• SMSFs post-super reform

    Kasey Macfarlane, Assistant Commissioner, Superannuation

    Speech to the Chartered Accountants Australia & New Zealand (CAANZ) National SMSF Conference

    Hilton, Sydney, 26 September 2017

    1 Introduction

    Thank you for the opportunity to talk at your national SMSF conference today.

    Since I spoke at your national conference in Melbourne last year we have all been through a period of reform and many changing expectations for us all and the significance for SMSFs of this important phase in Australia’s superannuation system cannot be underestimated.

    Australia’s super system currently comprises close to 600,000 SMSFs with over 1.1 million members. The estimated total value of assets held by SMSFs is approaching $675 billion.

    There is no question that SMSFs are a significant and integral part of the super system. In fact, recent media reports have highlighted that the value of super held in SMSFs has now eclipsed that of retail and industry funds.

    The significance of the SMSF sector together with the fact that we have just seen the introduction of the most significant super reforms in several years means that the partnership between the ATO as the regulator and professional bodies such as CAANZ is more important than ever.

    It is vital that we continue to work together to ensure that SMSF members who have chosen to take control of their retirement and their financial future by taking an active role in the management of their super savings are supported and have readily available information and guidance, in order to make informed financial decisions and are protected from unexpected regulatory and income tax risks.

    The ATO and CAANZ have a positive and ongoing relationship across all the different aspects of the tax and super systems, including those specific to the SMSF sector. We are very appreciative of the support that we have had from CAANZ since the enactment of the super changes in November 2016 and in the lead up to their implementation on 1 July 2017.

    Through our various consultative committees and direct engagement with the CAANZ super team headed by Tony Negline, CAANZ has been a strong voice in providing feedback, advice and insights that have allowed us to provide timely and relevant guidance and to implement practical administrative approaches to support a sensible transition for the SMSF sector in the post-1 July 2017 environment.

    2 SMSFs and the post-super reform environment

    We're almost three months past the 1 July 2017 introduction of the measures that arose from the 2016 Federal Budget super reforms. Since the measures were enacted in November 2016, and leading up to 1 July, the ATO’s key focus was directed at engaging with the SMSF sector to provide practical guidance and support for SMSFs, their members and their advisers, working from our preferred stance that ‘prevention is always better than correction’.

    We deliberately adopted a staged approach to our guidance and messaging in the lead up to 1 July. Our approach began with a campaign to provide awareness, general guidance and information through our law companion guidelines (LCGs) and guidance notes.

    We then moved towards more specific messaging and information by publishing frequently asked questions and answers about the super changes on our website, and providing practical support on particular matters through targeted practical compliance guidelines (PCGs).

    As 1 July approached, our focus shifted to providing specific and tailored information so people could undertake necessary actions before the changes came into effect including writing to people, based on data we had available, who may have been at risk of exceeding the caps and limits that apply under the new rules.

    In addition, from November 2016 leading up to 30 June 2017, we received approximately 1,400 enquiries about various aspects of the changes. Perhaps unsurprisingly, many of these enquiries related to the transfer balance cap. During this period we also had 60,000 views of our SMSF super changes web pages.

    Although 1 July 2017 has passed, this work doesn't stop. We remain committed to early engagement, early certainty and practical support to the SMSF sector and the super industry more broadly as outcomes and consequences start to materialise and further practical matters of compliance and administration become apparent. This is reflective of our pursuit to be facilitator, supporter and balanced regulator in the SMSF sector.

    I'll now move on to some specific and practical items that SMSFs need to consider now that the super changes are in full operation.

    3 Key practical matters for SMSFs post-1 July

    Whilst there are a number of different aspects to the changes that came into effect on 1 July 2017, central to almost all these are the concepts of an individual’s ‘transfer balance cap’ (TBC) and their ‘total super balance’ (TSB). Today I will focus on three key practical considerations that these concepts bring into focus for SMSF trustees and members, and which have been the subject of attention for SMSFs leading to and post-1 July:

    • visibility of up-to-date information about a member’s super interests.
    • SMSF asset valuations.
    • the regulatory and tax risks of certain planning arrangements.

    In many respects these things aren’t new. These considerations have always been relevant, necessary and important areas of focus and hallmarks of good governance that enable informed decision making in relation to an individual’s super savings in an SMSF.

    However, the relative importance of these matters is undoubtedly heightened now that the reforms announced in the 2016 Federal Budget are in full operation.

    I recognise that this audience is well versed in the various aspects of the TBC and the TSB. However, it's relevant and worthwhile to briefly recap some of the practical aspects of the operation of these two measures.

    4 Total super balance (TSB)

    In essence a member’s TSB is the sum of the accumulation phase interests across all their super interests.

    It's important to note that the value of a person’s TSB is measured and determined annually at 30 June, based upon relevant asset values supporting their accumulation and retirement phase interests at that date.

    A person’s TSB immediately prior to 30 June then impacts their contributions caps and ability to access several tax offsets in a given financial year.

    An SMSF member’s TSB also has an impact at a fund level. From 1 July 2017, an SMSF cannot use the segregated method to calculate its exempt current pension income if one or more of its members has a TSB greater than $1.6 million and at least one of its members is receiving a pension from the SMSF.

    5 Transfer balance cap (TBC)

    In contrast to the TSB, which is concerned with an individual’s accumulation and retirement phase interests, the TBC is solely focused on a person’s retirement phase interests.

    Relevantly, the TBC limits the amount or value that an individual can transfer into the tax-free retirement phase across all of their retirement phase interests.

    Because the TBC is only concerned with the movement of capital in and out of the tax-free retirement phase, pension payments, investment earnings and losses, capital growth and reductions in the value of assets don't count towards a person’s transfer balance in any way.

    The most common events that impact a person’s transfer balance are when they start an income stream or pension or when they partially or fully commute a pension and receive a lump-sum payment or transfer the relevant amount back to their accumulation interest.

    However, further changes enacted before 1 July also mean that certain limited-recourse borrowing arrangements (LRBA) loan repayments now count towards a person’s TBC.

    SMSF members receiving a transition-to-retirement income stream (TRIS) also need to be aware that their TRIS will automatically move into the retirement phase when they turn 65 or alternatively when they notify the trustee that they have met a condition of release with a nil cashing restriction and at the time that this occurs the current value of that TRIS counts towards the SMSF member’s transfer balance.

    6 Transfer balance account - credits and debits

    Unlike the TSB that is determined annually on 30 June, a person’s transfer balance is tracked continuously. As provided for in the relevant legislation a person’s transfer balance is tracked continuously through the structure of the transfer balance account.

    Critically, it's the net balance of the individual amounts tracked through a person’s transfer balance account at any given time that determines whether they have exceeded their transfer balance cap at the end of any given day, and thus whether they are subject to excess transfer balance tax and required to remove the excess from their tax-free pension account.

    If someone does exceed the transfer balance account then their excess transfer balance tax liability continues to accrue for every day they remain over the cap.

    Therefore, someone who doesn't track their transfer balance account events regularly will be exposed to an increased excess transfer balance tax liability if they inadvertently and unknowingly exceed the TBC.

    As highlighted, albeit in different ways, the practical operation of the TBC and the TSB as underpinned by the legislation and underlying policy intent of the super changes clearly envisages that super fund members, including SMSF members, will have up-to-date and timely visibility of their position in relation to the various caps and limits that apply under the super changes. That timely visibility is vital to ensure that SMSF members and super fund members more broadly can make informed financial decisions in the frame of the new caps and limits.

    7 Transitional CGT relief

    Another aspect of the super changes that flows from the TBC is that of transitional CGT relief. Of course SMSF trustees have access to temporary CGT relief for relevant assets held throughout the period 9 November 2016 to 30 June 2017 if one or more of the fund’s members needed to take action to prepare for the changes because they would be impacted by the new transfer balance cap or the changes that removed the tax-exempt status of assets that support a TRIS.

    Whilst it's not possible to cover all of the intricacies of the transitional CGT-relief rules in my allotted time, I will highlight some key practical considerations.

    Firstly, in order to avail themselves of the transitional CGT relief that applies if they are eligible, SMSF trustees must elect to do so. They are required to do this in the CGT schedule accompanying the fund’s 2017 SMSF annual return (SAR). The election is irrevocable and must be made no later than the due date of the fund’s 2017 SAR.

    There have been misconceptions that if an SMSF trustee didn’t make this election before 30 June 2017 then it’s too late. This isn’t the case. Provided the election is made by the due date of the fund’s 2017 SAR, trustees still have time to determine whether or not they wish to avail themselves of this relief.

    However, of course applicable re-set cost bases and any deferred gains need to be determined in accordance with applicable asset values at the time that relief applies. Depending upon whether or not the SMSF is using the unsegregated or segregated method this may be as at 30 June 2017 or at an earlier date when relevant assets were commuted back to the accumulation phase.

    It's important to note that it' the trustee’s responsibility to maintain appropriate records outlining relevant values and the re-set cost bases of applicable assets, as well as the individual amounts of any deferred gains. The ATO won't be keeping these records and we won't require trustees to provide this more detailed information in the SAR.

    This now brings me to the issue of SMSF event-based reporting for the purposes of the TBC.

    8 SMSF event-based reporting

    From 1 July 2018, it's proposed that SMSFs will report those events that impact their members’ transfer balances to the ATO on an events basis through what is known as the transfer balance account report (TBAR).

    This topic has been the subject of significant attention and discussion in the SMSF sector. There are some myths and misconceptions about what is actually proposed in terms of SMSF event-based reporting for the purposes of the TBC, so I'll take this opportunity to make some key points at the outset:

    1. The event-based reporting model that will apply to SMSFs from 1 July 2018 is confined to the TBC and events impacting an individual member’s transfer balance.
    2. The proposed model doesn't require SMSFs to report investment earnings, gains and losses more regularly. Similarly, it doesn't require reporting of member account balances more often; nor does it require more regular reporting of contributions or pension payments (including changes in the value of pension payments).
    3. Reporting is only required under this model if an SMSF has one or more members in pension phase and one of those members has an event that affects their transfer balance in the relevant reporting. That is, it does not require all 600,000 SMSFs in the system to report to the ATO every quarter or every month (whatever the case may be) and it doesn't require reporting of ‘nil’ events.

    Also, contrary to some common misunderstandings, SMSF event-based reporting doesn't require SMSFs to value assets in their fund monthly or quarterly and/or more regularly than they are currently required to do.

    It's also important to emphasise, regardless of the frequency of any reporting requirements, the manner in which the TBC operates; events and relevant amounts affecting a person’s transfer balance need to be tracked on an ongoing and continuous basis by SMSF trustees. Otherwise members won't be able to make informed financial decisions in the context of the super changes and will be at risk of breaching the super and taxation laws.

    Current annual SMSF reporting arrangements aren't sufficient for what people need to manage the TBC across all their super interests or for the ATO to effectively administer the TBC. The operation of the transfer balance simply doesn't contemplate retrospective construction of a person’s transfer balance account on an annual basis.

    9 What will SMSFs be required to report?

    The most common events that will need to be reported are:

    • the values of any retirement phase income stream (pension) that an SMSF member is entitled to receive, including reversionary income streams
    • the value of any commutation of a retirement income stream (pension) by an SMSF member
    • any structured settlement payment that an SMSF member receives and contributes to their fund
    • certain LRBA repayments that give rise to a transfer balance credit as a result of recently enacted legislation.

    10 Why is more regular reporting of TBC events required?

    As already noted, there are tax consequences for individual members if they exceed the cap.

    Excess transfer balance tax is payable on the notional earnings associated with any excess and the notional earnings compound daily until the member takes action to remove the excess or the ATO issues an excess transfer balance tax determination.

    Therefore without visibility of an individual’s position in relation to the TBC, they are at risk of a continually accruing and increasing tax liability.

    Unless a member knows they've exceeded the cap they're not in a position to take action to remove the excess.

    Similarly, if the ATO doesn't have visibility and isn't aware an individual has exceeded the cap then we can’t issue an excess TBC determination.

    In other words, the individual’s excess TBC liability will continue to increase and when it eventually becomes apparent that they have an excess they will be liable for a greater amount of tax than would otherwise have been the case if there had been earlier visibility of that excess.

    Moreover, without the additional visibility provided by event-based reporting the ATO won't be able to provide reliable services to warn people when they may be approaching the cap or at risk of exceeding the cap.

    These types of services are likely to be important where individuals have multiple super interests, for example, a retirement-phase interest in an SMSF as well as an APRA regulated fund. This is because the TBC is a limit that applies across all of an individual’s super interests.

    11 What are the consequences if SMSFs don't report members transfer balance account events as required and on time?

    The transfer balance account report (TBAR) is an approved form for the purposes of the Taxation Administration Act 1953 and late lodgment penalties do apply.

    However, the ATO will be taking a judicious approach in the 2018-19 year and won’t be seeking to impose late lodgment penalties unnecessarily – rather we will focus on supporting and assisting SMSFs with reporting and moving to this model of more regular reporting.

    The greatest risk of not reporting on time is that individual members may inadvertently and unknowingly exceed the cap and be faced with an unexpected and increased tax liability.

    It’s also worthwhile mentioning that contrary to some recent media reports the ATO doesn't have plans to deny an SMSF exempt current pension income (ECPI) on the basis that they haven't reported TBC events on time.

    12 The ATO's position paper about SMSF event-based reporting and feedback received

    The ATO recently issued a position paper explaining how event-based reporting of transfer balance account events will operate for SMSFs from 1 July 2018. We were aware there were concerns about the frequency with which SMSFs might be required to report relevant transfer balance events. Our position paper specifically sought feedback about two possible options in this regard.

    Under the first option SMSFs would generally report these events monthly but would be provided additional time to report the start of an income stream and LRBA loan repayment credits on a quarterly basis. The second option was that SMSFs would report relevant events quarterly for an initial transition period of say two to three years after which they would move to reporting all events monthly.

    The feedback period closed on Friday 15 September and the ATO received over 170 submissions. Overwhelmingly preferred was the second option allowing quarterly reporting for a transitional period.

    Additionally, the feedback in response to the ATO’s position paper and through other forums highlights a growing concern about the additional administrative costs that SMSFs may incur in reporting these events more regularly outside the current annual reporting requirements for SMSFs. In particular, feedback highlights concerns about the respective weighting of costs and benefits for those SMSFs with members whose super balance is significantly under the $1.6 million TBC limit.

    Moreover, the ATO needs to be in a position to administer the TBC as we are required to do, and to maintain the integrity of the TBC measure. As the administrator and the regulator, we need to be in a position to know when we need to issue an excess transfer balance determination to individuals who have exceeded the cap.

    We are cognisant that there is a need to balance administrative ease and efficiency with the need to mitigate the risk of SMSF members being exposed to unexpected and increased excess transfer balance tax liabilities, as well as allowing the TBC to be appropriately administered as intended and the integrity of the super changes maintained. Our aim is to ensure that all SMSF members are in the best position possible to make informed decisions about their super savings in light of the super changes which by their nature envisage that all super fund members will have ongoing and continuous visibility of their position in relation to the new caps and limits.

    However, we also recognise and acknowledge that a move to more timely reporting by SMSFs is a significant shift and there needs to be a sensible transition. In light of the strong feedback and concerns raised we are further considering how we may be able to provide some transitional relief for SMSFs whose members’ balances are significantly below $1.6 million. One approach may be to allow those SMSFs to report relevant events annually for a specified transitional period before being required to move to more regular reporting.

    This now brings me to the topic of SMSF asset valuations. Clearly, SMSF asset valuations are also very important in terms of a person’s transfer balance, their TSB and the application of transitional CGT relief.

    13 SMSF asset valuations

    Whilst the super changes heighten the importance of SMSF asset valuations, the requirement for SMSFs to undertake valuations of fund assets is not new. For many years now SMSF trustees have been required to determine the market value of their fund’s assets for a number of purposes under the super and income tax laws, including:

    • preparing the financial accounts and statements of the fund
    • the acquisition of assets between SMSFs and related parties
    • disposing of certain collectables and personal use assets to a related party of the fund
    • determining the market value of an SMSF’s in-house assets to a related party of a fund
    • determining the value of assets that support a member’s super pension and the associated minimum pension payment requirements.

    The super changes that came into effect on 1 July 2017 mean that SMSF asset valuations are also now pertinent for the following additional purposes:

    • determining the value of existing retirement-phase income streams as at 1 July 2017 for TBC purposes
    • determining the value of new retirement income streams on or after 1 July 2017 for TBC purposes
    • determining the market value of assets that are eligible for transitional capital gains tax relief (CGT) relief in the 2016-17 income year
    • determining the market value of assets supporting members’ retirement phase and accumulation accounts for the purposes of calculating the members’ total super balances.

    14 SMSF asset valuations in the post- super reform environment

    Three key points to make about SMSF asset valuations in the post-super reform environment are as follows:

    1. The principles set out in the ATO’s valuation guidelines for SMSFs still apply.
    2. In accordance with those guidelines an external independent valuation is not required every year. However, as also stated in the guidelines, SMSF trustees must still satisfy themselves that the values attributed to assets in their fund can be supported by objective data and evidence every year. If they're relying on an independent valuation undertaken in a prior year they must be satisfied that the valuation still reflects the market value of the asset in question.
    3. An SMSF trustee must apply relevant SMSF asset valuations consistently for all purposes. For example, different valuations cannot be adopted in relation to the same asset for TBC and TSB purposes compared to transitional CGT relief purposes.

    15 Valuing different classes of SMSF assets/investments

    Allocating a value to listed shares and other listed securities, as well as cash-based investments in an SMSF is straightforward. However, it is other types of investments, such as real property, unlisted shares and securities and investments in other assets such as art, collectables and personal-use assets that often raise questions about what is appropriate and acceptable; particularly from an ATO compliance perspective.

    Real property

    Often an independent professional valuation will be the best source of evidence to support the value attributed to an SMSF’s investment in real property. However, SMSF trustees can also rely on other data such as an evaluation by a real estate agent, comparable sales data, property valuation website data or rates notices as objective evidence to support a real property valuation.

    Importantly, if relying on evidence other than an independent valuation, such as data from property valuation websites or comparable sales data, SMSF trustees do need to ensure they have considered the assumptions and methods underlying the data to ensure that it produces a reasonable reflection of the value of the real property in question. For example, does the comparable sales data sought to be relied upon relate to properties in the same location with similar features, is the value stipulated on a rates notice an unimproved or improved value?

    A question that often arises in relation to valuations of SMSF investments in real property is what if the relevant valuation or data produces an estimated range of values that a property falls within? This is relatively common in relation to valuations undertaken by real estate agents.

    From an ATO perspective, any value within a stipulated range where that range is fair and reasonable based upon objective and supportable data will be acceptable. However, it is not acceptable to use a value at the lower end of that range for one purpose and a value at the upper end of the range for another purpose. For example, we will closely scrutinise cases where it appears that a value at the top end of the range has been used for transitional CGT relief purposes but a value at the lower end of the range has been used for TBC and TSB purposes.

    Investments in unlisted entities

    Valuing investments in unlisted shares and other unlisted securities is undoubtedly more complex. However, they must have a value. Otherwise, the question has to be asked as to why the SMSF trustee invested in them in the first instance.

    The starting point for valuing an SMSF’s investment in unlisted shares or other unlisted securities is the relevant entity’s financial statements. However, if the underlying assets held by the relevant entity are not recorded at market value in their financial statements then the trustee will need to obtain objective data and evidence as to the value of those underlying assets in order to determine the value of their investment.

    Art, collectables and personal-use assets

    The regulatory rules now require all SMSF investments in art, collectables and personal-use assets to be insured. Therefore, a clear starting point for valuing these items is the insured value as stated in the SMSF’s contract of insurance for the item.

    Alternatively, in the case of artwork and collectables an independent appraisal could be obtained from a gallery or antique dealer for example. Or if the item was only purchased in the last few months then the purchase price would be an acceptable reflection of the value of the item.

    16 Are more frequent valuations of SMSF assets required as a result of the recent super changes?

    In short, the super changes don't require frequent SMSF asset valuations. As noted at the outset, SMSFs have always been required to value their assets at least annually and at other times when certain other events occur. For example when an SMSF member starts a pension or when a fund asset is disposed of to a related party.

    Whilst the frequency with which SMSF asset valuations are required to be undertaken has not changed, the timing of when SMSF asset valuations are undertaken is considerably more important in the post-super reform environment. In many instances more timely SMSF asset valuations will be required to ensure that an SMSF member does not inadvertently exceed the TBC. For example, when a person starts a new pension.

    The final matter that I will address is that of tax planning arrangements in the context of the super changes.

    17 The regulatory and tax risks of certain planning arrangements

    From time to time we have seen the emergence of schemes and arrangements targeting SMSF members, particularly those members approaching retirement, encouraging them to undertake investments or implement arrangements intended to inappropriately channel monies into their SMSF to take advantage of the concessionary or nil tax rates that apply.

    Leading up to 1 July there was some renewed interest in these types of arrangements in light of the super changes. This perhaps was a function of the reduced caps and limits and new restrictions that apply under the changes.

    A vital part of the ATO’s role as the regulator of SMSFs is to warn people about the risks of arrangements that expose SMSFs and their members to regulatory risks. Whilst ordinarily we only find a small number of SMSFs who engage in schemes and arrangements that we consider to be significantly high risk, it's critical that we take action to prevent them from becoming a bigger problem. We don’t want to see people inadvertently putting their retirement nest eggs at risk from significant regulatory sanctions and the pecuniary penalties that can apply.

    Therefore, in November we will publish an update to our Super Scheme Smart campaign to highlight existing and new emerging arrangements that we consider are high risk from a regulatory and tax perspective. Whilst a number of the arrangements highlighted are not necessarily specific to the recent super changes, the nature of some of the arrangements may mean that they appear more attractive to uninformed SMSF trustees in light of the changes.

    In addition to the arrangements (such as dividend stripping arrangements, arrangements intended to divert personal services income to a SMSF, and non-commercial LRBAs) that we've previously warned people about in our earlier Super Scheme Smart campaigns, the pending updates will highlight the risks associated with the following arrangements and transactions:

    • contrived arrangements involving SMSF investment in property development ventures involving related parties
    • the granting of a legal life interest over a commercial property to an SMSF, and
    • arrangements where an individual deliberately exceeds their non-concessional contributions cap in order to manipulate taxable and non-taxable components of their super interest upon refund of the excess.

    We will also highlight some further arrangements directly related to the new TBC cap and TSB measures that we are closely monitoring. These arrangements are as follows:

    The use of reserves by SMSFs

    It's been suggested that the recent super changes, particularly those relating to the TBC and the TSB are likely to see an increased use of reserves in SMSFs.

    Whilst the establishment of a reserve in an SMSF is not strictly prohibited, the ATO considers that there are very limited circumstances when it is appropriate for a reserve to be established and maintained in an SMSF. The use of reserves beyond these circumstances may suggest that they're being used as part of broader strategies to circumvent the new limits and restrictions that apply under the super changes. Any unexplained increases in the creation of new reserves or in the balance of existing reserves maintained by SMSFs is likely to attract close scrutiny from the ATO.

    We will shortly be issuing some further guidance on when it may be appropriate for an SMSF to establish and maintain a reserve.

    SMSF trustees who are considering using reserves to circumvent the TBC or TSB measures should be very wary and seek independent professional advice or seek advice from the ATO before doing so. There is no doubt that the use of reserves that appear to be an attempt to circumvent the TSB or the TBC will attract our attention and compliance activity.

    The establishment of a second SMSF intended to manipulate tax outcomes

    The establishment of a second SMSF is a strategy that is often put forward as a means to getting around the restriction on SMSFs using the segregated method to calculate their ECPI because one of its members has a TSB over $1.6 million.

    The establishment of a second SMSF by itself doesn't give rise to compliance issues, but those cases where it appears that a second SMSF has been a pre-cursor to subsequent behaviour intended to manipulate tax outcomes will attract our scrutiny. This behaviour could include, for example, switching each of the respective funds between accumulation and retirement phase.

    18 Conclusion

    I've focused today on some of the practical impacts of the super changes on SMSFs, both now and into the future. However, I'd also like to reflect on the progress we've made in bedding down the changes.

    Since last November, when the changes became law, we made a commitment to work with our stakeholders. We did so by engaging industry through consultative forums, webinars and early guidance about the new laws.

    The law companion guidelines and practical compliance guidelines published on our website remain valuable tools for tax and super practitioners as the super changes are now in effect.

    I would like to close by acknowledging that the progress made in implementing the super changes, since their enactment in November 2016 and leading up to 1 July 2017, could not have been achieved without the positive support, insights and advice provided to us by the SMSF sector and representative bodies such as CAANZ.

    Thank you.

    Last modified: 10 Nov 2017QC 53881