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  • Trust and confidence in self-managed superannuation funds: our common purpose

    James O’Halloran, Deputy Commissioner, Superannuation, ATO

    Opening address to the Chartered Accountants Australia and New Zealand

    National SMSF Conference

    Tuesday 18 September 2018

    Crown Promenade Conference Centre, Melbourne

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    Introduction

    Thank you to Chartered Accountants Australia and New Zealand (CAANZ) for the opportunity to join you today.

    It’s a pleasure to share some observations and advice from the ATO’s perspective as regulator for the self-managed superannuation fund (SMSF) sector.

    One of the fundamental motivations for establishing an SMSF is the desire to be self-directed and self-sufficient in managing one’s retirement savings.

    The ATO recognises the significant role SMSFs play within the Australian financial sector – they make up some 27% ($712 billion) of assets held in super in Australia. So by any measure, the SMSF sector is a key part of the Australian super and retirement landscape.

    We also recognise the valuable contribution made by tax agents and advisers in guiding the investment decisions of SMSF members and trustees.

    To be clear, the ATO does not have prudential oversight of SMSFs. This is why we have always emphasised working in partnership with financial professionals and helping SMSF trustees to understand their obligations. However, as you appreciate, our role does not stop at education and assistance.

    An essential element of what we do is to uphold and work with you to protect the integrity of the sector. We also aim to address behaviour that seeks to take advantage of the closely held and concessionary nature of an SMSF or which seeks to undermine the retirement system by accessing savings in circumstances not allowed under the law.

    A foundation piece worth reminding us all about is trustee obligations. Whether a trustee or director of a corporate trustee, these people are responsible for running the fund and making decisions that affect the retirement interests of each fund member, including themselves.

    As importantly, a trustee or director must:

    • act honestly in all matters concerning the fund
    • act in the best interests of all fund members when making decisions
    • manage the fund separately from their own affairs
    • know, understand and meet their responsibilities and obligations
    • ensure that the SMSF complies with the law.

    These foundational obligations are not unreasonable and more importantly they are ones that the community and indeed you would expect of any investment sector. Indeed they are well in line with community expectations and general governance principles. From my perspective they are not overly complex for any reasonable person, with or without support and advice.

    To give you a sense of our journey as a regulator, we made our first SMSF fund ‘non-complying’ in 2001 and disqualified our first trustee in late 2003.

    Since then we have also advocated for a wider range of regulatory controls, including directions powers and administrative penalties to help maintain the integrity of the SMSF sector. We did this so we could respond appropriately to deal with the different circumstances in which SMSFs may find themselves if they breach the law or regulations.

    Of course at the same time, our role as regulator of SMSFs involves facilitating, monitoring and regulating trustees. Trustees have chosen to undertake an important duty with all the attendant obligations of managing their own retirement savings.

    Our regulatory approach

    Simply put, we regulate by managing the registration process and who enters the sector; monitoring approved auditors and the behaviour of trustees and their compliance with lodgment obligations.

    At the same time, especially during periods of reform, we seek to enable early engagement and provide certainty of how the Commissioner is going to apply the law, while also recognising there will be transitional issues that need to be addressed.

    Our focus

    As regulator, we focus on behaviour in the market after such significant reforms to see what patterns and trends are emerging. Now that we’re well into the post-implementation stage of reform, I can share some aspects of interest to us.

    Total super balance and transfer balance cap

    As you would know, central to the super changes that took effect on 1 July 2017, was the introduction of two important new concepts: the total super balance (TSB) and the transfer balance cap (TBC).

    Both these requirements are based on a dollar value of $1.6 million that introduces limitations to the concessionary tax environment afforded to super and are central for the broader Australian tax environment, as outlined in the policy settings now well in place.

    As these concepts are key foundational pieces for fund members, the importance of actively monitoring and considering them cannot be underestimated.

    Market-linked pensions

    As part of the implementation of the TBC, we’re aware of circumstances where market-linked pensions had been commuted on or after 1 July 2017 resulting in a transfer balance debit of nil.

    Where the individual then starts a new market-linked pension, this may cause them to exceed their TBC. To assist, we recently issued a Client Relationship Team Alert 066/2018: Advice for funds where members have a market-linked pension on this matter. The government does recognise the unintended consequences associated with the current law and is committed to ensuring smooth implementation of the 2016–17 super tax changes.

    As such, our ATO practical compliance approach will be not to take compliance action at this stage if a fund doesn’t report the transfer balance account events of the commutation or the start of the new market-linked pension.

    As outlined in the alert, we won’t take any compliance action at this stage where the fund has reported the transfer balance debit for the commutation as other than nil.

    Reserves

    The use of reserves is another area where we recognise there was a need for more information; SMSF Regulator's Bulletin 2018/1: The use of reserves by self-managed super funds, released on 15 March 2018, discusses our approach to reserves created before and after 1 July 2017.

    To give you a sense of scale, we estimate that about 1,900 SMSFs reported reserves in their 2016–17 annual return, totalling $375 million. This is an average value of $192,000 in reserves. Of these funds, 35% (690) have not previously reported reserves. To date, ‘new’ reserve amounts equate to approximately $65 million, with the average value of these ‘new’ reserve amounts equalling $95,000.

    Events likely to attract close scrutiny from us include any unexplained increase in new reserves, increases in the balances of existing reserves, or allocation of amounts from a reserve directly into the retirement phase. Where SMSFs implement strategies using reserves designed to circumvent restrictions in the super and income tax legislation, thereby weakening the integrity of these measures, we will consider the potential application of the sole-purpose test under section 62 of the Superannuation Industry (Supervision) Act 1993 (SISA) and Part IVA of the Income Tax Assessment Act 1936.

    With the release of Regulator’s Bulletin 2018/1, we will now be looking to examine the more recent return data from the 2016–17 financial year to see any trends post the introduction of the TBC.

    Given this, trustees should be mindful that in order for the allocation not be counted as a concessional contribution it needs to be allocated in a fair and reasonable manner to all members of the SMSF and the amount must be less than 5% of the member’s total super interest in the SMSF.

    Where an SMSF does have reserves, we will be looking to see whether they’re being maintained by a trustee in line with the sole-purpose test. Section 62 of SISA requires the trustee of an SMSF to ensure the fund is maintained solely for legislated core or ancillary purposes, most commonly the provision of retirement benefits.

    So, before establishing any reserving strategy, it’s important you and your trustees have carefully reviewed the SMSF’s trust deed to ensure it has the ability to create and manage the limited type of reserves identified in the bulletin as being appropriate in an SMSF.

    In any event, where reserves are kept, the trustee must formulate and put in place a strategy for their prudential management. These must be consistent with the entity’s investment strategy and its ability to discharge its liabilities as and when they fall due as required by paragraph 52B(2)(g) of SISA.

    It should also be noted that where an SMSF is maintaining more than one reserve, the investment strategy may apply to all reserves or alternatively each reserve may have its own investment strategy.

    To summarise, our work in the coming year will focus on examining new or increased reserves in the 2016–17 income year where the facts and circumstances indicate the reserve was used as a means of circumventing the 2016 reforms.

    Multiple SMSFs

    Another emerging issue is the use of multiple SMSFs to manipulate tax outcomes. Given the recent introduction of the TBC, and disregarded small fund assets provisions, we will closely scrutinise arrangements where an individual with multiple SMSFs acts within these funds to circumvent the intended outcomes of these measures; for example, if the individual repeatedly switches between accumulation and retirement phase in these funds to ensure that large gains and income are always incurred by assets in the retirement phase, achieving a greater effective tax exemption than would ordinarily be available.

    At a baseline level, we believe there are some 13,600 trustees who have more than one SMSF, with 35 trustees having more than five SMSFs.

    You should note the ATO does recognise there are genuine reasons for multiple SMSFs. Events which may give rise to multiple funds include:

    • blended families – wanting to keep particular assets or amounts separate for a particular family unit
    • large families
    • business versus family – similar concept to blended families where there is desire to keep business assets separate from family assets in the business SMSF that is then leased back to the business
    • differing investment strategies (life stages) – a risk strategy of sorts, as younger people in accumulation can afford to make longer term or higher risk investments, whereas those in pension phase need liquidity.

    I raise this matter because while the establishment of multiple SMSFs does not of itself contravene any regulatory provision, we are examining instances where it appears the establishment of another SMSF has been a precursor to behaviour intended to manipulate tax outcomes.

    A combined role – SMSF regulator and administrator of the tax system

    Our role as regulator is combined with our responsibility to administer the tax system.

    We ensure SMSF compliance with the Superannuation Industry Supervision (SIS) Act and Regulations which forms the basis for SMSFs to receive concessionary tax treatment. We also of course, administer the tax system which involves far more than just ensuring SMSFs pay the right amount of tax or receive the correct refund.

    Our dual role as regulator of the SMSF sector and administrator of the tax system has been even more evident since the implementation of the 2016 super reform measures. These encompass a whole range of contributions or pension caps. While the caps are specifically relevant to an individual, the closely held nature of an SMSF means that in our dual role we must take a whole-of-tax and super system approach to ensure SMSFs continue to be operated within the bounds of the law, and that the integrity of the sector is maintained.

    The role of professional associations such as CAANZ and of the professionals within the SMSF industry cannot be understated in achieving this and I would like to acknowledge the significant investment you have made in our collaborative relationship.

    While we don’t always agree, it’s clear from our extensive consultation that the integrity and success of SMSFs is of the utmost importance to both the ATO and the SMSF industry. We recognise the important role of advocacy that CAANZ undertakes with government and appreciate the involvement and expertise of its members in the many ATO consultation groups.

    SMSF registration

    The ATO’s administration and regulation of SMSFs intersects across several phases of a person’s life. As such, we’re involved with many of you in important administrative and regulatory processes relating to the creation and conduct of an SMSF.

    In the 2018 income year, approximately 26,000 new SMSF registrations were made with approximately 9% (2,100) of these funds taken off line for further reviews. Of these, 29% (621) had their ABN cancelled and 16% (336) had their details withheld from Super Fund Look Up with the public indicator reported as ‘registration details withheld’. This was done to ensure ongoing regulatory integrity.

    ‘Withheld’ status means third-party employers or super funds can’t pay any contributions or rollovers to the fund. This is a necessary safeguard to protect against non-genuine players who want to be in the SMSF sector for apparent ‘non-retirement’ reasons. In these types of review situations, our risk model and processes examine factor such as:

    • individual members’ and trustees’ financial history, behaviour and business acumen
    • compliance of administrators, agents and other professionals
    • structural and set-up issues.

    The importance of an SMSF being a compliant fund is essential, given the concessionary nature of the super settings and implications for the correct tax treatment for income tax purposes. A fund that is not compliant and not operating as intended is of concern and for that reason we seek to take action, as you would expect us to do on your behalf.

    To this end, what we seek to see through our registration processes is that individuals establishing an SMSF:

    • are clear about their motivation for setting up an SMSF
    • have considered whether an SMSF is the right vehicle to meet their short- and long-term retirement savings goals
    • are aware of the costs involved when establishing an SMSF. We all know there are organisations that offer easy and inexpensive SMSF start-ups but there are ongoing costs associated with running and meeting the legislative obligations of the fund
    • understand this cost and how high costs can potentially impact retirement lifestyle
    • understand the risks, time, resources and compliance obligations associated with setting up and running an SMSF.

    The role of professionals in the registration process

    As SMSF professionals, you play an integral role in the registration process. Specifically, you need to review your clients’ tax, debt and lodgment compliance history and make sure they have a clean bill of compliance health before you establish an SMSF on their behalf.

    It is also important that you look ahead for life events that may impact an SMSF, such as marriage, divorce or death. While I know many of us would prefer to not dwell on some of these events it’s prudent to ensure from the outset that there is a strategy to deal with them and wind up the SMSF if necessary. As an SMSF is a long-term retirement vehicle and unexpected events can occur, thinking about these issues at establishment can help handle these situations when they do arise.

    Approved auditors

    The ATO works closely with ASIC as co-regulator of approved SMSF auditors. The ATO monitors the conduct of these auditors and may refer compliance matters under section 128P of SISA to ASIC, as the registration body.

    Where ASIC determines an approved SMSF auditor has been non-compliant, they may take enforcement action, they can:

    • impose or vary conditions on the approved SMSF auditor’s registration
    • issue a court enforceable undertaking
    • cancel the approved SMSF auditor’s registration
    • disqualify or suspend the auditor from being an approved SMSF auditor.

    Trustees

    Now I will turn to the role of trustees and trustee behaviour. The ability to operate an SMSF is an important obligation and one which the ATO takes seriously. Trustees who run an SMSF need to remember their role comes with a range of legal obligations.

    As financial advisers and experts in the SMSF sector, we rely on you to advise your trustees appropriately and to ensure they’re meeting their obligations.

    There are a range of emerging behaviours which I’ll talk about later that focus on investment choices by trustees and this is where you play a key role. However, I’ll start with some of the more fundamental requirements: two of these are the obligation to lodge on time, and ensuring that a withdrawal of money from the SMSF meets a condition of release.

    Lodgment

    Keeping SMSF lodgments up to date is a cornerstone obligation for any trustee in a properly operating SMSF. As at 30 July 2018, some 90% of SMSF returns for the 2016–17 financial year were lodged on time. While this is good, it still highlights there are some trustees out there not meeting their lodgment obligations.

    Moreover, due to some concerted effort from tax agents and the ATO, from approximately 49,000 SMSF non lodgers as at July 2018, over 22,000 funds have either re-engaged with us and lodged all overdue SMSF annual returns or decided to exit the system and wind up their fund.

    No matter how large a compliance issue may be, if the SMSF and their adviser are genuine in wanting to return their SMSF to complying status, if they engage with us we will work with them to try to find a resolution.

    On our radar now are some 27,000 registered SMSFs that have not lodged since their establishment, including some 8,900 funds that registered in the 2016–17 financial year and have not as yet lodged their 2016–17 return.

    While this number is improving, we’re concerned that in some cases, this may be an indicator of illegal early release of funds. So we will continue to look at funds that have not lodged a return since they registered where we can see that at least one of the members has rolled money out of an APRA super fund account.

    Transfer balance reporting (TBAR)

    Event-based reporting was introduced for the SMSF sector this financial year.

    By the end of July 2018, approximately 23% (135,000) of SMSFs had reported TBC information to us.

    And we had high volumes of transfer balance account reporting from SMSFs in June and July 2018.

    As many trustees who needed to have now provided us with the initial TBC information for their members we’re moving to business as usual where many SMSFs will have limited TBAR reporting obligations. TBAR is for important transactions that affect a member’s transfer balance account such as starting a pension and commuting an amount. It’s often when making decisions like these that a trustee or fund member seeks advice from advisers or tax agents.

    There has been some commentary calling for a similar approach to declarations for TBAR reporting as the concessionary approach recently announced for Single Touch Payroll. Under Single Touch Payroll, employers with 20 or more employees are required to report at each pay event, which could be as frequent as weekly. Under the announced approach, agents can get an engagement authority from the employer instead of obtaining the declaration required under the Taxation Administration Act 1953 for each report. We’re not considering extending this approach to SMSFs.

    Although those SMSFs whose members have more complex affairs may have more events to report, it’s not expected the reporting will be as frequent. Based on the information reported to us on the TBAR, as at 30 June 2018 we had issued approximately 2,000 excess transfer balance (ETB) determinations to individuals who were members of SMSFs. We expect that some of these determinations will be amended or revoked as further information is reported to us, for example if a member rectified a small excess under the transitional rules.

    However, some individuals will need to act on these determinations and ensure the excess is commuted in full, including cents, by the due date. Trustees will then need to ensure that the commutation is reported to us no later than 10 business days after the end of the month, otherwise we may send a commutation authority to the member’s fund and the member will be at risk of having the money removed from retirement phase twice.

    If the individual needs more time to respond to a determination or to allow their fund to correct any reporting issues, they should contact us on 13 10 20 to request an extension of time. Note, we can’t grant an extension of time if we’ve already sent a commutation authority.

    We appreciate agents want to be able to see the information we’ve relied on when determining their client has exceeded their TBC. Agents for the individual member will be able to do so through our online services environment when it moves into public beta testing, which is expected to be later this year. In the meantime, your client can access this information through their myGov account, download the information and email it to you.

    I would remind you that ETB determinations do not issue to SMSFs, or any other funds; they issue to individuals (members) taking into account their reported retirement-phase income streams across all their funds.

    Trustee disqualification

    For the financial year 2017–18 we disqualified 257 trustees who were trustees for 169 funds. Illegal early release (IER) of funds and loans to members were the reasons for disqualification in over 70% of cases.

    More broadly, the disqualifications were many and varied but included:

    • some 124 funds had trustees disqualified for allowing early access of benefits to members or providing loans to members
    • some 64 trustees were disqualified for unrectified contraventions reported through ACRs
    • some 16 trustees were disqualified for taking part in tax planning arrangements such as dividend stripping
    • some five were disqualified for non-lodgment of the SMSF annual return.

    Disqualified trustee - Hart’s case

    This brings me to Hart’s case.

    In reflecting on nearly 20 years of regulation, it’s clear that the vast majority of SMSF trustees seek to do the right thing and operate their SMSF within the boundaries of the regulatory and tax rules. However, some do not, and Hart’s case is a good example of the firmer action we take where trustees don’t comply with their obligations

    The matter of Hart v Commissioner of Taxation was recently heard by the AAT. In this case the Tribunal upheld the Commissioner’s decision to disqualify the individual, for not being a ‘fit and proper person’ to be an SMSF trustee.

    The AAT found:

    • there was a failure to keep assets of the fund separate from personal or business assets
    • the fund acquired property from a related party of the fund in contravention of the law
    • the trustee allowed a charge to be placed over an asset of the fund
    • the trustee failed to comply with payment standards and allowed early access to member benefits
    • there was a consistent failure to comply with lodgment of the fund’s tax returns.

    Our decision to disqualify the trustee on the basis they were not a fit and proper person was affirmed by the Tribunal who stated that the trustee’s ‘behaviour could only be described as falling significantly below the standard one would expect from a competent trustee’.

    SMSFs and streaming arrangements

    The introduction of the transfer balance cap (TBC) brings renewed focus to this area, as the basis of the TBC is to capture the movement of capital transfers to and from retirement phase for each individual. This most commonly occurs by starting or commuting a retirement-phase super income stream, specifically not built to capture accrued growth or losses in retirement phase. As such we will continue to monitor schemes or arrangements designed to stream income into the super environment, or in particular, the retirement phase.

    As advisers you need to be mindful of the regulatory and income tax risks that arise from particular planning arrangements, many of which may appear attractive in light of the new caps and limits brought in from 1 July 2017.

    Our program of work examining dividend stripping cases is ongoing and we will renew our focus on any emerging behaviour as a result of the recent reforms. Given this, it’s worth highlighting some of the results to date and reflecting on the Commissioner’s approach to these cases as well as the impact an adverse finding has on the individuals involved.

    The key driver behind this body of work is to change the behaviour and to protect the integrity of the retirement-income system. The Commissioner has shown his commitment to seeing these cases through to finalisation with the following outcomes to date:

    • a number of trustees have been removed
    • some funds have lost their complying status
    • arrangements have been unwound in a significant number of cases.

    Many of the cases have been referred to the GAAR panel and have received a positive recommendation of Part IVA application

    These outcomes only tell part of the story though. It’s more important to focus on the human impact of these sanctions. There are significant repercussions for individuals who are identified as implementing these arrangements. Most of the individuals involved are nearing, or have reached, retirement age. There is a significant amount of anxiety and stress placed on the trustees/members when challenged about the fund’s involvement in the scheme largely because they are at a point where they are planning the next phase of their life. 

    Some trustees have been formally disqualified whilst others have voluntarily agreed to cease acting as a trustee of an SMSF indefinitely. This action alone has severe repercussions for the individuals involved and should not be taken lightly. The consequence is that the fund must be restructured or wound up. This isn’t an easy task in most of these cases, especially where the fund has complex non-passive investments that can’t easily be unwound or liquidated.

    In a large number of cases, in concluding the audit, the Commissioner has stipulated the fund must divest itself of its investment in the related entity to ensure future compliance with the law. Once again this can be quite difficult and can come at considerable cost and heartache to the trustee. The threat of a fund losing its complying status is also a huge risk for trustees who are involved in arrangements of this nature. Whilst the Commissioner acknowledges it is a severe and detrimental outcome on the retirement savings on the members, it is nevertheless an action the Commissioner will consider as an appropriate measure in the most blatant of cases. We have removed the complying status in a small number of cases which is a significant, but warranted, price for trustees to pay for being involved in an aggressive arrangement of this nature.

    It’s worth noting the Commissioner will seek to apply the promoter penalty legislation where warranted. This is particularly relevant in light of the recent reforms and the potential for arrangements to be designed to circumvent the new rules.

    High-balance funds

    One way we’re identifying these kinds of arrangements is by implementing a deliberate strategy this financial year to review our highest balance funds. We will progressively review the top 100 ranked SMSFS based on the total assets reported by the funds in their 2016–17 return. Specifically, we will be looking at non-arm’s length income, dividend stripping and structured tax arrangements designed to avoid tax.

    We will do this to ensure the money moving into the fund is taxed at the appropriate point and trustees are not gaining inappropriate access to concessional tax treatment unavailable outside the super environment.

    Looking forwards – 2018 budget announcements

    The future environment for SMSFs continues to reflect change. The government recently made some policy announcements that are before parliament. As these are finalised through the parliamentary processes, they’ll need to be considered for their impact. However one I would like to mention now is the ability for SMSFs to be able to more efficiently roll over contributions from APRA funds to their SMSF.

    SuperStream expansion to SMSFs

    Currently, rollovers are primarily processed manually and often involve multiple interactions between the SMSF member and their APRA funds. As about 65,000 rollovers to SMSFs are completed annually, the administrative costs and impacts are potentially significant for both the APRA funds and the SMSFs.

    Including rollovers to SMSFs in SuperStream is expected to start in late 2019. This will improve the quality of data and the timeliness of rollovers and reduce processing time, making it more consistent with the APRA rollover data standard. In essence it will align with the current APRA SuperStream standard for rolling over super accounts, within three days of initiation, reducing manual interactions and repeat engagements between SMSFs and APRA funds. As a result, trustees will experience greater ease in rolling over accounts through the ATO’s online portability tool and faster allocation of monies.

    Data security is important to everyone and we’re aware there are some concerns in industry that this proposal may lead to identify theft and possible fraud. In early August, we met with industry (both APRA and SMSF) to talk through the design of an SMSF verification service, our thinking so far and to gauge design concerns. Key to our design will be the SMSF Verification Service (SVS) which will enable APRA funds to electronically verify an SMSF and trustee or member before a rollover occurs.

    But APRA funds and their administrators won’t be able to rely solely on the SVS to meet their ‘know your client’ obligations. They’ll still be required to use current processes and procedures before processing rollovers to SMSFs in order to satisfy the trustee processes and obligations, based on anti-money laundering obligations.

    The information in the SVS request message will be verified against ATO-held data (not the bank) to confirm:

    Conclusion

    In summary, the focus areas the ATO would like you to take away from today are:

    • make sure your clients are well informed about what it means to be a trustee of an SMSF and all the legal and reporting obligations that go with this role before they apply for registration
    • encourage your clients to think about the future and plan for events such as death, breakdown in relationships and other events that may impact their SMSF
    • make sure the person who audits your client’s SMSF is independent and meets the high standard of professional and ethical behaviour required of an auditor
    • make sure your clients meet their ongoing reporting obligations and make informed investment decisions that meet the sole-purpose test and comply with the law.

    Of course I encourage you as advisers and experts in the SMSF sector to reflect on your own role as key influencers and indeed guardians of the SMSF sector and how it’s seen and trusted.

    We remain committed to working with you and to playing our part in ensuring the self-managed super fund sector remains a trusted and valued part of Australia’s retirement-income system.

    Thank you.

    Last modified: 19 Sep 2018QC 56804