December 2020 - Practical Systems Super

SMSF asset compliance considerations

Dec 17,2020 Comments Off

Investing in certain asset classes or implementing particular structures to do so can result in additional compliance issues for SMSFs. Mark Ellem, head of education at Accurium, identifies areas where trustees will need to pay extra attention.

When an SMSF considers acquiring an asset or making a new investment, there are several compliance rules and issues that need to be considered at the time of acquisition. For example:

whether the asset can be acquired from a related party,
does it fit within the fund’s investment strategy,
will the investment be regarded as an in-house asset,
does the acquisition meet the sole purchase test, and
is the acquisition or investment permitted under the trust deed.

In addition to these considerations at the time of acquisition, the ongoing and potential future compliance and audit requirements should also be factored in when the trustees are weighing up whether a particular investment is one the SMSF should be making. SMSFs can have additional layers of compliance when compared to using other non-super structures when acquiring and holding an asset. These ongoing compliance requirements, potential costs and hurdles should be understood by SMSF trustees prior to purchase.

Let’s consider what these issues are for various types of commonly held SMSF assets.

Real estate

One of the most popular asset types held by an SMSF is real estate, which presents several ongoing compliance issues that SMSF trustees need to be aware of. A few of these are discussed below.

• Year-end market value – The market value of real estate held by an SMSF must be considered by the trustee(s) each and every 30 June. SMSF trustees need to be aware of the potential ongoing costs associated with determining and substantiating market value for real estate. Potential costs include the expense of obtaining an independent valuation or other forms of market-value evidence and additional administration and audit costs for an SMSF owning real estate. The ATO has recently released guidance on the evidence trustees need to provide their auditor to substantiate the market value used in the fund’s financial statements (search QC 64053 on the ATO’s website).

• Leasing real estate to a related party – Where the property is leased to a related party, trustees must ensure it continues to meet the definition of business real property (BRP). There should be an examination of the lease agreement to ensure the terms are being adhered to, including any review of the market of rents and that the rental agreement has not expired. In addition to the initial costs to draft and execute a lease, there would be ongoing costs to extend, renew and vary it. This may include the cost of obtaining an independent assessment of market rental value. Variation to a lease may also be caused by unexpected market conditions, for example, the COVID-19 rent relief measures.

• Residential property – Where the property is residential, the SMSF auditor may require evidence it has not been used by a fund member, relative or related party. This could be brought into question where the property is situated in a popular holiday destination and is rented out as holiday rental accommodation. An SMSF auditor may require the trustee(s) to provide evidence the property has not been used by a related party and that this is provided at each annual audit.

• Charges over the property – The SMSF auditor may wish to conduct a search each audit year to ensure the property has not been used to secure any borrowings, unless permitted. This may incur additional costs for the SMSF.

• Investment strategy – It is not uncommon for an SMSF holding real estate to have no other assets, apart from its bank account. The ATO and SMSF auditors have a focus on funds with single-asset investment strategies to ensure compliance with the requirements under the Superannuation Industry (Supervision) (SIS) Act 1993. SMSF trustees need to be prepared to dedicate time to ensure the investment strategy will stand up to audit scrutiny.

• LRBAs – Real estate held via a limited recourse borrowing arrangement (LRBA) is subject to certain SIS requirements. For example, the property cannot be developed. SMSF trustees need to be mindful of the limitations and restrictions of property purchased using an LRBA.

Units in a non-related unit trust

A common scenario is where two or more unrelated SMSFs hold units in a unit trust and that unit trust acquires an asset, typically real estate. In these cases, each SMSF must not hold more than 50 per cent of the issued units in the unit trust. This, together with other requirements, ensures the SMSF’s investment is not treated as an in-house asset.

• Ongoing assessment of relationships – In addition to an initial assessment to ensure a unit trust is not a related trust of each of the SMSF unitholders, there will be a requirement for an ongoing annual assessment to ensure this remains the case. This would include determining whether there has been any change in circumstances that makes members from different SMSFs related parties. For example, a member from each fund jointly acquiring a rental property together or children of members from each SMSF getting married to each other may mean they become related parties. The trustee should not be surprised if their auditor reviews the structure each and every year.

SMSFs can have additional layers of compliance when compared to using other non-super structures when acquiring and holding an asset.

• Exit plan – It is important when this type of structure is entered into that the SMSF trustees are aware of the potential issues when one of the SMSF unitholders wants to dispose of their units in the unit trust. The assessment of whether the investment is caught by the in-house asset rules is examined from the perspective of each SMSF unitholder. A unit trust may be a related trust to one of the SMSF unitholders, but not another SMSF unitholder. For example, a unit trust is set up with three unrelated SMSF unitholders, SMSF A, SMSF B and SMSF C, each holding one-third of the issued units. SMSF C unitholder wants out and SMSF A offers to buy the units at market value. From a practical perspective, this achieves the desired outcome. However, there is now a significant compliance issue for SMSF A as it now holds two-thirds of the units in the unit trust. As SMSF A now holds more than 50 per cent of the issued units, the unit trust is a related trust of SMSF A and caught by the in-house asset rules. From SMSF B’s perspective, it still holds units that represent less than 50 per cent of the issued units and so the unit trust is not a related trust of SMSF B. Assuming SMSF A’s unitholding value represents more than 5 per cent of the total value of its assets, it will be required to dispose of the excess in-house asset amount by the following 30 June. This may cause issues, particularly where the asset held by the unit trust is the business premises of the business operated by members from one or more of the SMSFs. SMSF trustees in this type of non-related unit trust structure need to have an exit plan prior to executing the acquisition to deal with unitholders wanting to dispose of their interest, either voluntarily or involuntarily, such as when a member passes away.

• Market value – As with real estate, SMSF trustees who hold units in a unit trust, or any other unlisted entity, will be required to determine and substantiate the market value each and every 30 June.

Division 13.3A unit trusts

Another common scenario is where an SMSF acquires an asset via an interposed unit trust that complies with SIS regulation 13.22C in Division 13.3A, commonly referred to as a non-geared unit trust. This type of structure can be used where the SMSF is the sole unitholder or where the fund and a related party are the unitholders. While the unit trust is prima facie a related trust of the SMSF, the SIS provisions exempt the units from being treated as an in-house asset, provided it complies with the requirements of SIS regulation 13.22C.

One of the most popular asset types held by an SMSF is real estate, which presents several ongoing compliance issues that SMSF trustees need to be aware of.

• Checklist of prohibited events – SMSF trustees need to be aware of the consequences where certain events occur after the structure has been established. These events are commonly referred to as 13.22D events and will cause the unit trust to be forever tainted as an in-house asset. A 13.22D event can occur simply through the SMSF buying listed shares with surplus cash. Rectification can be a challenge, as well as costly. The fund auditor will need to assess, during each annual audit, that there have been no 13.22D events.

Overseas assets

Two issues that arise where SMSFs acquire assets overseas, particularly direct assets such as real estate, are ownership and market value. Often local laws prohibit the asset being held by the SMSF and an interposed entity is required to hold the asset as a custodian or nominee, resulting in additional costs. Without relevant documentation, substantiating asset ownership can be a challenge.

Market value is also a challenge and may require engaging a local valuer to provide a market-value report. Again, this may be more expensive than arranging a valuation of a property situated in Australia.

• Language used – Where documents are not in English, translation costs may be incurred so that the accountant and auditor can understand them.

• Foreign currency translation – Where a transaction in relation to the overseas asset is in a foreign currency, there may be additional accounting and compliance costs associated with converting the amounts into Australian dollars and dealing with the related income tax consequences. Further, the SMSF may have an obligation to lodge local foreign jurisdiction returns and pay taxes. Generally, the administration and compliance costs associated with an SMSF owning an overseas asset, such as real estate, will be higher than where the asset is situated in Australia.

Collectables and personal-use assets

The rules for an SMSF owning these types of assets are very prescriptive and are generally seen as a back-door prohibition on SMSFs holding such assets. Commonly, when SMSF trustees are made aware of the ongoing compliance requirements of these types of assets, they decide to acquire the asset outside of their fund.

Forewarned is forearmed

Advice at the time an SMSF acquires an asset, or makes an investment, is important to ensure the superannuation rules are followed, but such advice should not end there. Where SMSF trustees have the knowledge and understanding of the ongoing compliance requirements for different types of asset classes, preparation of the annual financial statements and performance of the annual independent audit can run a lot smoother. It also prompts forward planning to deal with potential future events. In fact, it may even lead to the SMSF trustees deciding not to acquire the asset or make the investment. Educating trustees on these and other asset-type issues can reduce the risk of compliance matters or simply lessen the level of annual audit angst for trustees, their accountants and even the auditor.

Source: smsmagazine.com.au

Can an SMSF claim this as a deduction?

Dec 16,2020 Comments Off

SMSF auditors have been witness to some outlandish expense claims and get frequently asked: “Can an SMSF claim this as a deduction?”

One of the most extraordinary claims was for the cost of a 20,000-litre water tank purchased for a property owned by the fund. Unfortunately, it was a small two-bedroom townhouse that couldn’t accommodate a 1,000-litre tank, let alone a 20,000-litre one.

And while it was purely coincidental that the trustee’s residential address was in a rural area, the expense was quickly identified as a mistake and promptly removed from the fund.

The current COVID-19 crisis has only highlighted more uncertainty, with a recent private binding ruling (PBR) providing additional insight into allowable deductions for SMSF expenses claimed by trustees.

The ATO has said that while PBRs cannot be relied upon by taxpayers, this particular ruling applies to the 2021 financial year where the fund attempted to claim a deduction for the costs of a course and subscription for share trading.

Nature of expenses

The general nature of a deductible expense extends to whether it relates to assessable income or not. Where an expense relates to the gaining of non-accessible income (such as exempt current pension income [ECPI]) or when it’s capital in nature means that it is non-deductible.

It is also essential to make sure that the expense is in line with the assets and investments outlined in the fund’s investment strategy and also allowed under the trust deed and SIS.

Paragraph 4 of TR 93/17 states that subject to any apportionment of expenditure, the following expenses are deductible:

Actuarial costs
Accountancy fees
Audit fees
Costs of complying with SIS (unless the cost is a capital expense)
Trustee fees and premiums for an indemnity insurance policy
Costs in connection with the calculation and payment of benefits to members
Investment and adviser fees and costs
Subscriptions for memberships paid by a fund to industry bodies
Other administrative costs incurred in managing the fund

General deductions

There is even more confusion about general deductions, which get classified in this way when a specific deduction provision is absent.

These types of deductions are subject to exclusions that include:

Whether it is incurred in gaining or producing assessable income
Whether it is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income

According to the ATO website, expenses that fall under this category (unless a specific deduction provision applies) include:

Management and administration fees
Audit fees
Subscriptions and attending seminars
Ongoing investment-related expenses

Several other exclusions also apply in understanding whether a general deduction is allowable. An SMSF cannot deduct a loss or outgoing to the extent that it is a loss or outgoing of capital (or of a capital nature) or private or domestic nature.

Some income tax laws also prevent the fund from deducting an expense as well as where the fund produces non-assessable income, such as ECPI.

Additionally, a fund cannot claim more than one deduction for the same expenditure and can only claim under the most appropriate tax provision for the expense.

Investment-related expenses

A very well-debated question within the SMSF industry is whether investment-related expenses are deductible or not.

The answer is that it’s the exact nature of these expenses which is critical in determining deductibility.

The focus of the PBR was whether an SMSF could claim a deduction for the reimbursement of the costs of a course and subscriptions for share trading purposes under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997).

The answer from the ATO was a resounding no.

One of the reasons is that subsection 295-85(2) of the ITAA 1997 operates to modify the operation of ordinary income and general deduction provisions so that the CGT rules are the primary code for calculating gains or losses realised by a complying SMSF on the disposal of CGT assets.

The exception to this treatment includes CGT assets that are debentures, bonds, bills of exchanges, certificates of entitlement, promissory notes, deposits with a bank or other financial institution, or a loan.

While there is also an exception for trading stock, shares and derivatives of shares are not trading stock because they are covered assets under section 275-105 of the ITAA 1997.

Courses and subscriptions not deductible

Any gains made by an SMSF trading in shares will be assessable under the CGT provisions, and any expenditure regarding courses or subscriptions is capital in nature.

The costs incurred for the course and the subscriptions relate to specific activities that will only generate capital gains and not ordinary income and are therefore not deductible.

Additionally, they have not been incurred in the administration, operation or management of the SMSF and are not of the type as referenced in paragraph 4 of TR 93/17.

In particular, the PBR noted that the subscriptions were not for memberships to the Association of Superannuation Fund of Australia Limited and other such industry bodies.

Based on the information provided, the expenses were not incidental, relevant or sufficiently linked to any of the fund’s trading activities.

Seminar-type expenses may also not be deductible if the expenditure does not have a sufficient connection with assessable income and is an investment of capital made to prepare for the future commencement of an investment business as found in Petrovic and FCT (2005) 59 ATR 1052, [2005] AATA 416.

In this case, the taxpayer was denied a deduction in respect of property seminars after it was found that the expenditure was not incidental to his pre-existing rental income.

Conclusion

Apart from depreciating assets, SMSFs should be claiming fund expenses in the year the trustee incurs them. From a compliance point of view, it is also best practice to have all invoices in the name of the SMSF and to pay them directly from the fund’s bank account.

Where the fund incurs expenses specifically relating to assets that generate capital gains or losses, a deduction cannot be claimed under section 51AAA of the ITAA 1936.

To this extent, the latest PBR makes it clear that trustees are unable to claim a deduction for the costs of courses and subscriptions that relate to share trading activities which are capital in nature.

Which means that the answer is no, an SMSF can’t claim this as a deduction.

Shelley Banton, head of education, ASF Audits
Source: SMSF Adviser

Analysis of SMSF running costs

Dec 8,2020 Comments Off

Further analysis of the running costs of an SMSF has found they can be run for less than $3000 a year at an average cost of 1.34 per cent a year for a $200,000 fund and 0.5 per cent for a $500,000 fund.

The figures were calculated by mSmart, a fintech firm that produces retirement planning models and apps, and given to the House Economics Committee in August, following the recent release of the SMSF Association’s research on the cost competitiveness of SMSFs.

MSmart managing director Derek Condell said analysis conducted by the firm found costs ranged from around $2200 a year up to $3800 a year, depending on the use of financial advice and the use of accounting and fund administration software.

“By use of the accounting software technology, [such as Practical Systems Super] in the SMSF sector, funds can be operated at very, very, low fees, such as say $2200 to $3000 per annum, including investments and brokerage,” Condell said.

He said given the difficulty of comparing like-with-like fee structures across a range of service providers in the SMSF sector, it was not possible to produce “scientifically robust” results, but mSmart’s comparison showed costs could be held below $3000 a year.

“The low costs are a major reason for the explosion in numbers of SMSFs that has occurred in the last 10 years,” he said, adding the sector has been innovative, efficient and made use of high-speed processing in its systems.

“This has occurred in a sector that is often labelled as ‘fragmented’ and ‘a cottage industry’. By comparison, the non-SMSF sector – retail sector in particular – has an abundance of excess capital and resources to create efficiencies, but rarely shakes itself loose from the legacy systems that it created 30 years ago.

“These efficiencies, speed and innovation are largely as a result of the widespread use of accounting software in the industry and its move ‘to the cloud’, and the low costs that accompany the software.

“This software effectively brings ‘straight-through processing’ by linking stockbrokers, fund managers, banks, accountants and administrators all for the benefit of the SMSF trustee. This remarkable software cuts out many costly and inefficient services that APRA (Australian Prudential Regulation Authority) funds are so heavily wound into.”

The mSmart figures echo those released earlier this year by the ATO, which found the median annual operating expense level for an SMSF in 2017/18 was $3923.

Source: smsmagazine.com.au

Deadline to amend discretionary trusts fast approaching

Dec 4,2020 Comments Off

lients with discretionary trusts that hold residential land in NSW will need to amend their trust deed to exclude foreign persons as beneficiaries by the end of this month to avoid paying the NSW foreign duty and land tax surcharge.

With 31 December now only a few weeks away, SuperCentral has reminded professionals and clients about the changes in NSW to the Land Tax Act 1956 (NSW), Land Tax Management Act 1956 (NSW) and the Duties Act 1997 (NSW).

The amendments mean that a discretionary trust will be deemed as foreign for the purposes of surcharge land tax and surcharge duty, unless the trust prevents any foreign person from being a potential beneficiary of the trust, which may require amendments to the trust deed, SuperCentral explained.

SuperCentral also warned that while the changes apply to NSW, it is important to note that Victorian and Queensland discretionary trust deeds may be in a similar position as NSW.

Earlier this year, Cooper Grace Ward Lawyers (CGW) warned that in order to avoid foreign land tax and duty surcharges, the trust deed needs to be amended before midnight on 31 December 2020 to exclude all foreign persons as eligible beneficiaries, and prevent any amendment to the exclusion of foreign persons as beneficiaries, so that the exclusion is permanent and irrevocable.

“This is the case even if none of the eligible beneficiaries of a discretionary trust are foreign persons,” the law firm stated in an online article.

The trust deed and all the variations should then be submitted to Revenue NSW for confirmation that the trust is not a foreign person, it said.

If a discretionary trust is deemed a “foreign person”, CGW warned that surcharge duty of 8 per cent and surcharge land tax of 2 per cent will be payable on any residential land in NSW acquired or owned by the trust since the surcharges were introduced in 2016.

“This can also be the case where the discretionary trust is a shareholder or unitholder in a company or unit trust that owns the residential land,” it said.

Residential land for these purposes has a wide meaning, the law firm stated, with the surcharges applying to vacant or substantially vacant land (including farming property) that is zoned for residential purposes.

“These new changes apply retrospectively, so that if a discretionary trust paid surcharge duty or land tax but amends its trust deed to permanently exclude foreign persons as beneficiaries before 31 December 2020, the trust may apply for a refund of the surcharge,” it said.

“[However, if a discretionary trust] owns residential land in New South Wales but does not amend its trust deed to permanently exclude foreign persons as beneficiaries before 31 December 2020, the surcharge duty and land tax may apply for prior years since the surcharges were initially introduced in 2016.”

Different transitional rules apply to testamentary trusts, it said.

Source: SMSF Adviser

1800 951 855

[email protected]

Archive December 17, 2020