. We are firmly of the view further changes are needed.

As our CEO, Peter Burgess, said at our recent Technical Summit: “I’m not sure these outstanding

issues remain unresolved in Treasury’s mind. Having addressed the issue of general expenses, it seems they have now moved on to other legislative priorities and getting them back to the table to discuss our unresolved issues with the NALE rules will be no easy task.”

In particular, applying NALI rules to specific fund expenses remains a vexed issue. How is it fair or equitable the entire capital gain from the sale of a property held for many years could be NALI simply because the trustee did not incur an expense on commercial terms for a minor renovation completed just before the property was sold?

Similarly, how is it possible the entire capital gain Continued on next page

In our view, a legislative change is required to enable trustees to remedy the undercharging of a specific asset expense in situations where the NALE was due to a genuine oversight or mistake.

Continued from previous page

from the sale of a property could be tainted as NALI simply because of an improvement completed on non-arm’s-length terms, regardless of its value or materiality? In many cases like this the value of the improvement has long since dissipated and is no longer reflected in the property’s value.

Another example of the harshness of the current law is where the trustees of an SMSF wholly in retirement phase are preparing to sell a property the fund has owned for 15 years to provide liquid funds to keep meeting pension liabilities, but make an error when doing so. Specifically, the member pays an unrelated contractor $500 to clean the property for open house inspections, but forgets to get reimbursed.

The $500 NALE can taint the entire net capital gain from the disposal of the asset.

So, if the net capital gain was $1 million, not only can the fund not claim exempt current pension income (ECPI), but tax of $450,000 may be triggered for the failure to pay a

$500 expense.

Of course, all these issues can be avoided by assuring all transactions occur on commercial arm’s-length terms. But what constitutes a commercial arm’s-length dealing is not always a straightforward concept, particularly when related parties are involved or inadvertent mistakes are made.

These issues, as well as others relating more generally to the application of the NALI rules to specific expenses, are now, at least for the SMSF Association, the new frontline in the ongoing battle to ensure the NALE provisions introduced in 2019 work appropriately for SMSFs and small Australian Prudential Regulation Authority (APRA) funds.

But before going into the details about what we believe is needed to fix these issues, we happily acknowledge the recent NALE law changes have given the industry much needed relief and certainty. And, after a gestation period approaching five years, so it should.

The recent amendment to the NALI rules removing the potential for NALE to be applied retrospectively is commendable.

Before this change was made it was possible for income received on or after 1 July 2018 to be taxed as NALI because of a transaction triggering the NALE provisions occurred before 1 July 2018.

Despite the bill predominately focusing on general expenses, from what we can ascertain this amendment also applies to specific fund expenses. It seems fair to assume a capital gain that has been impacted by a non-arm’s-length expense, other than an expense relating directly to the acquisition of an asset, incurred before 1 July 2018 would not be taxed as NALI if the asset were sold today.

With the NALE changes also came the finalisation of the ATO’s position on how the NALI provisions interact with the

capital gains tax (CGT) rules. The ATO’s recently released Taxation Determination (TD) 2024/5 only fuelled our call for a legislative fix that ensures fairness, prevents disproportionate outcomes and avoids the tainting of arm’s-length capital gains. This TD explains how the NALI and CGT rules interact in situations where a fund incurs an arm’s-length capital gain, a non-arm’s-length capital gain and a capital loss all in the same income year.

However, before we get stuck into the challenges, let’s first take a moment to acknowledge some of the positives in TD 2024/5. These include: • the amount of a capital gain that is classified as NALI cannot exceed the net capital gain for the fund for the income year, • when calculating net capital gains, NALI capital gains are eligible for the one-third CGT discount, • NALI capital gains are reduced by capital losses and carry-forward capital losses.

For example, if there are capital losses, the net capital gain can reduce to nil, which means there may be no NALI even if there has been a non-arm’s-length capital gain, and • the cost base of assets that trigger the non-arm’s-length rules can be increased by the market substitution rule, which, in essence, reduces the amount of NALI. For example, where an asset is acquired for less than market value, the market substitution rule applies to adopt a higher cost base when calculating CGT (noting the market value substitution rule doesn’t apply if proceeds are inflated).

So what changes are needed to ensure the 2019 NALI amendments work appropriately for SMSFs and small APRA funds? In our view, a legislative change is required to enable trustees to remedy the Continued on next page

QUARTER III 2024 51

COMPLIANCE

Table 1 TD calculation approach ($)

Proportionate approach ($)

Non-arm’s-length capital gain (72%)

1.3m

1.3m

Plus arm’s-length capital gain (28%)

500,000

N/A

Less capital loss

200,000

144,000

Less one-third CGT discount

533,333

385,295

Net NALI capital gain

$1,066,667

$770,705

Continued from previous page

gain. However, it’s our contention a proportionate approach could be considered where the NALI capital gain is calculated as a percentage of the fund’s total capital gain. This percentage would then be applied to the fund’s capital losses and the one-third CGT discount to determine the fund’s net NALI capital gain.

Table 1 provides a comparison of the two approaches. It assumes a fund receives a $1.3 million NALI capital gain, a $500,000 arm’s-length capital gain and incurs a $200,000 capital loss for the income year.

There are well-established examples contained within the taxation law that seek to apply a proportionate approach in a superannuation context. One example is the calculation of ECPI. This allows for the proportionate taxation treatment of both ordinary and statutory income.

The association recognises any legislative changes are a policy consideration and outside of the ATO’s remit. We would therefore encourage the regulator to engage with Treasury for an appropriate legislative solution.

Certainly we will be speaking with government and Treasury to advocate for a legislative amendment that will allow a proportionate approach to be applied both

undercharging of a specific asset expense in situations where the NALE was due to a genuine oversight or mistake.

We also believe a threshold-based approach should be considered for specific expenses so NALE below a certain dollar threshold or percentage of the market value of the asset is deemed not to taint all of the income or capital gains from that asset.

In other situations, the NALI capital gain could be determined by applying a proportionate approach rather than treating the entire capital gain as NALI. That is, the NALI capital gain could be determined by determining the proportion of the market value of the asset that comprises the capital expenditure not charged on commercial terms.

We also believe a proportional approach could be used to address many of our concerns with TD 2024/5.

The association acknowledges the ATO’s position, as set out in the TD, accords with how the legislation currently stands, adding the operation of the law is complex.

Under the TD, the amount of capital gains that is NALI cannot be greater than the SMSF’s overall net capital

52 selfmanagedsuper

How is it possible the entire capital gain from the sale of a property could be tainted as NALI simply because of an improvement completed on non-arm’s-length terms, regardless of its value or materiality?

when determining the capital gain and the net NALI capital gain in income years when the fund also receives an arm’s-length capital gain and incurs capital losses. This, in our view, will provide more appropriate outcomes while still achieving the desired policy objectives.

So while it’s disappointing Treasury did not tackle this issue considering they were in the process of amending the non-arm’slength provisions for general expenses, we are hopeful it will be just as receptive to the CGT issue as it was about the disproportionate tax treatment of general expenses.

And in the event we cannot get a law change, we will shift our focus to the ATO to advocate at a minimum for safe harbour provisions allowing trustees to rectify non-arm’s-length arrangements within a set timeframe without triggering the full application of NALI in relation to a specific asset.

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STRATEGY

The blended family challenge

The increasing number of blended families makes estate planning more of a challenge for SMSFs. Jemma Sanderson details some options available that can enable a satisfactory outcome.

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

54 selfmanagedsuper

With divorce being a constant statistic in Australia, including ‘grey’ divorces, those involving people over age 55, blended families will also continue to increase. As the population ages, the number of second and third marriages is likely to rise whether due to the death of a spouse or divorce.

When there are blended families in the mix, it can create some substantial challenges from an estate planning perspective where often it is the intention of the party with more wealth to want to look after their new spouse, but ensure assets are ultimately passed on for the benefit of their children. Further, it is also often the intention that the tax effectiveness of superannuation is also maintained to its utmost and that intention can taint the other priorities, which may be for certain beneficiaries to receive benefits.

Fundamentally it is of utmost importance to ascertain the estate planning intentions and who the client wants to benefit. That may end up not achieving the most tax-effective outcome, but the beneficiaries will be pleased they received 85 per

cent of something rather than 100 per cent of zero.

Blended finances When second, third and sometimes more marriages arise, it is often tempting for finances, and in particular superannuation, to be consolidated in an effort to: • manage the costs, • have a consistent investment approach, or even just an investment approach that isn’t the default option, • have one party remain in control of assets where they may employ a withdrawal and recontribution strategy to maximise the tax effectiveness, and • try and equalise for tax purposes resulting in two transfer balance caps and two bites at the Division 296 tax threshold.

It is quite straightforward, SuperStream notwithstanding, to consolidate benefits into an Continued on next page

Continued from previous page

SMSF, however, it is a lot more challenging and painful to extricate one member from a fund on death, divorce or dispute. It is also a substantial consideration to have the survivor potentially in control of a fund on death. If death benefit nominations are not valid and binding, then the outcome upon death could be akin to the Ioppolo v Conti case or Munro v Munro, where the surviving spouse had full control of the fund and was able to designate the superannuation benefits to themselves and where the children of the deceased received nothing.

Further, it is the author’s view segregated investment accounts in modern software programs are not efficient to run, and therefore where that is intended, it is often the same cost or cheaper to have a separate SMSF. The challenging times with these sorts of arrangements and consolidated superannuation come when there is a life event where the relevant person’s children may get involved, such as: • death, • imminent death, • disability/incapacity, • divorce, and • other disputes (including the pending divorce of a child).

Further, where there is a disparity between the wealth of the couple, it can lead to estate intentions that are challenging to implement without further complexity or to mitigate against an estate challenge.

Estate intentions Where the parents in a blended family die, it is not uncommon for the person with the higher level of wealth to express their intentions to look after their spouse with a regular income stream, while expressing:

• they do not want the capital to pass to the spouse, • they may not believe the spouse can manage the money, as they may not be financially savvy, • they want the capital to ultimately pass to their children, and • they don’t want the capital to pass to the survivor’s children.

Achieving the above is a challenge in an SMSF context because a regular income stream left behind for the survivor will have a capital sum underpinning it, raising issues such as to whom the capital sum belongs and whether the amount would form part of the survivor’s capital.

Further, it must be determined to whom the survivor can leave their superannuation benefits. Can previous stepchildren be eligible as Superannuation Industry (Supervision) Act dependants? ATO Interpretative Decision 2011/77 says they cannot.

Also, should the benefits be directed to the estate and in turn the survivor’s will, it must be assessed whether the instructions provide certainty for the family given the survivor could update their binding death benefit nomination to pay out their benefits to their own children. The will could also be contested by the survivor’s own children and in many states the previous stepchildren have a very limited ability to do so.

So, it may be tax-effective for the survivor to have in place an income stream within the fund, however, from an estate planning perspective this may result in substantial complexity, inflexibility and conflict.

Alternative strategies to consider In these scenarios, we can have blind spots when it comes to superannuation, as it is the most tax-effective vehicle in the country to provide a regular income. However,

Blended families introduce a lot of additional considerations, however, it is the estate planning objective/ intention that is the most important consideration. it may be that an alternative structure is more appropriate to consider to achieve the intentions, albeit not as tax effectively.

However, using a structure like this could also compromise other intentions.

Option one – leave some capital In this scenario, a level of capital would be left behind for the survivor designed to fund regular cash flow for them over the remainder of their life. It is their capital, they have control of it and therefore it would pass to their beneficiaries, and they would manage the money. The initial level of capital has some science behind the value in terms of a regular income stream for life expectancy, and then if the survivor dies early, the capital is available for their children. Conversely, if they live a long life, the amount may run out although it is up to them to manage the investments for that longer term.

The benefit of this scenario is that the children of the deceased are not waiting for the step-parent to die and can receive their inheritance at the time their parent dies, allowing them to move on with their lives. There could still be some assets that are intertwined, such as a life tenancy in the family home, however, by and large when we are looking at these matters, there is usually a reasonable pool of money

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Where there is a disparity between the wealth of the couple, it can lead to estate intentions that are challenging to implement without further complexity or to mitigate against an estate challenge.

Continued from previous page

that people are considering. Accordingly, leaving an amount of capital behind is palatable.

Further, it could be left in superannuation for the survivor, whether in a separate fund where the succession passes easily to the survivor or in the same fund where the amount is retained in the fund and the balance is paid out, leaving the survivor behind.

The author’s preference is the first option whereby a separate fund is set up for this purpose, with the succession of the fund having no involvement from the children.

The new fund will be established with assets that are due to pass to the children, limiting the likelihood of conflict.

The clear downside here is having capital left behind for the survivor and if they do not live for a long time, then their beneficiaries will receive these monies. However, given there is the intention of providing an income stream for the survivor for their life, then there is generally an acceptance

56 selfmanagedsuper

of this circumstance. Again, some science can be put behind how much to designate into this second fund and it can be adjusted each year with rollovers while everyone is still alive. It needs to be undertaken with the expectation the survivor will live into their dotage, and thus any calculation can factor in the exhaustion of the capital at life expectancy plus five years to be cautious.

Option two – discretionary trust where the kids inherit An alternative is to look at the regular income stream for the spouse provided in a structure external to superannuation, with capital left over then passing to the control of the children. The most efficient means to achieve this is through a discretionary inter-vivos trust where the structure is run for the benefit of the spouse over their lifetime.

Under the arrangement they would receive a designated annual income amount, which would be taxable to them, with the capital remaining within the trust. The children could be receiving the balance of any income above the designated income stream amount.

Upon the survivor’s death, the capital doesn’t have to be paid out, unless they are owed money by the trust, which isn’t likely given it could be managed via actual distributions matching the taxable distribution, and the children are the controllers and can fully benefit.

The benefit is if the survivor doesn’t live much longer than their partner, then a level of capital won’t pass to their beneficiaries.

However, there are other items to consider.

Firstly, succession and control are important to designate correctly, including instructions for the deceased children with respect to how the trust is to operate.

If there is likely to be conflict and those instructions will not be followed, perhaps an independent person will be required

to be involved in the trust until the survivor dies.

Secondly, ongoing interaction between the survivor and the deceased’s children may not be ideal, particularly if there is conflict regarding how the assets are to be invested.

Further, the strategy is not as tax-effective as superannuation for the survivor as income would be taxable.

And finally the family trust election provisions need to be reviewed in detail to ensure there is no risk of family trust distribution tax if the incorrect test individual is nominated. In this regard it may be appropriate for the trust to be set up and assets gifted prior to the passing of the first.

Option three – faith In this scenario, the wealthier member of the couple would leave their superannuation to their spouse, given it would be more tax-effective to do so, and then have faith they would disburse it appropriately.

The author would counsel against this course of action as it is very risky and it wouldn’t take much conflict or a disagreement for the whole scenario to be derailed just to save a bit of tax.

Summary The above is but a few scenarios to consider when having the conversations with clients in these situations. Blended families introduce a lot of additional considerations, however, it is the estate planning objective/ intention that is the most important consideration. If structuring can be undertaken that achieves the objective first and foremost and also has a taxeffective outcome, it would be worthwhile.

However, if tax savings are the primary concern, conflict could occur at a later date.

Who will have control is also paramount.

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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COMPLIANCE

The related-party loan labyrinth

Related-party loans are a complicated compliance area for SMSFs. Tim Miller examines some of the intricate details pertaining to these arrangements.

TIM MILLER is technical and education manager at Smarter SMSF.

SMSF trustees transact with related parties on a regular basis, but it is uncertain if they are aware of the restrictions and prohibitions attached to certain of these types of dealings and, by extension, the consequences of doing the wrong thing.

The ATO has released an annual SMSF statistical report every year since at least 2008/09, providing an update on the number and types of contraventions lodged each year. Loans and/or financial assistance using fund resources to members or relatives of members has consistently ranked as the number one breach committed by trustees and you only have to look at recent case law to appreciate financial assistance can take many forms, but more on that later.

It’s appropriate to understand what the law and the regulator have to say about loans and financial assistance.

The law Section 65 of the Superannuation Industry (Supervision) (SIS) Act prohibits super funds, including SMSFs, from providing financial assistance to members or their

relatives: “The trustee or an investment manager of a regulated superannuation fund must not: a. lend money of the fund to: i. a member of the fund, or ii. a relative of a member of the fund, or c. give any other financial assistance using the resources of the fund to: i. a member of the fund, or ii. a relative of a member of the fund.”

Related individuals For the purposes of this article, but perhaps also as a handy reference, members and relatives will herein be referred to as ‘related individuals’. This is an important distinction because a loan to a related party is considered an in-house asset under Part 8, section 71 of the SIS Act and therefore subject to a 5 per cent investment restriction. However, section 65 states nothing in Part 8 shall have any bearing on the prohibition. In other words, section 65 overrules section 71.

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Practical implications The effect of this restriction not only means SMSFs are unable to lend money to related individuals, but also related individuals cannot use fund assets without providing appropriate commercial consideration to the fund, such as paying commercial rent for the use of any direct property. In certain circumstances the use of fund assets by a member or relative will be strictly prohibited, such as collectables and personal-use assets.

An important reminder when dealing with any transaction, specifically when contemplating investment restrictions, is there are many restrictions and all legislative provisions must be reviewed when considering investment transactions, not just the obvious ones.

As an example, the use of SMSF fund assets by members or their relatives for no or reduced cost could be considered to be providing financial assistance to the related individual.

It may also cause the sole purpose test and/ or the in-house asset and/or the arm’s-length standards to be breached.

ATO rulings The ATO previously issued SMSF Ruling (SMSFR) 2008/1 on the application to SMSFs of the prohibition regarding giving financial assistance to members or relatives. The interpretation is extremely broad and, when determining if ‘financial assistance’ exists, can also extend to interposed third parties or entities, that is, indirect assistance. This is where the link between the in-house asset rules and those governing loans to members start to blur.

Example If a fund lends money to a related company, let’s say Super Investor Pty Ltd, this would appear on face value to be in accordance with the in-house asset requirements. If, however, Super Investor Pty Ltd then on lends the money to a related individual, then it is clearly in breach

Loans and/or financial assistance using fund resources to members or relatives of members has consistently ranked as the number one breach committed by trustees. of section 65.

SMSF trustees should ensure they are aware of ATO SMSFR 2008/1 to seek clarity on financial assistance, but should also use other ATO resources that contemplate whether a transaction could be in breach of section 65.

While not an exhaustive list, SMSFR 2009/4 provides the definition of a loan for in-house asset purpose, whereas Taxpayer Alert (TA) 2010/5 and SMSF Regulator’s Bulletin (SMSFRB) 2021/1 look at more nuanced scenarios, such as using unrelated trusts or providing financial assistance through property development.

SMSFR 2008/1 highlights In the ruling, the ATO sets out a number of transactions or arrangements it would and would not consider as providing financial assistance.

Transactions that the tax commissioner would consider to contravene the lending provisions are: i. giving a gift of an SMSF asset to a member or relative of a member, ii. selling an SMSF asset for less than its market value to a member or relative of a member, iii. purchasing an asset for greater than its market value from a member or relative of a member, iv. acquiring services in excess of what the

SMSF requires from a member or relative of a member, v. paying an inflated price for services acquired from a member or relative of a member, vi. forgiving a debt owed to the SMSF by a member or relative of a member, vii. releasing a member or relative of a member from a financial obligation owed to the SMSF, including where the amount is not yet due and payable, viii. delaying recovery action for a debt owed to the SMSF by a member or relative of a member, ix. satisfying, or taking on, a financial obligation of a member or relative of a member, x. giving a guarantee or an indemnity for the benefit of a member or relative of a member, and xi. giving a security or charge over SMSF assets for the benefit of a member or relative of a member.

Factors that assist in determining whether the law has been contravened include: • the arrangement or transaction exposes the SMSF to a credit risk or exposes the SMSF to a financial risk of a member or relative of a member, • the arrangement or transaction is on nonarm’s-length terms that are favourable to a member or relative of a member, • the arrangement or transaction is not a usual or normal commercial arrangement in the context in which SMSFs operate, • the arrangement or transaction is not consistent with the investment strategy of the SMSF, • under the arrangement or transaction an amount is paid by the SMSF, and later repaid to the SMSF, in amounts or in a manner that may be equated with the repayment of a loan whether with or without an interest component, and • the arrangement or transaction results in a diminution of the assets of the SMSF Continued on next page

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whether immediately or over a period of time.

Related parties At the centre of this problem is we are dealing with related parties and the definition of a related party requires consideration. A related party of a superannuation fund is defined in section 10(1) of the SIS Act as meaning any of the following: a. a member of the fund, b. a standard employer-sponsor of the fund, or c. a Part 8 associate of a member or a standard employer-sponsor of the fund.

For the most part what we are interested in here is the member and the associates of a member.

Part 8 associates Part 8 associates of an individual can be summarised as follows: • a company that is sufficiently influenced by the individual or the individual holds a majority voting interest in. This also includes companies influenced by other Part 8 associates of the individual, • a partner in partnership with the individual, including the spouse and or children of the partner, • a trust where the individual (or Part 8 associates of) hold a fixed entitlement to more than 50 per cent of the capital or income, have a sufficient influence or have the ability to remove or appoint the trustee or a majority of the trustees, and • a relative of the individual defined as a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of that individual or of his or her spouse, the spouse of that individual or of any other individual specified above.

It is the final element that consists of related individuals as identified earlier where problems arise for section 65, but of course it is loans to

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related entities as is allowed under the in-house asset rules that is creating confusion.

Legal history As mentioned earlier, there have been a number of court cases that have highlighted the different ways financial accommodation can be made. The following is not an in-depth analysis of each of these cases, but rather a means of identifying how some trustees have been held accountable for their actions.

Coronica and Commissioner of Taxation (Taxation) [2021] AATA 745 Coronica is an interesting case. The above reference is from the initial case that has subsequently led to further hearings largely focusing on an initial decision to disqualify the trustee, which has now been upheld.

At its core, Coronica represents the misguided use of a suspense account to record money owed to the fund by the member and money the fund owed to the member. The amounts were not trivial, nor was there any official documentation supporting the concept of any loan, interest or repayment terms.

Ultimately this was one among many facts that led to the fund being deemed non-complying and the trustee disqualified.

It should be noted Mr Coronica was an accountant and tax agent for over 50 years and was found to have created some quite unique interpretations of multiple ATO resources.

WZWK and Commissioner of Taxation (Taxation) [2023] AATA 872 WZWK also involves an accountant who not only lodged SMSF returns, but also audited them. Ultimately the trustee entered into numerous transactions that resulted in him paying himself a non-commutable income stream from age 47, releasing in excess of $800,000 from his fund prior to winding it up.

This was done under the guise of a condition of release linked to the cessation of employment, which was demonstrated through the case to have been a carefully crafted arrangement

An important reminder when dealing with any transaction, specifically when contemplating investment restrictions, is there are many restrictions and all legislative provisions must be reviewed when considering investment transactions, not just the obvious ones.

aimed at accessing super benefits early and ultimately providing financial assistance to the member.

Merchant and Commissioner of Taxation [2021] AATA 915 The final case, which has recently been the subject of a decision impact statement being released by the ATO, related to the trustee’s disqualification and subsequent reinstatement and regarded the acquisition of listed shares from a related party. Acquiring shares from a related party is allowable under section 66 of the SIS Act, however, in this instance, the share acquisition was entered into to create a $55 million loss in the member’s family trust, which was used to offset an $85 million gain, the net result being a considerable tax saving to the beneficiary of the trust, who of course was the SMSF member.

So as can be seen, there are many ways to obtain financial assistance other than just taking money out of a fund. The consequences for doing so can be diabolical, just ask Mr Merchant, Mr Coronica and Mr WZWK.

STRATEGY

Bigger isn’t always better

On face value, running an SMSF with a large asset balance is a good situation to be in. However, Grant Abbott points out this may not always be the case.

GRANT ABBOTT is director and founder of LightYear Docs.

Day one for SMSFs or, as they were called, excluded super funds was all the way back on 1 July 1994.

There were 70,000 on that first day and $10 billion in assets. Things moved slowly for a long time and they became a major super vehicle of choice for the baby boomer generation as the older guard had already retired and did not meet the contribution requirements of the day.

Moving forward, we find there were 210,000 SMSFs in 2000 with $76 billion in assets. Things gathered a lot of steam when the 2007 Simpler Super legislation introduced tax-free retirement savings for those over age 60. Taking an account-based pension where there was no tax in the fund on those pension assets and also getting tax-free income plus refundable franking credits was a honey pot for any person over 60. By 2015, what I consider the high point for SMSFs in terms of tax effectiveness, there

were 547,000 funds holding $603 billion in assets.

As at March 2024, there were 616,000 SMSFs, indicating a surprising jump of 22,000 funds in the nine months to that date and with asset holdings of $896 billion.

What does this all mean?

Well for starters, high net worth retirees have been accumulating large balances within their SMSFs, with some funds holding well over $2 million in assets and more. Now on the surface, a large SMSF appears to be a smart financial move as it means more assets under management, more control, the potential for greater returns and lower taxes.

However, beneath the surface, large SMSFs, particularly those with only one or two family Continued on next page

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members as trustee directors, are a ticking time bomb. While the opportunity to accumulate wealth within an SMSF is significant, so too are the risks. Lack of diversification, inadequate governance, continuous government tax changes, the taxation on unrealised capital gains, liquidity issues and family disputes are just a few of the dangers that can unravel years of careful planning.

This is a three-part series on the dangers of large SMSFs and by the end of it, I promise you will never look at large SMSFs in the same way again, but more importantly, you will start to adjust your strategies to minimise your clients’ and, as an adviser with strict liability under the Superannuation Industry (Supervision) (SIS) Act 1993, your liability.

Let’s first break down the distribution of SMSFs by asset size to give context to the magnitude of this issue.

SMSF assets – number of funds and size Recent data from the ATO reveals the distribution of SMSFs by asset size, showing a concentration of funds in the $1 million to $5 million range. How the numbers stack up is shown in Table 1.

Out of 600,000 SMSFs, 40 per cent of funds hold more than between $1 million and $2 million in assets, and 20 per cent of all funds have over $2 million under management. This concentration of wealth within a few hands, especially in familycontrolled funds with one or two trustees, brings several inherent risks.

The 10 dangers for large funds While managing a large SMSF might seem like a dream for control-minded investors, it is important to recognise bigger isn’t always better, especially if the fund is controlled by only one member. By that I mean the mum

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Table 1

0 to 50,000

Number of SMSFs 33,000

50,000 to 100,000

15,000

100,000 to 200,000

35,400

200,000 to 500,000

114,600

500,000 to 1 million

152,400

1 million to 2 million

132,000

2 million to 5 million

91,200

5 million to 10 million

19,800

10 million to 20 million

5400

20 million to 50 million

1200

Over 50 million

600

Asset range ($)

and dad funds, that is, the one and twomember funds making up 94 per cent of all SMSFs. In these funds generally only one of the members makes the investment decisions and runs it. This raises a number of potential issues.

1. Lack of diversity in decision-making When the decision-making power lies in the hands of one individual, there is an increased risk of narrow investment strategies. The absence of diverse opinions can lead to biased decisions that fail to consider all investment options, potentially hampering the fund’s performance. Over the past decade, with all asset prices rising, investing has been easy, but it is when markets fall that we see the merits of asset diversification.

2. Overconcentration of power In a small SMSF with one dominant trustee, the concentration of power can lead to issues where one person dominates the entire running of the fund. This lack of balance may result in poor decisions, especially if the dominant trustee does not have sufficient financial expertise.

Beneath the surface, large SMSFs, particularly those with only one or two family members as trustee directors, are a ticking time bomb.

While the opportunity to accumulate wealth within an SMSF is significant, so too are the risks.

3. Increased risk of mismanagement Large funds require diligent management to ensure compliance with SMSF regulations.

If a fund’s running is left to only one or two people, without proper knowledge or external guidance, important legal obligations can be overlooked, leading to mismanagement or inadvertent noncompliance that can result in severe penalties or losses.

4. Liquidity issues Large SMSFs with significant holdings in illiquid assets such as property may struggle to meet income stream obligations or fund members’ needs as pension valuation factors increase with age. With only one or two trustees, finding a solution for liquidity issues often results in forced asset sales at unfavourable times, leading to potential financial loss or worse still not satisfying minimum pension payment requirements.

5. Inadequate succession planning One of the most common oversights in small Continued on next page

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family-controlled SMSFs is the lack of proper succession planning. If a trustee passes away or becomes incapacitated, the remaining trustee may not have the skills, knowledge or resources to run the fund, leaving the SMSF vulnerable to mismanagement or forced winding up. Further, if the last member dies, the fund can face serious legal problems.

6. Running accumulation and pension accounts The larger the fund, the more chance that the trustee(s) is running accumulation and pension accounts for members. This is not an easy process and, to do it correctly, separate investment strategies should be used for either account as the accumulation account is for estate planning, while the pension account is for retirement income – two completely different objectives.

7. Vulnerability to family disputes Family-run SMSFs are highly susceptible to disputes, especially when there are only one or two trustees involved. Conflicts over investment decisions, contributions or benefit payments can lead to longerterm issues, including the breakdown of relationships and costly legal battles.

This can also be the case where there are blended families as fights can arise over who gets what and when.

8. Greater tax and compliance risks Large SMSFs are subject to strict tax rules and reporting requirements. Funds with one or two trustees may struggle to keep up with the complexities involved, resulting in inadvertent tax breaches or costly penalties, particularly as they get older. The larger the fund, the higher the stakes when errors occur and more often than not the accountant or auditor does not find out until it’s too late.

9. Higher audit and compliance costs Larger SMSFs often face greater scrutiny from auditors and regulators. The risk of an audit increases with the size of the fund and

the complexity of managing such a fund can lead to higher compliance costs. For trustees with limited resources or expertise, this can be a significant burden on the fund’s overall performance.

10. Is the fund an SMSF on death of the last member?

This is a complex and dangerous issue.

Where the last member of the fund passes away and is a director of the corporate trustee, can it be determined who will take over. We will look at the importance of the successor director solution for the executor of the will, but if there is no company involved, then when the trustee dies, their additional trustee pursuant to section 17A(2) of the SIS Act is no longer valid. Also, where the period of no trustee extends too far, there is a danger, under section 19 of the SIS Act, that the fund is unable to be regulated so all tax concessions are lost.

Additional issues to think about In the next instalment we are going to look at the death of the last member in detail and how the majority of accountants are unaware of the legal mechanics on death. To this end, we still see the preponderance of the use of binding death benefit nominations despite ongoing courtroom battles over them, which will intensify with the larger SMSFs.

So what are the big ones?

1. If both members have hit their pension maximums, how are you going to work out what to do and get the numbers right?

There can be significant tax consequences if a mistake is made, which is why we see many funds missing the one-year deadline for decision-making.

2. If the assets are going to be paid out on the death of the last member, where there is no reversionary to the pension, then capital gains tax is to be paid on the sale of assets and the non-tax dependent beneficiaries will be up for tax charged at 17 per cent. You could pay it to the estate

The larger the fund, the higher the stakes when errors occur and more often than not the accountant or auditor does not find out until it’s too late.

and reduce that to 15 per cent, but that results in exposure to the family provision trap.

3. Of course, the Division 296 tax on unrealised capital gains disaster is almost upon us.

Plus there is a lot more for us to unpack, build models for and get right.

In summary While large SMSFs with over $1 million or even $5 million in assets may seem like the ideal vehicle for maximising control and wealth-building, the reality is that size brings complexity and complexity brings risk. These risks are further exacerbated when only one or two family members are left in the fund.

And you cannot stop age and infirmity.

It is essential for trustees to recognise these dangers and take proactive steps to mitigate them. Whether through seeking professional SMSF advice, establishing robust governance frameworks or creating clear succession plans, trustees must ensure they are not only growing their wealth, but also protecting it for the long term.

In the end, the true value of an SMSF is not just in its size, but in how well it is managed, safeguarded and passed down through generations.

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COMPLIANCE

A defining case for SMSF structure Daniel Butler revisits a watershed court case and the learnings it provided the SMSF sector.

DANIEL BUTLER is director of DBA Lawyers.

The prudence of employing a corporate trustee rather than individual trustees was noted shortly after the Katz v Grossman decision was handed down in late 2005. It remains relevant today and is a great war story for advisers.

Indeed, there have been a great number of cases that have since added to our understanding in death benefit disputes, including Wooster v Morris [2013] VSC 594 and Wareham v Marsella [2020] VSCA 92.

But in this article we revisit the Katz v Grossman case to reinforce some key points.

On 19 September 2003, Ervin died. Probate was not obtained until 5 August 2004 (probate was granted to his son and his daughter, that is, the plaintiff and the defendant).

Shortly after Ervin’s death, Linda appointed her husband, Peter Grossman, as trustee of the SMSF on 5 December 2003. Subsequently, Linda refused to follow her late father’s non-binding nomination that expressed his wishes to have an equal sharing of his superannuation benefits between her and her brother, Daniel.

The decision Facts This case involved a dispute between a brother, Daniel Katz, and a sister, Linda Grossman, over who technically were the trustees and members of their deceased parents’ SMSF and therefore who had control over their dead father’s $1 million-plus benefits.

The father, Ervin Katz, and the mother, Evelin Katz, were the trustees and members of the fund.

After his wife’s death, Ervin appointed Linda as the other trustee of the SMSF on 18 March 1999, relying on the powers conferred upon him by the Trustee Act 1925 (NSW). Section 6(4) of this piece of legislation provides: The appointment may be made by the following persons, namely: a. by the person or persons nominated for the purpose of appointing new trustees by the instrument, if any, creating the trust, or b. if there is no such person, or no such person able and willing to act, then by the surviving or continuing trustees or trustee for the time being, or by the legal representative of the last surviving or continuing trustee.

The equivalent Victorian provision is section 41(1) of the Trustee Act 1958 (Vic).

On 30 August 2003, Linda completed an application form for admission as a member of the fund, which was also signed by her as trustee.

Was Linda a trustee?

The court held Linda had been validly appointed as a trustee.

Daniel had argued Linda had not been validly appointed in 1999 as Ervin did not have the authority to do so because: • Ervin and the estate of Evelin (that is, the majority of members – the court accepted that under the current deed, membership does not cease upon death) should have appointed the new trustee under the deed, and • there was no power for the continuing trustee, Ervin, to appoint under section 6(4)(b) of the NSW Trustee Act because that provision only comes into force where the people mentioned by the trust instrument, that is ,the majority of members, did not exist.

The court rejected Daniel’s arguments because since it took so long for Evelin’s probate to be obtained, it can be said “there is no person having the power ... who is able and willing [sic] to act”.

Therefore, section 6(4)(b) of the NSW Trustee Act applied and the continuing trustee, that is, Ervin, did have the power to appoint Linda.

Is Linda a member?

The court held Linda was not a member because she failed to comply with the deed. The deed Continued on next page

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This was a costly case that could have easily been avoided. A brother and sister will probably never speak again.

Further, most of the legal costs of both sides were paid by the SMSF.

of the SMSF. However, because Daniel and Linda were also the executors of Ervin’s estate, it was “doubtful” whether they would have agreed upon an appointment. Accordingly, for the purposes of section 6(4)(a) of the NSW Trustee Act, the person to whom the instrument gave power to appoint, that is, the executors of Ervin’s estate, were not ready and willing. Therefore, section 6(4)(b) came into force a second time. As a result it was determined the surviving trustee, Linda, had the power to appoint a co-trustee, which she did when she appointed her husband to this role.

Conclusions

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stipulates the trustees determine membership: Linda’s application had only been signed by one of the two trustees and there was no evidence of her father’s consent. Moreover, there was no evidence of the trustees delegating to Linda the power to admit a member.

It is interesting to note the original 1965 deed stated membership ceased on death. However, the 1995 deed referred to a ‘deceased member’ and the court therefore decided the deceased member’s estate remained a member until the death benefit had been paid.

Is Linda’s husband a trustee?

The court held Linda’s husband was validly appointed as co-trustee of the SMSF. This was because, upon Ervin’s death, his estate was the sole member

This case highlights: 1. The importance of following correct legal procedure. When disputes arise, usually upon death, divorce or ATO audit, aggrieved parties are always quick to find flaws in prior documents. Documents prepared by many suppliers, such as those online especially where the prior document trail is not reviewed, may not stand up to close scrutiny.

2. The person who prepares the documentation must have an in-depth knowledge of all the relevant laws.

Superannuation law, general trust law and succession law were all vital to this case. The ability to appoint the co-trustee, on two separate occasions, relied on the NSW Trustee Act and not the express provisions of the fund’s trust deed.

3. The succession to the trustee of an SMSF is vital. If the two children had been appointed members of the fund, they would have become the

When disputes arise, usually upon death, divorce or AT O audit, aggrieved parties are always quick to find flaws in prior documents. successor trustees. Allowing one child to be a co-trustee in this case provided control over the deceased father’s death benefit.

4. The importance of a binding death benefit nomination. If Ervin had implemented a binding death benefit nomination, this whole case could have been avoided. This is because the case arose from Linda refusing to give effect to Ervin’s non-binding request that his death benefit be shared equally between Linda and Daniel.

This was a costly case that could have easily been avoided. A brother and sister will probably never speak again. Further, most of the legal costs of both sides were paid by the SMSF. We therefore recommend SMSF documentation, including deeds, change of trustee, admission of member, binding death benefit nominations and pension documentation, be prepared by lawyers with relevant practical and technical skills. In our opinion, quality documents provide much greater value over the longer term and end up costing less.

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COMPLIANCE

SMSF compliance overreach

Close to three years ago, design and distribution obligations were introduced to the financial services industry. Michael Hallinan makes an argument as to why they should not apply to SMSFs.

MICHAEL HALLINAN is superannuation special counsel at SuperCentral.

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The Australian Securities and Investments Commission (ASIC) introduced the Design and Distribution (D&D) Regime in 2021. Given the obligations are a significant compliance responsibility with noticeable penalties attached, it is important to consider whether there is a legal basis as to whether they should apply to superannuation products issued by SMSFs. The critical element of the D&D Regime is the ‘target market’ for the superannuation products of the issuing entity. In the case of SMSFs, the target market will usually be one or two people and at most six individuals. Does a market of this size justify the D&D Regime applying to SMSFs? Certainly not.

In November 2014, the Financial System Inquiry, also known as the FSI or Murray review, recommended D&D obligations apply to financial products. Such requirements are present in the European Union (Markets in Financial Instruments directive 2 or MiFID 11).

The FSI considered the current disclosure model for financial products at the time, disclosure without any assessment by the issuer of the product of the suitability of the product to the investor, was not effective and had not prevented the mis-selling of financial products.

The government adopted the recommendation of the FSI and enacted by the Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019. Additionally, there were various amendments to the Corporations Regulations (made by Corporations Amendment (Design and

Distribution Obligations) Regulations 2019, as well as Regulatory Guide 274 issued by ASIC. The legislative basis for the D&D Regime is Part 7.8A of the Corporations Act and specifically section 994A to 994Q. The D&D Regime applies to financial products issued on or after 5 October 2021.

Regime application The D&D Regime applies to issuers and distributors of eligible financial products. In the context of superannuation products, the issuer will be the trustee of the relevant super fund. While superannuation products of Australian Prudential Regulation Authority (APRA)-regulated funds (apart from small APRA funds) may have distributors, this is not necessarily the case with an SMSF. If there is any marketing, then it would be done by the trustee of the SMSF. With reference to the design component of the obligation, product issuers are required to design financial products such that the features of the product are likely to be consistent with the likely objectives, financial situation and needs of investors for whom the products are intended – the target market.

The distribution obligation requires issuers and distributors to ensure financial products are distributed only to the investors within the target market.

Common to both elements is the concept of a target Continued on next page

In the case of SMSFs, the target market will usually be one or two people and at most six individuals. Does a market of this size justify the D&D Regime applying to SMSFs? Certainly not.

Continued from previous page

market. In the context of a superannuation fund, the trustee must determine the target market for which the super product is intended; that is, the class or classes of investors for whom the superannuation product will, in general, be suitable. The specification of the target market must be in writing and this specification, called a target market determination (TMD), must satisfy certain legislative requirements.

The legal obligation upon a superannuation trustee under section 994B(1) of the Corporations Act is to make a TMD before any person engages in “retail product distribution conduct” in relation to a financial product (Corporations Act section 994B(2)) which is the subject of the determination.

Such conduct includes a dealing in the superannuation product (for example, applying for a super product or issuing such a product) or issuing a product disclosure statement (PDS) for the product.

What is the product?

In the context of SMSFs, what is the superannuation product? Unlike APRAregulated super funds, SMSFs generally only have one class of members. Once an individual is admitted as a member, the trustee will accept contributions made by or on behalf of the member, the trustee will apply those contributions mixed with other

contributions into one or more investment pools and the member will be paid the member’s proportionate share of the invested pool or pools as benefits upon specified events conditions. Once the member satisfies an unrestricted access condition, the member may then elect to access their proportionate share of the investment pool or pools either as a lump sum or as an income stream.

In general, SMSFs issue two types of superannuation products – an accumulation product and account-style income stream products. Given the same contribution rules, benefit access rules and income stream rules apply to all SMSFs, the accumulation products and income stream products are highly regulated in products design and have the same or very similar features.

The differences that holders of SMSF accumulation product experience will usually be attributable to the amount, frequency and timing of contributions, investment performance and cost control. Similarly, the differences holders of SMSF income stream products experience will usually be attributable to the drawdown rate, investment performance and cost control.

The target marked determination The TMD is a written determination in respect of a financial product that specifies the class of retail investors (all super investors are retail investors) for whom the financial product will, in general, be suitable. This determination must be prepared by the SMSF trustee as the issuer of the superannuation products.

For each type of superannuation product issued by the SMSF, the trustee must prepare a written TMD. Given most SMSFs issue only two types of superannuation products – accumulation and income stream – then the trustee would have to prepare two TMDs. If the SMSF issues various types of income streams, then possibly a separate TMD may be required for each type of income stream.

The content of a TMD is set out in section 944B(5) of the Corporations Act and includes: • a description of the class of retail clients that comprises the target market, • the specification of the conditions and

restrictions on retail product distribution, • the specification of events or circumstances (triggers) that would (reasonably) suggest the determination is no longer appropriate, and • specification of the maximum period before the first review of the TMD and subsequent reviews.

Additionally, the TMD must set out the distribution conditions of the financial product which is the subject of the determination and those distribution conditions must be drafted so if the product was issued to a retail client in accordance with the distribution conditions, it could be readily determined whether the retail client is in the target market or not and whether the product would be likely to be consistent with the probable objectives, financial situation and needs of the retail client.

Once a TMD has been prepared, the person who made the determination must ensure the determination is available to the public free of charge. This publication requirement also applies to superseded determinations.

Can TMDs sensibly apply to SMSFs? The essence of a TMD is the target market for the superannuation product. Is there a market for a particular SMSF? In the case of a single-member SMSF – no. In the case of multimember SMSFs – at best the target market would be the spouse and children of the person establishing the SMSF or the existing members of the fund.

Given the maximum member rule of SMSFs, six individuals hardly constitutes a market or even a section of a market.

Additionally, individuals become members of an SMSF because of personal invitations issued by the trustee and not by way of a standing invitation to the public or a section of the public. Finally, with most SMSFs, once the fund has the intended members, the trustee will effectively cease to offer new superannuation products of the SMSF. The content, distribution and publication requirements of TMDs are all suitable for openContinued on next page

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COMPLIANCE

Continued from previous page

ended superannuation products issued to the public or a section of the public. They have no sensible application to SMSFs and if they did apply, would provide no consumer outcome to the members of the SMSF to justify the regulatory burden on the trustees, the cost of which would be borne by the members (let alone the poor regulators, which would have to review many thousands of TMDs).

Unfortunately, there is no principle of law that the stupidity of the regulatory regime is justification for non-compliance.

Consequently, there must be a legally principled reason for the non-application of the D&D Regime to SMSFs. Justification for non-application to SMSFs There seem, apart from the non-application from stupidity argument, to be five possible arguments that could be used to justify the non-application.

First, SMSFs could fall within an express exception to the application of the regime. Some exceptions are provided by section 994B(3) of the Corporations Act and Corporations Regulation 7.8A.20.

Unfortunately, SMSF accumulation and account-style income stream products are not within the scope of those provisions.

Second, could a trustee apply to ASIC to request the exercise of the exemptions and modifications power contained in section 994L of the Corporations Act? Yes. However, such an application must be reasoned and address the various issues raised in Regulatory Guide 51.

Third, the SMSF trustee could, after the initial members have been admitted, close the fund to further members. This would avoid issuing further superannuation products and thereby avoid the trigger event for the requirement to have a TMD. The initial members, the individuals who become members by reason of the establishment of the SMSF, would not normally be treated as having been issued a superannuation

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product. However, this approach may not adequately deal with the issue of income stream superannuation products to the initial members.

Fourth, the D&D Regime only applies to the superannuation products of an SMSF if the fund trustee is required to prepare a PDS in relation to the product. While section 1012D(2A) of the Corporations Act exempts an SMSF trustee from the requirement to issue a PDS, it is only a conditional exemption and not absolute. Must the exemption from the requirement to issue a PDS be absolute or is a merely conditional exemption sufficient?

The relevant condition is the trustee believes, on reasonable grounds, that the retail client has access to all the information that would be required to be contained in a PDS for the product and that the client knows they have such access. The critical issue is how the trustee is to have a reasonable basis for the belief as to the state of knowledge of a particular client without relying on a PDS in relation to the relevant superannuation interest having been issued to the client or the client having received a statement of advice containing that information. The PDS must be prepared and issued by the trustee, or on behalf of the trustee, of the super fund. As the mere issue of a PDS constitutes retail product distribution conduct, the trustee is required to have a TMD in place prior to the issue of the PDS. To require a statement of advice to be given to a retail client, for example, the spouse or child of the initial member or members, as a precondition for admission is unnecessarily burdensome.

The fifth argument is that the infrequency of an SMSF trustee issuing financial products means the trustee is not in the business of issuing financial products and, as Part 7.9 of the Corporations Act only applies to financial products issued in the course of such a business, then Part 7.9 does not apply to financial products issued by SMSFs. While this argument is good so far it goes, it is shipwrecked on the deeming provided by Corporations Act section 1010B(2), which is

SMSF trustees are in a most unsatisfactory position. It would be far better to have an absolute exclusion of SMSF superannuation products from the T MD requirements than to rely on the application of the conditional exemption from the PDS. to the effect the issue of any ‘superannuation product’ is taken to occur in the course of a business of issuing financial products.

Could SMSFs have a TMD? Clearly yes. However, the TMD would be very anodyne and fall far short of the intended function of being another means of preventing mis-selling of superannuation products. If a TMD was required for SMSF superannuation products, then undoubtedly they could be drafted and would satisfy the content requirements. The target market would, presumably, be children and possibly other relatives of the initial member or initial members. But this would at best be performative compliance.

To conclude SMSF trustees are in a most unsatisfactory position. It would be far better to have an absolute exclusion of SMSF superannuation products from the TMD requirements than to rely on the application of the conditional exemption from the PDS. It is not the current industry practice for SMSFs to have TMDs and ASIC, as the regulator, is not devoting regulatory resources to the matter. The absolute exclusion could be achieved by ASIC exercising the exemption and modification power or better still by regulation.

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SUPER EVENTS

SMSF Association Technical Summit 2024

The SMSF Association Technical Summit 2024 was held in Sydney this year.

Around 300 specialist advisers attended the event.

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1: Peter Burgess (SMSF Association). 2: Jemma Sanderson (Cooper Partners). 3: Bryce Figot (DBA Lawyers).

4: Shelley Banton (ASF Audits). 5: Craig Day (Colonial First State). 6: Conference delegates.

7: Tim Miller (Smarter SMSF) 8: Louise Biti (Aged Care Steps). 9: Linda Bruce (Colonial First State).

10: Scott Hay-Bartlem (Cooper Grace Ward) 11: Melanie Dunn (Accurium). 12: Conference delegates

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“ 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