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Is your SMSF diversified?

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SMSF trustees need to truly understand diversification and better diversify their portfolios.

The benefits of a well-diversified portfolio are numerous but the key ones that SMSF trustees should focus on are the benefits of mitigating volatility and short-term downside investment risks, preserving capital and the long-run benefits of higher overall returns. By spreading an SMSF’s investments across different asset classes and markets offering different risks and returns, SMSFs can better position themselves for a secure retirement.

However, did you know that 82% of SMSF trustees believe that diversification is important but in practice many do not achieve it?

This is because half the SMSF population cite barriers to achieving diversification. The top being that it is not a primary goal for SMSF trustees, and they believe they have a lack of funds to implement it.

Furthermore, 36% of SMSF trustees say they have made a significant (10%) asset allocation change to their SMSF over the last 12 months. This demonstrates that SMSFs may not be actively restructuring their portfolio on an annual basis to respond to changing market conditions.

Another clear problem regarding diversification is the amount of SMSFs with half or more of their SMSF invested in a single investment. SMSF trustees say they primarily invest in shares to achieve diversification in their SMSF, while just a quarter say they invest in at least four asset classes to achieve this.

The bias and significant allocation to domestic SMSF equities conversely may highlight the fact that SMSFs are not adequately diversified, especially across international markets and other asset classes.

So what can you do?

Some of the steps you, with the help of an SMSF Specialist, can take to diversify your retirement savings and control your investments in a disciplined and planned way include:

  • Ensuring there is a clear and demonstrable retirement purposes in the choices you make.
  • Ensuring you have an investment objective and a strategy to achieve that objective in place.
  • Reviewing your portfolio and assessing it against the objectives you have set as often as you feel is necessary.
  • Minimising concentration to any one asset class.
  • Ensuring your Australian share portfolio is sufficiently diversified.
  • Considering the benefits of geographic diversification.
  • Ensuring your cash allocation is appropriate.
  • Considering the benefits of exchange traded funds, listed investment companies and other digital investment platforms that allow low cost access to different markets.

Always remember to document your actions and decisions, as well as your reasons, and keep them as a record in order to demonstrate that you have satisfied your obligations as a trustee.

Given the importance of having an appropriately diversified portfolio and its impacts on quality of life in retirement trustees ought to consider professional assistance in managing this important aspect of an SMSF.

Source: SMSF Association

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Superannuation death benefit limitations

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As an SMSF trustee, you need to take special care when paying death benefits as you are responsible for ensuring that the payment rules are met. Strict rules apply, affecting who can receive a death benefit, the form in which the death benefit can be paid and the timing of such a payment.

Firstly, death benefits can only be paid either to dependants of the deceased member or the estate of the deceased.

Second, the law limits the group of dependants who are eligible to receive a pension on the death of the deceased member.

Finally, trustees must pay a death benefit as soon as possible after the death of the member. Additionally, each death benefit interest can only be paid to each dependant as either:

  • a maximum of two lump sums (an interim and final lump sum), or
  • a pension or pensions in retirement phase, or
  • a combination of both.

It is the limit of a maximum of two death benefit lump sums per dependant that trustees need to keep track of to ensure that the cashing rules are not inadvertently breached, especially where the death benefit is being paid as a pension.

Given the account-based nature of death benefit pensions that can be paid by an SMSF trustee, an SMSF member is generally afforded the flexibility to nominate to convert a death benefit pension into a lump sum payment. This process is generally referred to as the commutation of a pension although may be subject to specific restrictions found in a trust deed.

A partial commutation is where the beneficiary requests to withdraw a lump sum amount less than their total pension entitlement, allowing their death benefit pension to continue. This is common where members withdraw their required minimum drawdown as a pension with any additional income needs met by accessing multiple lump sums from their pension account. This strategy allows the death benefit pension to continue without breaching the superannuation death benefit rules, despite payments in excess of the maximum two lump sum limit.

A full commutation will result in the death benefit pension ceasing at the time the member decides to withdraw their entire pension entitlement as a lump sum. Despite the number of lump sum death benefits previously received, the law allows the beneficiary to roll over the lump sum resulting from a full commutation to another superannuation fund for immediate cashing as a new death benefit pension.

However, where a lump sum resulting from the full commutation of a death benefit pension is paid out of the superannuation system, further clarity is being sought from the ATO to ascertain whether or not this will be treated as an additional lump sum death benefit that would count towards the maximum two lump sum cashing limit. Until further clarity is provided by the ATO, caution needs to be exercised before a death benefit pension is fully commuted and paid to the dependant, especially where the dependant has previously received a lump sum death benefit.  

As an SMSF trustee, you need to be aware of the restrictions placed on the payment of death benefits to eligible dependants of a deceased member. Trustees who ignore these limitations risk breaching superannuation standards and potentially being liable to be fined by the Regulator.

Source: SMSF Association

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COVID-19: Providing concessions for the LRBA in my SMSF

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The economic impacts of the COVID-19 crisis are causing significant financial distress for many businesses and individuals.

If your SMSF has a related party loan and is impacted due to the financial effects of COVID-19, you may be able to provide your LRBA with relief under an agreed commercial arrangement.

Ordinarily, not paying market interest rates in an SMSF is usually a breach of superannuation laws. However, the ATO have provided guidance which allows SMSFs with an LRBA to negotiate a reduction in or waiver of interest payments because of the financial impacts of the COVID-19.

If the repayment relief reflects similar terms to what commercial banks are currently offering for real estate investment loans as a result of COVID-19, the ATO will accept the parties are dealing at arm’s length and the NALI provisions do not apply.

What do you need to do?

There are some important things you should ensure are in place when you are providing a loan concession, especially when this is a related party.

  • Ensure the relief only applies to the related party loan
    • Any relief offered on the loan can only relate to that loan agreement. The ATO concession does not extend to other loans.
  • Ensure that the concessions are temporary.
    • This means it should have an agreed period of time or agreed date where the concessions are reviewed in light of the economic circumstances.
  • The financial difficulty faced by the SMSF is linked to the financial impacts of COVID-19.
    • Any negotiated concession will need to be measured against the COVID-19 financial impact suffered by your SMSF.
  • Clear arrangements which detail the amount of discount, waiver or deferral of the concession.
    • In evidencing that the concession is reasonable, it would be best practice if it is consistent with an approach taken by an arm’s length loan.
    • For example, terms currently include temporary repayment deferrals for most businesses of up to 6 months, with unpaid interest being capitalised on the loan.
    • It is also expected that there is evidence that interest continues to accrue on the loan and that the SMSF trustee will catch up any outstanding principal and interest repayments as soon as possible.
  • Ensure you have proper documentation which allows your independent auditor to be satisfied that the concession satisfies all of the above.
    • This may take the form of a signed minute, renewed loan agreement or anything deemed appropriate to amend the terms of the loan.
    • The parties to the arrangement must also document the change in terms to the loan agreement and the reasons why those terms have changed.
    • Even if you are both the lessor and lessee, the above should all be documented.

These are extraordinary times and the ATO is providing this guidance to allow SMSF trustees to be flexible and agile.

If trustees act in good faith in implementing a reasonable and measured reduction concession because of the impacts of COVID-19 they should not fall foul of the law.

Source: SMSF Association

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SMSF members who split can’t convert assets to cash

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Self-managed superannuation fund (SMSF) members who are looking to split assets due to a divorce will not be allowed to convert their fund into a cash asset, according to Townsend Business and Corporate Lawyers.

The law firm said this was a common misconception and unless members had reached retirement or preservation age, any interest within the fund must not be paid out to a member, or any other individual.

The splitting order would depend on the type of super interest and whether it was in the growth phase or the payment phase.

Examples, it said, included:

  1. An order for a member to roll-over their interests into another fund (which also means the member leaving the SMSF);
  2. An order for a member to pay a percentage or dollar amount of their pension to the other member; or
  3. An order that one of the members give their superannuation interest in the fund to the other member.

Townsend warned that some super interests could not be split such as:

  1. Contributions you make with a personal injury election;
  2. Transfers from foreign funds;
  3. Government co-contributions; and
  4. Super interest that is subject to another unrelated payment split (previous divorce).

Another myth Townsend said were that it was incorrect and “dangerous” to believe that the parties could agree on what should happen to the super fund and simply sign resolutions giving effect to that agreement.

“The conversion of a member’s entitlements under a super split can only be undertaken pursuant to the provisions of Part 7A.2 of the Superannuation Industry (Supervision) Regulations 1994 which are lengthy and can be difficult to comprehend,” it said.

“Splitting couples should therefore always seek independent legal advice on how to give effect to super splitting orders and on the options for reinvesting their respective interests into another fund whilst ensuring that any action taken remains compliant within the law.”

Townsend noted that a failure to comply with regulations would likely cause material adverse tax consequences for the members and the fund.

“It is also imperative to remember that contribution splitting in accordance with a Family Court Order has no effect in reducing the amount counted towards the annual concessional contributions cap,” the law firm said.

“Contributions which fall outside the Australian Taxation Office’s contributions cap may result in extra tax.”

Source: Super Review

The SMSF audit post-COVID-19: Related commercial tenancies

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The SMSF industry is experiencing rapid change in the wake of COVID-19. The goalposts of commerciality have shifted, as have the reporting requirements for SMSF auditors dealing with tenancies affected by COVID-19 in the 2020 and 2021 financial years.

The SMSF audit is critical to the decisions trustees and their advisers make today.

No one wants a train wreck with their SMSF auditor.

Notwithstanding the ATO’s decision not to devote compliance resources to this area, SMSF auditors have certain reporting obligations and the ATO has made its expectations clear.

So, what is required to navigate post-COVID-19 tenancies with the auditor’s green light?

What the auditor must do

For engagements in the 2020 and 2021 financial years, the SMSF auditor must:

  • Form an opinion as to the commerciality of a post-COVID-19-related tenancy. 
  • Request sufficient appropriate audit evidence from SMSF trustees to support this opinion.
  • If the tenancy is not conducted on commercial terms, recognise a contravention of SIS Act section 109 and communicate this to the trustees in the management letter.
  • If the contravention of section 109 is material, modify the Part B Compliance Audit Opinion.
  • If the contravention is reportable under the regulator’s reporting criteria, report the section 109 contravention (and any other contraventions) as usual to the ATO.

Hold on — isn’t there compliance relief?

Yes. Provided the post-COVID-19 tenancy reflects an arm’s-length standard of dealing, the SMSF auditor is not required to report any contraventions arising from this tenancy to the ATO.

The fact is, the Superannuation Industry (Supervision) Act 1993 was not drafted to work in the current environment. Even where a post-COVID-19 tenancy is being conducted on an arm’s-length basis, an SMSF could find itself in breach of other provisions. For example, by extending rent relief to a related-party tenant, the fund may provide indirect financial assistance to its members or their relatives. The SMSF will therefore contravene section 65. In the current environment, this breach is not reportable.

Important note: The auditor is required to modify their Part B compliance report where such unavoidable contraventions are material — but the matter will go no further.

It is clear that section 109 is an extremely important provision when dealing with post-COVID-19-related tenancies.

Let’s have a look at the new audit landscape and how section 109 will apply.

What does the Mandatory Code of Conduct mean for SMSFs?

The federal government’s recommendation for tenancies impacted by COVID-19 was for the parties to “sit down, talk to each other and work this out”. The Mandatory Code of Conduct for SME Commercial Leasing Principles During COVID-19 is both a safety net and a starting point for these discussions.

The code applies to commercial tenancies that are eligible for the JobKeeper program. In the SMSF environment, this relates to small businesses that have experienced a reduction in turnover of 30 per cent or more due to COVID-19. The principles of the code are requirements for any SMSF related-party tenant that qualifies for the JobKeeper program. For these severely impacted businesses, the code is a mandatory standard of arm’s-length dealing.

This does not mean that commercial tenants suffering a 20 per cent downturn cannot reach an arm’s-length agreement with their landlord for the reduction of rent. However, they are not covered under the Mandatory Code.

The golden rules — related commercial tenancies with downturn of less than 30%

What about those related-party tenants impacted to a lesser extent by COVID-19? While not directly applicable, the code provides a good yardstick for the new normal in commercial practice.

There are three golden rules for the SMSF landlord:

  1. Reduction in rent must be proportionate to the negative impact of COVID-19 upon the business and may take the form of a rent waiver.
  2. A freeze upon all rent increases may apply until the economic situation improves.
  3. Where possible, reduce any unnecessary burden for the tenant. Are there overheads that no longer have utility? Don’t charge the tenant and (if possible) switch off the service altogether.

There is one golden rule for the related-party commercial tenant:

  1. Stick to the lease, including any specific amendments relating to COVID-19. If the tenant fails the lease conditions, the arrangement may be considered non-arm’s length and in breach of section 109.

This is important. It bears repeating.

The tenant has one job: ensure compliance with the lease.

What does the auditor need to see?

If your SMSF has a related-party tenant that qualifies for the JobKeeper program, the auditor will require the following:

  • Evidence that the tenant is eligible for the JobKeeper program.

This should include confirmation of the successful JobKeeper application, together with evidence supporting the decline in projected turnover.

This evidence is critical, not only for audit purposes, but also to substantiate the business’s claim for the JobKeeper payment. The Treasury has advised that tolerance will be exercised where a good faith estimate of turnover reduction proves slightly inaccurate. To benefit from this goodwill, the evidence of a good faith calculation must be retained.

  • A current executed lease agreement, together with any amendments contained in an addendum to the lease. The lease arrangement should comply with the principles of the Mandatory Code.

If your SMSF has a related-party tenant that has experienced a significant downturn of less than 30 per cent as a result of COVID-19, the auditor will need to see:

  • Evidence that the tenant has been negatively affected by COVID-19.

This should take the form of a letter from the related-party tenant addressed to the SMSF trustees, describing the negative impact of COVID-19 upon the business. You must substantiate the estimated reduction in turnover and retain this evidence. The letter should request a reduction in rent proportionate to the virus’s financial impact upon the business.

The SMSF trustee should reply to this letter, confirming their acceptance of the new lease terms. A series of emails may take the place of letter writing, if convenient.

  • A current executed lease agreement, together with any amendments contained in an addendum to the lease. The lease arrangement should reflect with the golden rules outlined above and must be complied with as though it were an arm’s-length commercial arrangement.

Remember, this is a temporary agreement. There should be a trigger point for a return to normal commercial dealings. Where the Mandatory Code applies, this event would be cessation of JobKeeper payments. Finally, if the lease agreement has expired or requires review, this should be attended to as soon as possible.

What about related-party tenancies within a Reg 13.22C entity?

Where an SMSF holds business real property via a non-geared entity subject to Div 13.3A in Superannuation Industry (Supervision) Regulations 1994, the requirement for arm’s-length dealing in related tenancies is paramount.

Non-geared unit trusts and companies must deal continually on an arm’s-length basis or lose their status as Reg 13.22C vehicles — which generally precipitates the SMSF’s disposal of its shares or units as in-house assets. Beware the spectre of non-arm’s-length dealing for these entities. If the lease agreement is not legally enforceable or if rent accrues to create a borrowing in the non-geared entity, this will compromise the entity’s status.

The ATO has stated that the deferral of rent for commercial tenancies within a non-geared trust or company due to the impact of COVID-19 will not cause these investments to be treated as in-house assets. It is uncertain whether a waiver of rent enjoys the same immunity. However, the standard of arm’s-length dealing has changed as a result of COVID-19 and non-geared entities are not exempt. Based on the information available, the above principles will apply equally within a Reg 13.22C environment. Given the high stakes of non-compliance, a legal review of the lease and any amendments is recommended.

Conclusions

The goal posts for commercial dealing have changed significantly post-COVID-19.

While the ATO’s decision not to apply compliance resources to related commercial tenancies for the 2020 and 2021 financial years is welcome, fund administrators must keep in mind a few basic rules, or risk a reluctant collision with their SMSF auditor.

Action now will determine the audit ramifications later. It is always worth a question to get it right!

Naomi Kewley, managing director, Peak Super Audits

SMSFs and rent relief due to COVID-19

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SMSFs that own property are facing the prospect of tenants falling behind in their rent payments and their other obligations under the lease due to the economic stress arising from COVID-19.

Australian states and territories will put a six-month moratorium on evictions for both residential and commercial tenants during the coronavirus pandemic, Prime Minister Scott Morrison announced on 29 March 2020. “Now there is a lot more work to be done here and my message to tenants, particularly commercial tenants and commercial landlords is a very straight forward one: we need you to sit down, talk to each other and work this out,” he said.

At the time of this article, the states and territories are still to provide detail on any arrangements that are proposed to assist landlords and tenants.

The ATO have provided a non-binding practical approach of broadly not applying resources to this issue for FY2020 and FY2021. However, this announcement, while positive, should not be relied on given the considerable downside risks.

From a legal perspective, if these matters are not carefully managed and documented, SMSFs and their trustees/directors could potentially face the risk of significant penalties under the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’) and the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’).

This article examines the position of an SMSF leasing business real property to an arm’s length tenant and to a related party tenant and provides recommendations for those that wish to ensure they minimise downside risk and can position themselves with sound legal backing.

SMSF and arm’s length tenants

If the tenant has no direct or indirect relationship with the SMSF trustee (who is the landlord), then the SMSF trustee may be in a position to grant rent relief without contravening the SISA. Under this scenario, the parties probably would be dealing at arm’s length and, as outlined below, there may be various factors supporting a rent reduction in whole or in part as being in the best interests of fund members. For example, the following reasons could support rent relief:

  • The tenant may have a better chance of successfully trading out of its current predicament; especially as many other landlords are being requested to grant relief due to the economic stress arising from COVID-19.
  • The tenant may also be in a position to continue to cover holding costs such as council rates, land tax, regular maintenance of equipment and insurance subject to any applicable law (eg, the Retail Leases Act 2003 (Vic) may preclude a landlord from recovering land tax). Note that a property that has been vacant for some time may not be covered by insurance and having a tenant occupy premises, by itself, can be a significant advantage to a landlord who’s otherwise at risk without insurance.
  • There may be further risks of having a vacant property such as break-ins and fires and other damage arising while a property remains vacant and not maintained.
  • There may also be little prospect of obtaining another tenant in the near future until the economy recovers after COVID-19 which some predict may take years.

The states and territories arrangements may provide some detail on what changes, if any, are required to be made to a lease agreement as the states and territories have the power to override any lease agreement with a direction or order when a state of emergency is declared. Subject to further developments, a lawyer should be consulted in relation to the terms and conditions in each lease agreement as some may include a ‘force majeure’ clause that allows a party to suspend or terminate the performance of its obligations if certain events occur such as an act of god. Note that since a lease confers a form proprietary interest in relation to the land, the usual contractual law rules such as ‘frustration’ of a contract may not necessarily apply. This area of law is being well researched and commented on by many property law experts.

SMSF and related party tenants

If the tenant is a related party of the SMSF trustee, it is very easy to contravene the SISA provisions and extreme care is required when handling these situations.

Where an SMSF wants to grant any concession under a lease to a related party tenant, they should, after taking appropriate accounting and legal advice, be careful to follow the appropriate steps and gather relevant evidence.

Some of the key issues that an SMSF dealing with a related party tenant will need to deal with include:

  • The sole purpose test –– s 62 of SISA. Is the SMSF trustee merely reacting to assist a related party rather than acting in accordance with what an arm’s length landlord would do? As noted above, an arm’s length landlord may decide to grant a concession to an unrelated tenant where that is in the landlord’s best interests.
  • The in-house asset test –– pt 8 of SISA. Non-payment of rent is likely to give rise to a loan by the SMSF to the related party and if that loan exceeds 5%, then an in-house asset contravention may arise. Note also that the terms of the lease may apply a penalty interest rate to the amount owed.
  • The prohibition against lending or providing financial assistance to a member or relative –– s 65 of SISA. If the SMSF is leasing to a member or relative of an SMSF, then there is a potential contravention of s 65 if the arrangement is not on arm’s length commercial terms.
  • The arm’s length test –– s 109 of SISA. Broadly, all investments and transactions involving an SMSF must be made and maintained –– on an ongoing basis –– on an arm’s length terms.

As you can appreciate from the above, an SMSF trustee will need to demonstrate that granting any concession is consistent with what arm’s length parties would agree to do and is in the best interests of the fund and its members.

They should also examine all available options and obtain advice from an experienced real estate agent with regard to the prevailing market conditions for that particular lease in that location and determine whether another tenant can be obtained and when, etc.

Additionally, the SMSF trustee should gather any evidence that supports the course of action proposed to be taken, and make sure to consider other alternatives assuming the tenant was an arm’s length tenant (rather than a related party tenant) in those particular circumstances.

A detailed review of the lease documentation should be undertaken as soon as practicable and advice taken on what variations may be needed to be made to the lease to reflect any concession that may be granted. Naturally, any variation to the lease agreement should be prepared by an experienced and qualified lawyer.

Note that even though the SMSF trustee may gather evidence that the outcome of the concession granted to a related party tenant under the lease reflects arm’s length terms, that may not necessarily protect them from contraventions of the SISA occurring if, for instance, there is a loan or financial assistance that invokes ss 65 or 109 of SISA.

ATO practical approach

The ATO’s website (at QC 61775) on 27 March 2020 was updated to state under the heading ‘Temporarily reducing rent’:

Question: My SMSF owns real property and wants to give my tenant – who is a related party – a reduction in rent because of the financial impacts of the COVID-19. Charging a related party a price that is less than market value is usually a contravention. Given the impacts of the COVID-19, will the ATO take action if I do this?

Answer: Some landlords are giving their tenants a reduction in or waiver of rent because of the financial impacts of the COVID-19 and we understand that you may wish to do so as well. Our compliance approach for the 2019–20 and 2020–21 financial years is that we will not take action where an SMSF gives a tenant – who is also a related party – a temporary rent reduction during this period.

Broadly, the ATO will not actively seek out cases where an SMSF gives a related party tenant a temporary rent reduction during the remainder of FY2020 or FY2021. However, the usual position for such practical approaches previously issued by the ATO is that if the ATO do come across contraventions from other sources, eg, via its usual data detections, reviews or auditor contravention reports (‘ACR’), the ATO will usually apply the legislation in the normal manner. While the ATO should be congratulated on the practical approach reflected above, SMSF trustees should not rely on this non-binding guidance given the substantial downside consequences, especially given these situations may be legitimately resolved with appropriate action as outlined below.

We do understand however that some SMSF trustees and/or businesses may not have the time or resources to obtain proper advice with regard to related party tenants, and may choose to simply rely on the ATO practical approach at their own risk. However, given the consequences, landlords should take every measure available to them to place themselves in as sound position as possible to minimise future risk.

Furthermore, the ATO website does not provide any express relief for an SMSF that owns property via an interposed unit trust, such as a non-geared unit trust (‘NGUT’). Once a contravention of one of the criteria relating to a NGUT is triggered under reg 13.22D of SISR, the trust is ‘forever’ tainted and the SMSF must dispose of its units in that unit trust to comply with the SISR. In particular, if the lease is not legally enforceable or if rent owing by a related party tenant accrues and constitutes a loan under the lease, the unit trust will cease to comply with the criteria in div 13.3A of SISR.

SMSFs with LRBAs –– further implications

If an SMSF has borrowed money under a limited recourse borrowing arrangement (‘LRBA’) to finance the acquisition of a property (whether residential or business real property) a range of other implications may arise including:

  • Similar issues to the potential SISA contraventions raised above also may apply if a related party lender does not act at arm’s length in relation to collecting all moneys owing under the LRBA as an arm’s length lender would apply to a third-party lender. However, a related party lender would typically not consider taking any such action against the SMSF trustee given they are related. Again, appropriate arm’s length evidence must be gathered and accounting and legal advice obtained to position against the significant penalties that may otherwise be applied.
  • If there is a related party lender, unless the ‘safe harbour’ terms and conditions of the borrowing are consistent with the ATO’s criteria in PCG 2016/5, that are continuously complied with (eg, regular monthly principal and interest repayments), the ATO have advised they will typically consider applying non-arm’s length income (‘NALI’). The following is a helpful extract from this PCG:

The trustees will need to be able to otherwise demonstrate that the arrangement was entered into and maintained on terms consistent with an arm’s length dealing. One example of how a trustee may demonstrate this is by maintaining evidence that shows their particular arrangement is established and maintained on terms that replicate the terms of a commercial loan that is available in the same circumstances.

Indeed, if the tenant reduces or stops paying rent, the SMSF’s ability to make repayments under the LRBA can easily fall into arrears and into default (with the default interest rate –– typically at least 2% higher than normal) under the loan agreement giving rise to a range of further ramifications. If the related party lender provides any relief to the SMSF trustee that is not benchmarked to arm’s length terms (that can be justified in these difficult times), based on recent ATO materials (including LCR 2019/D3) the ATO position is that NALI may then apply to any net income and net capital gain, if any, derived from that property for the entire future period of ownership.

We would be pleased to advise and assist to minimise the potential future risk of NALI being applied.

Possible consequences of contravening SISA

Despite the ATO’s non-binding practical approach outlined above, a range of other contraventions may also occur (or may occur in the near future) in these difficult and stressful economic times if, for example, money is withdrawn without a valid condition of release or existing SMSF assets are used as security for a borrowing by a related party. When added to non-compliance by an SMSF trustee or ‘connected’ unit trust renting property to a related party tenant (eg, a NGUT), then SMSF trustees may be widely exposed to a range of penalties and costly disputation.

There are a range of potential penalties that the ATO may apply unless these matters are appropriately and properly managed, including:

  • In extreme cases, the fund could be rendered non-complying with 45% tax imposed on the value of its opening account balance in the year it is rendered non-complying.
  • Contravention of a civil penalty such as s 62, s 65, pt 8 and s 109 can result in a monetary penalty of a maximum amount of $504,000 (ie, 2,400 penalty units x $210).
  • An administrative penalty, typically of $12,600 per contravention for s 65 and pt 8 and the ATO’s stated policy is to ‘automatically’ impose an administrative penalty for each and every occasion. An SMSF trustee can seek remission of any penalty; the success of which depends on whether the ATO considers any remission is appropriate in the circumstances.

This type of situation highlights the need for making sure SMSF trustees act in compliance with the law and do not make rash or hasty decisions that they may later regret, especially if the actions were designed to assist a related party without any evidence documenting that the actions were consistent with an arm’s length dealing and/or without following and taking the appropriate steps to implement a lease variation.

This is where a written opinion from an SMSF lawyer, which is subject to legal professional privilege, outlining the law in view of the particular facts is a prudent first step to take in this journey. A written opinion that is supported with the right evidence and that is implemented correctly can save on costs that may otherwise arise from needing to respond to the likely auditor or ATO queries and any ACR that may be lodged, which may give rise to unnecessary inquiries by the ATO.

Sole purpose SMSF corporate trustee

If an SMSF trustee grants a concession to a related party tenant, the administrative penalties on their own can, in these types of circumstances, give rise to hundreds of thousands of dollars as the ATO might argue that each monthly payment of rent not made is subject to an additional penalty.

If the SMSF has say two individual trustees, then the administrative penalties will be double the amount that would be imposed on two directors of an SMSF corporate trustee as each individual trustee is subject to the same amount of administrative penalties. For example, if the SMSF has two members who are individual trustees, then the typical $12,600 for a single administrative penalty is double, ie, $25,200. If the SMSF had a corporate trustee with the two members as directors of the corporate trustee, the administrative penalty is $12,600.

Naturally, we strongly recommend that each SMSF has a sole purpose SMSF corporate trustee to minimise legal risk given the current economic conditions. Many SMSFs still have individual trustees who remain personally liable for a fund’s liabilities and the administrative penalty system is a big incentive to move to a corporate trustee in these testing times.

Our recommendation that an SMSF have a sole purpose corporate trustee is also very important in these difficult economic times given that many ‘trading’ companies that also double up as an SMSF trustee, may be facing insolvency with the appointment of an administrator, liquidator, receiver or some other form of external management which could soon ‘take over’ control of that company and make the management the SMSF assets very difficult until that company’s external controller is convinced that the SMSF assets are not capable of being applied towards the creditors. This ‘fight’ alone may prove difficult and costly.

Conclusions

Naturally, the above matters should be taken very seriously and it is important that SMSF trustees obtain sound expert accounting, financial, valuation, legal and other advice to prevent hasty actions that are designed to preserve a related party tenant’s cash flow to assist their business from backfiring.

Written by Daniel Butler and Bryce Figot, DBA Lawyers 

COVID-19 and early access to super

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People financially affected by the coronavirus pandemic can access some of their super, but what will it cost long-term? 

Who is eligible to access super early?

In response to the disruption to the job market caused by COVID-19, the government has eased the rules around early access to super.

Several new groups of people are now eligible to access their super early:

  • unemployed people
  • those eligible to receive JobSeeker payment, Youth Allowance for job seekers, Parenting Payment, Special Benefit or Farm Household Allowance
  • those who’ve been made redundant or had their working hours reduced by 20%, or sole traders whose business has been suspended or faced a reduction of 20% or more since 1 January 2020.

However, just because you can access your superannuation doesn’t mean you should. 

We’ll help you weigh the pros and cons before deciding to dip into the funds meant to provide for your future and long-term financial security.

What are the risks of accessing your super early?

Taking out money before retirement means losing the benefit of compound interest over a number of years. Depending on how old you are, withdrawing money now could see you miss out on more than double that amount by the time you retire.

With this in mind, Super Consumers Australia director Xavier O’Halloran says you should weigh all of your options before dipping into your retirement savings. 

“There are a number of financial assistance options to help people through these tough times. Super will be the right option for some, but you should be looking at what else is available and possible cuts to discretionary spending before raiding the cookie jar.”

Although making a withdrawal now and/or next year will eat into your retirement savings, don’t forget that you may also be eligible to receive a pension.

The Moneysmart retirement calculator lets you enter in your details (including any breaks from the workforce) to see how much you would get in retirement from your super and/or the pension.

How will early access affect my savings?

An important point to consider is that the amount you withdraw from your super will no longer be invested. This means you may miss any eventual recovery in the market.

Super Consumers Australia modelling found that, for a 30-year-old, the impact of withdrawing $20,000 would be $49,823 by retirement age.

People with lower super balances will be more impacted by early withdrawal of the allowable amount, as it will be a larger proportion of their savings.

Super Consumers Australia has previously highlighted that women generally retire with lower super balances. The median superannuation balances for people approaching retirement age (60–64 years) was 26% higher for men ($154,453) compared to women ($122,848). Women also have greater needs in retirement due to a longer life expectancy.

Taking your super out early may mean you miss out on the market recovery

Experts like to say that ‘time in the market’ beats ‘timing the market’. This means that simply staying invested in the share market over the long term has historically produced higher returns than attempting to move in and out of the market to capitalise on fluctuations.

Analysis from finance publisher Firstlinks illustrates this point. It found that if you were invested in the S&P 500 (a US stock market index) between the start of 1999 and the end of 2018, the return was 5.6%. 

But if you weren’t invested for the best 10 days during that 20-year stretch, your returns fall substantially – to 2%. 

And if you missed the best 20 days, your returns would actually be negative.

This shows that missing out on being invested when the market surges, which can happen without notice over a very short period of time, can be very costly indeed. 

Trying to ‘time’ the market or pick the right point to put your money back in is extremely difficult. Most experts can’t consistently beat the market with timing or investment picking.

In the event that you do access your super early, you can make extra contributions to your super once back in secure work, in order to catch up. But you may not be in a position to start making those extra contributions before the recovery begins.

 

Many people are finding themselves in a financial situation they have never experienced before; if considering early access to your superannuation it is important to get independent advice about all of your options. 

Source: Super Consumers Australia & CHOICE 

The do’s and don’ts of property investing for SMSFs

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Self Managed Super Fund trustees are no different to many other Australians – they relish the opportunity to invest in direct property.

Australian Taxation Office figures show property comprises about 13 per cent of SMSF assets of about $750 billion – third on the list of investments behind Australian equities and cash and fixed deposits.

Investment is split between commercial and residential direct property, with the former comprising about 9 per cent and the latter 4 per cent.

The heavier weighting in commercial property in SMSF portfolios should not be a surprise.

For many small-to-medium-size businesses (SMEs), the opportunity to transfer their business premises into their SMSF and then lease them back at the market rate has two attractions – the fund has an asset that, in all likelihood, will appreciate in value, and it removes any risk from the “landlord-tenant” relationship.

For other SMSFs owning direct property, the benefits are rental income and a lower capital gains tax rate when the property is sold.

The rental income adds to a super balance and it comes with an added bonus of incurring only a 15 per cent tax rate (or zero tax for members in the pension phase). And, like any rental property, expenses are tax-deductible.

The cream on the cake comes if a property is held for more than 12 months before sale, with just two-thirds of any capital gain taxed at 15 per cent (nil tax for those in the pension phase).

However, SMSF trustees must be fully aware of some specific rules about owning and renting property in their fund, with the ATO taking a dim view of those who breach them.

In particular, there are restrictions on how you or a related party can buy and use the property. For example, the law prohibits an SMSF acquiring residential property from any related party to the fund (such as fund members or their relatives).

Investment issues

It is important to note that commercial property is exempt from this ruling, provided the ATO is satisfied it falls within the definition of business real property. A commercial office, factory or productive farm land are prime examples.

It is not just about the regulations; there are investment issues involved.

 

Acquiring a property can result in an SMSF’s investment portfolio lacking diversification.

Although there are no golden rules about portfolio diversification, both the Australian Securities and Investments Commission and the ATO have raised concerns about SMSFs having the bulk of their investments in a single asset, notably retail housing.

The regulators’ concerns are magnified if an SMSF has used a limited-recourse borrowing arrangement (LRBA) to acquire the property.

Trustees also have to ensure the acquisition of direct property falls within the guidelines outlined in the SMSF’s investment strategy – a legal document. It will detail how much exposure the fund should have to the property market, the form that exposure should take, and whether it is appropriate in the circumstances for the fund’s members.

 

The investment strategy document is not something that can be allowed to gather dust at the bottom of a drawer.

All investments must fall within the guidelines devised by trustees and set out in the strategy.

One of the duties of an SMSF auditor is to ensure there is an investment strategy in place and the trustees adhere to it.

One final cautionary note relates to property’s lack of liquidity. Unlike shares, selling a property takes time so if there is an unforeseen circumstance, such as the early death of a member or a divorce, it can cause complications.

 

None of these warning signs is reason not to buy direct property – whether it be commercial or residential. The long-term returns can justify the investment.

However, seek specialist advice before acquiring this asset class, especially if it involves debt (LRBA) or will comprise the bulk of a portfolio.

Written by John Maroney, CEO, SMSF Association 

 

What expenses can an SMSF deduct?

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Self-managed super fund (SMSF) expenses can be tax deductible provided that they comply with Australian taxation legislation.

It’s important to understand that SMSFs should only pay expenses that are:

  • Allowed for under superannuation legislation and the SMSF’s trust deed
  • Consistent with implementing the SMSF’s investment strategy

What are the general principles to follow?

Some SMSF expenses are tax deductible and some are not. It depends on whether the expenses relate to the fund gaining taxable income or not.

Expenses are tax-deductible if they relate to the fund gaining taxable (i.e. assessible) income. Superannuation funds (including SMSFs) are taxed on member contributions and their investment earnings. These contributions and earnings are taxed at the concessional super rate of 15% in Australia, up to certain contributions limits.

SMSF expenses are not tax deductible if they are capital expenses, such as the cost or purchasing fund assets.

Does it matter whether the SMSF members are in the accumulation or retirement phases?

Yes. SMSF expenses are not tax-deductible if they relate to the gaining of any non-taxable (i.e. non-assessable) income. Non-taxable SMSF income includes earnings form assets held to support member retirement phase income streams.

If an SMSF has members that are in both the accumulation and retirement phases, its expenses must be split appropriately between its taxable and non-taxable income. SMSFs in this situation should hire the services of an actuary to determine their non-taxable income. Only the expense amount that is apportioned to taxable income is tax-deductible.

No expense-splitting is necessary for any costs associated with collecting and processing fund member contributions or on the insurance premiums paid on behalf of members. However, splitting is necessary for most other types of SMSF expenses.

What SMSF expenses are tax deductible?

SMSF tax-deductible expenses can be grouped into the following categories:

  • Operating expenses
  • Investment-related expenses
  • Tax-related expenses
  • Insurance premiums
  • Statutory fees and levies
  • Legal expenses
  • Collectables and artwork expenses

We’ll now look at each of these categories in more detail.

Operating expenses

Operating expenses include:

  • Fund management and administration fees that trustees incur in carrying out their obligations. For example, collecting and processing member contributions.
  • Audit fees. SMSF trustees are legally obliged to appoint an approved SMSF auditor to examine their fund’s operations each year to ensure its compliance with super legislation.

Investment-related expenses

Investment-related expenses include:

  • Fees paid to fund investment advisers, provided that these fees are directly related to an investment that earns assessable income for the SMSF. Financial advice fees that do not meet this requirement include any of the following situations:
    • General financial advice
    • Financial plan preparation
    • Initial or upfront adviser fees
    • Ongoing advice fees for accumulated super in the fund
    • Advice for non-assessible pension income.
  • Bank fees.
  • Rental property expenses if the fund holds one or more investment properties in its portfolio of assets.
  • Brokerage fees (e.g. for share investments).
  • Interest on any SMSF funds borrowed for investment under a limited recourse borrowing arrangement.
  • Depreciation on investment assets (such as the plant and equipment in a commercial property owned by the fund).
  • Claiming subscriptions and attending seminars.

Tax-related expenses

Any expense associated with preparing and lodging an SMSF’s financial statements and annual return to the Australian Taxation Office (ATO) is tax deductible. In addition, funds can deduct any actuarial costs that they incur to determine the amount of tax-exempt income for any of their members.

Insurance premiums

Insurance premiums that SMSFs pay on behalf of their members are tax deductible. SMSFs are legally entitled to take out the following types of insurance for their members:

  • Life
  • Income protection
  • Total and permanent disablement
  • Terminal illness

Other types of insurance (such as trauma or health insurance) can’t be taken out by SMSFs on behalf of their members.

Statutory fees and levies

SMSFs must pay an annual ATO supervisory levy and this amount is tax deductible.

In addition, SMSFs that have a corporate trustee structure must also pay an initial Australian Securities and Investments Commission (ASIC) registration fee, as well as ongoing annual fees. All of these ASIC fees are also tax deductible.

Legal expenses

Some SMSF legal expenses are deductible, including costs associated with:

  • Amending the fund’s trust deed so that it remains compliant with any changes to super legislation.
  • Ensuring the fund’s compliance with its tax obligations.

Collectables and artwork expenses

Storage and insurance costs for any collectables and artwork that are owned by an SMSF are tax deductible. The insurance for these assets must be in the name of the fund and it must be taken out within seven days of them being acquired.

What is the process for claiming these expenses and deductions?

Tax-deductible SMSF expenses can generally be claimed in the year that they are paid. The only exception are any depreciation claims, which are “non-cash” expenses that are claimed over the estimated life of their associated assets.

All SMSF tax-deductible expenses should be claimed in the annual ATO return so that the appropriate tax debt or refund each year can be determined. Fund trustees should ensure that:

  • All tax-deductible expenses (excluding depreciation) are paid directly from their fund’s bank account.
  • All receipts and invoices are in their fund’s name.
  • They retain all their receipts and invoices for at least five years after their annual returns have been submitted to the ATO.

What expenses can’t you claim?

SMSF expenses that you can’t claim (and which you might expect that you can) include:

  • Any expenses associated with non-taxable income.
  • Travel expenses relating to residential investment property.
  • Legal expenses, such as those involved with preparing an SMSF’s initial trust deed (or significantly amending it a later date).
  • Any other costs associated with establishing the fund, as these are regarded as capital expenses.

In addition, if the trustees of the fund incur any administrative penalties from the ATO for non-compliance, these expenses cannot legally be paid by the fund. The trustees also cannot legally be reimbursed by the fund for the payment of these penalties. Administrative penalties are therefore not paid by SMSFs and accordingly are not tax deductible.

The bottom line

SMSF expenses that relate specifically to the fund’s taxable income are tax deductible. Some SMSFs have both taxable and non-taxable income. In this situation, fund expenses must be split between these two types of income, and the amount apportioned to non-taxable income is not tax deductible.

Source: superguide.com.au

What type of dishonesty disqualifies a person from having an SMSF?

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This article examines the nature of disqualification and what convictions can preclude a person from forever being an SMSF trustee/director. Given the serious consequences of disqualification, it is important to consider the circumstances in which a person may have been automatically, and even unknowingly, disqualified.

SMSF members should also consider that their children, as a child who gets caught out with a petty conviction, may subsequently discover that they can no longer be or become a member of their parents’ SMSF. This might seriously impact the family’s succession plans.

What is a ‘dishonest’ offence?

A person can be disqualified if they are convicted of an offence involving dishonesty. This is regardless of whether the conviction was in Australia or anywhere overseas. There is also no time limit that applies — a conviction in one’s youth even if they are under 18 years of age can forever preclude that person from becoming an SMSF member.

Unfortunately, there is no clear guidance on what convictions constitute “dishonesty”, and indeed, “dishonest conduct” is not defined in the legislation. However, the ATO has provided several broad examples of such convictions, including fraud, theft and illegal activities or dealings. Notably, disqualification can occur for convictions occurring at any time, including convictions that were not recorded by the court for reasons of the person’s age or due to the conviction no longer being publicly available.

While dishonesty may be apparent or obvious in many cases, there is often some grey areas where the specific intent and severity of certain acts may not readily constitute dishonesty and require expert advice to determine whether there is an issue.

For example, is a teenager who is convicted of fare evasion on public transport forever precluded from being a member of their family’s SMSF?

If we refer to the Explanatory Memorandum to the legislation, there is guidance including an example of a minor (under 18 years) shoplifting 20 years ago charged with an offence involving dishonesty that would disqualify them as an SMSF trustee/director.

This raises an interesting dilemma in terms of comparative culpability, as arguably a violent assault or even murder could be done without dishonest intent, and therefore would not result in disqualification.

Should the legislation be designed to apply this strictly? Are there any exceptions to being disqualified?

Generally, a person convicted of an offence involving dishonest conduct is a disqualified person for life. However, there is one important exception in cases which do not involve “serious dishonest conduct”.

Serious dishonest conduct is an offence where the penalty imposed can involve a term of imprisonment for more than two years or a fine of more than 120 penalty units. This equates to a monetary penalty of $25,200 (a penalty unit is $210 on 1 July 2019 and this amount is indexed each 1 July).

In a case where the dishonest conduct was not deemed “serious” (i.e. it involves less than two years’ imprisonment or less than 120 penalty units), an application can be made to the ATO seeking a waiver of the disqualified person status. Such an application must be made within 14 days of the conviction, unless good reason for the delay is provided to the ATO’s satisfaction. (See, for example, Mourched v FCT [2014] AATA 223 where the ATO refused to grant an extension of time beyond the 14-day deadline.)

Consequences of disqualification

If someone continues to act as an SMSF trustee when they are disqualified, they will be committing an offence with significant criminal and civil penalties. Furthermore, it is an offence for an SMSF trustee/director to become disqualified and fail to notify the ATO immediately.

It is also important to note that a person’s legal personal representative (e.g. an attorney acting under an enduring power of attorney) is also precluded from being a replacement trustee/director in place of a member who is a disqualified person, which generally forces a disqualified person to forever cease to be an SMSF member within a six-month period of their conviction. This is based on the usual six-month grace period that an SMSF has to restructure to comply with the trustee-member rules in s 17A of the Superannuation Industry (Supervision) Act 1993 (Cth) before ceasing to be an SMSF. That is, a member who is convicted of an offence involving dishonesty must cease immediately from being an SMSF trustee/director, but the SMSF will not contravene s 17A until after a six-month period.

Are there any other options?

Where an SMSF has a member who is a disqualified person who cannot obtain a waiver, the following options are available:

  • The first is to roll over the disqualified person’s account balance to a large (Australian Prudential Regulation Authority, i.e. APRA) super fund; for example, an industry or retail super fund.
  • The second is to convert the SMSF into a small APRA fund by appointing an APRA-approved trustee (which is more correctly known as a Responsible Superannuation Entity Licensee, i.e. RSE Licensee).
  • The third, where the disqualified person has retired, attained age 65 or satisfied another condition of release with a nil cashing restriction, is for the disqualified person to withdraw all their benefits from the SMSF. Careful consideration should be given prior to withdrawing money from the super system, as the contribution rules are now very limited.

Note that any corrective action must generally occur within six months of disqualification.

Conclusions

SMSF trustees, advisers and especially SMSF auditors should continually monitor the eligibility of members to ensure they have not been disqualified. Naturally, clients are not always forthcoming about prior offences and previous indiscretions, and therefore, it is particularly important for advisers to actively consider the issue of disqualification. Advisers should include appropriate checks in their procedures to ensure no disqualified person is admitted or remains for more than six months in an SMSF. Finally, advisers should check to see if any of the SMSF member’s children may be disqualified and fine-tune their estate and succession plans accordingly.

Daniel Butler, director, DBA Lawyers

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