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  • Fledgling SMSFs – the first 18 months of an SMSF’s life

    Presentation for SMSF Association Technical Day

    Tara McLachlan, Acting Assistant Commissioner, Superannuation

    (Adelaide, 14 August; Melbourne, 15 August; Sydney, 16 August)

    Dana Fleming, Assistant Commissioner, Superannuation

    (Brisbane, 21 August; Perth, 23 August)

    Check against delivery

    It’s a pleasure to be here today and I’d like to thank the SMSF Association for inviting me to speak.

    Background

    Since the ATO became the regulator of self-managed superannuation funds (SMSFs) in 1999, they’ve grown from a niche retirement product to a significant component of the superannuation sector. From about 200,000 SMSFs, holding approximately $70 billion worth of assets, there are now over 590,000 SMSFs, with $712 billion worth of assets – which is 27% of assets held in super (as at March 2018).

    Nearly 20 years of regulating SMSFs have given us valuable insights into the sector – the motivations, behaviours and drivers of both trustees and the professionals who support them. I hope to share some of those insights today as they relate fledging SMSFs, and in particular to offer some practical tips that you, as professionals, can consider in supporting new SMSFs.

    Birth: Setting up an SMSF

    There are many reasons why individuals establish an SMSF but the main one is a desire to take an active and direct role in managing one’s own super.

    Our role as regulator is to ensure that SMSFs:

    • are established for the sole purpose of providing retirement benefits for their members
    • are managed within the bounds of the regulatory and taxation rules.

    In the hands of engaged and informed trustees who know when to seek professional advice, SMSFs can be a suitable retirement strategy. On the other hand, if a trustee is not engaged and not informed, SMSFs can be a high-risk or expensive option.

    The average number of wind-ups per year is approximately 12,000, highlighting that SMSFs are not suitable for everyone.

    Deciding to be a trustee

    Deciding to become a trustee of an SMSF is a positive step towards retirement planning but it’s not a decision to be made lightly.

    Being a trustee of an SMSF presents opportunities but also carries serious and wide-ranging responsibilities. You as professionals play an important role in helping trustees decide not only if an SMSF is right for them, but in helping potential trustees understand the importance and context of their responsibilities.

    By far we find that the majority of people in the SMSF sector seek to do the right thing and operate within the rules. I think one of the reasons is because we seek to work in partnership with trustees and professionals to regulate the sector and support trustees to plan for their own security in retirement.

    So let’s consider the lifecycle of an SMSF in terms of stages. As I’ve stated, the decision to establish an SMSF is not one that should be made lightly. There are some right reasons for setting up an SMSF and some wrong ones.

    The right reasons

    So what are some of the right reasons? An SMSF is a trust and individuals who set up an SMSF are undertaking to be trustees with the attendant fiduciary obligations to hold their retirement funds for themselves to be paid out only when certain events, such as retirement, occur.

    An article by Adrian Raftery et al, Who Starts a Self-managed Superannuation Fund and Why?External Link, based on surveys of over 500 SMSFs states: ‘… control over investments and tax minimisation are the most common reasons for starting an SMSF ... SMSF members do not show any greater financial skills than non-members, but they do display overconfidence, a higher risk tolerance and a more trusting attitude to financial professionals. Model results show that the majority of SMSF members start their funds at the suggestion of financial professionals’.

    So the decision to set up an SMSF rather than contributing to an APRA fund is usually driven by the desire to set up a structure that allows individuals to set aside assets for their retirement while still retaining control and management of those assets.

    However, it’s that ability to control and manage assets that brings other players, who are not interested in retirement, into the SMSF sector.

    The wrong reasons

    Wrong reasons for setting up an SMSF:

    • some individuals see an SMSF as a vehicle to allow them to roll their protected retirement money out of an APRA fund and into an account they can access to use as they wish – to pay bills, for holidays, a new car and so on. These individuals never had any intention of managing their own super and established an SMSF to gain illegal early access to their benefits. We also see promoters operating in this space, assuring participants that this practice is OK
    • other schemes operate by pulling on the heartstrings of average Australians struggling to enter the housing market. Retirement savings are targeted by promoting the buying of the property through an SMSF, often with a complicated limited recourse borrowing attached, with no regard to the size of the SMSF or its ability to grow retirement savings.

    I think we can all agree we don’t want to see these kinds of activities flourish or be ignored. Remember, you are our eyes and ears and we’re keen to work with you to make sure these behaviours are discouraged and, where appropriate, penalised.

    It’s for these reasons, to foster transparency and confidence, that the ATO maintains super fund lookup and does its new registrant work – which sets the scene for that first crucial step in an SMSFs life – its birth.

    If a person determines that an SMSF is right for them, there are some important steps they need to take and on which they should consider seeking professional advice. It is at these initial stages that you as professionals will start to get involved in creating and shaping the SMSF and the trustees’ understanding of their obligations. There are useful resources and checklists on our website, covering topics including:

    • choosing between individual trustees or a corporate trustee
    • creating the trust and trust deed
    • appointing trustees or directors
    • setting up a bank account
    • obtaining an electronic service address
    • preparing a windup strategy.

    Ideally where trustees follow these steps and you as advisers have helped them undertake appropriate due diligence, when you seek registration from the ATO there should be no issues and the SMSF will receive its ABN and be registered on Super Fund Lookup (SFLU; a public register of super funds that third-party funds and employers can use to determine if they can pay rollovers or contributions to an SMSF) within 28 days.

    The thing to remember is that this is really just about due diligence and informed decision making, both on your part as professional advisers and ours.

    The role of the ATO

    At this point, I’d like you to consider the crucial role the ATO plays in only allowing genuine trustees into the SMSF sector and that it is the registration process that is the initial threshold for this.

    Like you, we recognise the importance of a segment with a good reputation and which operates as intended for members. Therefore, to help maintain the integrity of the SMSF sector the ATO does two things. We maintain SFLU and we undertake pre-registration checks on newly registered SMSFs and new members added to existing SMSFs.

    How professionals can help trustees

    What we want to see from potential trustees establishing an SMSF is that they:

    • clear about their purpose in setting up an SMSF
    • have considered whether an SMSF is the right vehicle for them
    • are aware of the costs, initial and ongoing, involved in running an SMSF and understand the risks, time and resources required and compliance obligations.

    While it’s not mandatory, we encourage all potential trustees to complete a trustee education course.

    We also want to check that a new SMSF or individuals associated with it are not a risk of illegal early release or non-compliance. Our new registrants checks are based on analytical risk models that look at a number of factors and data related to the new SMSF or new members.

    Risk factors

    Risk factors we consider include individual members’ and trustees’ financial history and behaviour. For example, the following may trigger a review of the SMSF’s registration:

    • bankruptcy
    • debts owed to the ATO
    • outstanding lodgments
    • poor lodgment or payment compliance history
    • ability to maintain an ongoing super fund
    • whether the individual has been linked to any other SMSFs of concern.

    We also look at administrators, agents and other professionals associated with the SMSF for similar issues, including:

    • any history or links to past SMSF clients of concern
    • debts owed to the ATO
    • poor lodgment or payment compliance history of their current and past clients.

    Structural and set up issues

    Some of the structural and set up issues we look at are:

    • whether the SMSF has been established correctly
    • if member, trustee or corporate trustee details have been completed
    • has the SMSF’s financial infrastructure been set up correctly.

    What happens if we identify a risk?

    If we identify a risk through the above factors, we will undertake further checks and interviews with the trustees to ensure they:

    • are genuine about wanting to establish an SMSF
    • understand their obligations and the consequences of failing to comply
    • have received adequate professional advice or undertaken education.

    What appears on SFLU during the registration process?

    At this point it might be helpful to discuss what appears on SFLU during the registration process.

    Processing

    When an SMSF seeks to be registered with the ATO it’s listed on SFLU with the status ‘Election to be regulated being processed’. This means it hasn’t gone through or is in the process of going through our new registrant check.

    At this time the SMSF can’t receive contributions or rollovers from third parties.

    No concerns with registration

    If the SMSF is not a risk, or our checks address our initial concerns then the SMSF’s status on SFLU will be updated to ‘registered – status not determined’. This allows the SMSF to receive contributions or rollovers from third parties.

    Concerns with registration

    However, if we still have concerns at the end of the review process we will update the SMSF’s status on SFLU with ‘registration details withheld’. This 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 those non-genuine players who want to be in the SMSF sector for non-retirement reasons.

    Review rights

    Naturally as a regulator we’re subject to review processes. Therefore, trustees can seek a review of our decision to withhold registration details on SFLU. However, they will need to address the concerns we raised during the new registrant check.

    Some facts about registrations

    In the 2017-18 income year, there were about 26,000 SMSF registrations with approximately 2,100 of these subject to further review. Of those reviewed:

    • 621 (29%) had their ABN cancelled
    • 336 (16%) had their details withheld from SFLU.

    The role of SMSF professionals

    SMSF professionals play an integral role in the registration process. Specifically, we suggest that advisers review their clients’ tax, debt, and lodgment history and make sure they have a clean bill of compliance health before they seek to register an SMSF on behalf of the client.

    Advisers might also like to consider the risk factors I outlined previously as these will assist with streamlining the registration process. For instance, it’s important to remember that tax agents should not use their own agency’s bank account when registering the SMSF. The SMSF must hold its own bank account for super purposes.

    Important regulatory considerations at establishment

    At this early stage it’s also important to look ahead for life events such as marriage, divorce or death that may impact an SMSF.

    While I know many of us would prefer to not dwell on some of these events it is prudent to ensure from the outset that there is a strategy to deal with them and to 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 should they arise.

    For example this may influence how you advise potential trustees on:

    • including certain clause in the trust deed
    • the decision as to whether to choose a corporate or individual trustee.

    Baby steps – first year of operation

    Let’s now talk about some of the key things to remember during an SMSF’s first year of operation. Here are some tips for new players and the professionals who support them.

    Context – retirement versus personal use

    So, the SMSF has been established, it has received contributions and rollovers and it’s now time for its core function to come into play – the investment and management of those funds so as to grow the members’ retirement balance and help provide for a comfortable and sustainable retirement.

    Because of the concessional tax environment afforded to super funds, the job of investing and growing that balance is governed by specific rules and is a lot more complicated than if you were just investing your personal savings.

    Personal use of this money or current-day benefit goes against the policy for why the tax concession was given in the first place. That’s why funds, including SMSFs, agree to be regulated and comply with the super and tax laws.

    Trustees are accountable for actions and decisions

    A significant portion of SMSF trustees engage and rely on professional advisers, however, as we know it is the trustee of the fund who is ultimately responsible.

    This places an onus on you as advisers to not only ensure your advice and administration ensures the fund complies with the rules but to do so in a way that helps trustees understand the legal or equitable obligations that underpin why the fund needs to be run a certain way.

    Reporting and lodgment obligations

    A core obligation is lodgment and reporting.

    Lodging the SMSF annual return (SAR) is so important in the first year as it:

    • provides assurance to the fund and trustees that they are complying and on track
    • demonstrates to the ATO that the trustee can run their SMSF properly.

    Some other important tips are:

    • in the first year, the due date for the SAR is 31 October. An SMSF will only move to a due date of 28 February once it had lodged its first return on time (and it must continue to lodge on time to retain that lodgment date)
    • the SMSF won’t be a complying fund and SFLU won’t be updated to ‘complying’ until the first SAR has been lodged and we assess the fund’s compliance
    • if an SMSF fails to lodge their SAR, their status on SFLU will be changed to ‘regulation details removed’.

    As you know, an SMSF must be audited before lodging its SAR. So a good tip, especially for new SMSFs, is to talk to your client early about who will audit the fund and what records and paperwork will be required.

    Investment rules

    The investment rules deserve a significant portion of an adviser or trustee’s time to understand, but there are some key ones I’d like you to think about.

    Sole-purpose

    All investment decisions must be for the sole purpose of growing and providing retirement benefits. Investments that provide current-day benefits to members or to related- parties of the fund may contravene the sole-purpose test.

    We have just had a recent decision on this by the Full Federal Court in Aussiegolfa v FCT. As you’ll appreciate the decision was only handed down recently so we’re still considering it, but I think it’s still fair to say the sole-purpose test will remain an important consideration for trustees and advisers.

    Related-party dealings

    The super laws have specific prohibitions with limited exceptions in respect of related-party dealings; for instance an SMSF is prohibited from acquiring most assets from fund members and strictly prohibited from lending to members or relatives.

    A good tip for trustees and advisers is to list all related parties of the fund right from the start and make sure they check the investment restrictions if contemplating a transaction with any of these parties.

    Borrowing

    SMSFs are prohibited from borrowing, although there are some exceptions; the main one being limited recourse borrowing arrangements (LRBAs). The point that trustees and advisers should note is that LRBAs are very specific borrowing arrangements which involve a holding trust and as such it’s important to get good advice on set up and structure to make sure you don’t inadvertently contravene the borrowing provisions.

    It’s also important to remember that an LRBA can only be used to acquire an asset that the SMSF is allowed to acquire under the super laws. If the trustee tries to acquire an asset the law doesn’t allow, this will result in a borrowing contravention.

    Payments out of the SMSF

    Because the trustee of an SMSF is also the member it is very important that advisers inform trustees about the need to carefully document payments made by the fund:

    Investment decisions

    Where the payment represents an investment decision, it’s crucial that this aligns with the SMSF’s investment strategy, is clearly documented and that the asset is properly registered in the fund’s name. The importance of this is so there is no doubt about the investment being for the fund and not instead the member accessing their benefits early

    Benefit payments

    Where the payment represents the members’ benefits, this should also be clearly documented both in terms of the amount and components but also the condition of release.

    It’s important to help trustees understand their retirement benefits are preserved and can only be paid in specified circumstances, some of which are quite prescriptive. Therefore I would encourage you to help trustees understand this and to approach you for advice before they make the payment.

    Where trustees don’t take their responsibilities seriously

    As the community would expect, where trustees demonstrate they’re not willing or capable of taking their responsibilities seriously, we take steps to address this.

    Hart case

    This is the perfect point at which to reflect on the matter of Hart v Commissioner of Taxation which 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.

    What went wrong? Some of the contraventions that occurred in this case were:

    • 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
    • consistent failure to comply with lodgment of the fund’s tax returns.

    Our evaluation of the individual not being a fit and proper person to be a trustee was affirmed by the Tribunal who stated that the trustees ‘behaviour could only be described as falling significantly below the standard one would expect from a competent trustee’.

    The message I take away from the Hart case is how important it for us and for you as professionals to help trustees understand that running an SMSF is not about being cavalier or taking a relaxed attitude to the rules. But neither should it be overly hard or stressful, which is why I encourage you as professionals to work with trustees, especially in that first year, to set up a good process for decision making, record keeping and regular check ins to make sure things are on track.

    Running an SMSF: the years after establishment

    So, you have helped your clients establish their SMSF and they’ve successfully made it through their first year, the fund has lodged its first SAR and received its notice of compliance from us. Essentially the SMSF is up and running.

    The takeaway message here is that while I have just gone through the importance of an SMSF’s first year, and encouraged you as professionals to help your clients establish good reporting and compliance processes, it’s not a case of setting and forgetting.

    Some important things for more mature SMSFs to focus on are:

    • reviewing the investment
    • regularly reviewing the trust deed
    • keeping up with changes in the law.

    Investment strategy

    Over time, your client’s circumstances will change and this needs to be reflected in the fund’s investments and management decisions.

    As a result, it’s important for trustees and advisers to review the fund’s investment strategy regularly to ensure it continues to reflect the purpose and circumstances of the SMSF, taking into account the retirement goals of the members, liquidity or growth needs reflecting the accumulation or retirement phase make-up of the fund and current economic and market factors.

    Trust deed

    While it’s important, at establishment, that the SMSF trust deed ensures the fund is set up to allow the trustees to manage the fund consistent with their retirement goals, again this should not be a set and forget task. I encourage you as professional advisers to think about reasonable processes and timeframes for reviewing the deed.

    Obvious times for review are when there have been changes in law or significant court cases. For example, if the law was changed to allow a new condition of release but the deed hasn’t been updated and doesn’t allow for benefits to be paid out under the new conditions, the SMSF would be restricted from making payments allowed by the new law, possibly resulting in a breach of the trust.

    Staying current

    This leads to the importance of professionals and trustees keeping up-to-date. As you’d all be aware, we’ve just been through the 2016 reforms, but super is a dynamic and interconnected industry to work in and even outside periods of major reform it’s important to stay current with developing law, financial practices and administration policy.

    As such I thought I would take you through a few updates from our perspective.

    2016-17 SAR and capital gains tax (CGT) relief

    I know this was a big year in terms of lodging the 2016-17 SAR which is why we deferred the lodgment for all SMSFs until 30 June 2018 to help trustees and advisers properly consider the reform changes and in particular the transitional CGT relief.

    To give you an update, as at 30 July, 90% of SMSFs have lodged on time and approximately 3% received a deferral based on the particular circumstances of the fund.

    Approximately 44,000 SMSFs have elected to apply the transitional CGT relief.

    Early analysis indicates that this is about one third of SMSFs potentially impacted by the transfer balance cap (TBC) and transition-to-retirement income stream (TRIS) measures, bearing in mind that trustees had a choice not to apply the relief if they thought it wasn’t in their best interest.

    I think this is a positive achievement and the ATO appreciates the efforts and support of the profession and individual trustees.

    Exempt current pension income (ECPI) and actuarial certificates

    There were several changes in the 2016 super reforms that meant SMSFs needed to look more closely at how the ECPI provisions operate. Before the 2016 reforms, individual members tended to be either entirely in retirement phase or accumulation phase. However, with the introduction of the TBC and the disregard small fund assets measures this meant that some members could no longer be entirely in retirement phase.

    The 2016-17 income year was a transitional year in that members with pensions over $1.6 million needed to bring the balance of those pensions down to $1.6 million before 1 July 2017. For some SMSFs this meant they went from using the segregated method to the proportionate method, requiring an actuarial certificate for the period the SMSF used the proportionate method.

    The ECPI method used was also an important consideration in the availability of the transitional CGT relief.

    However, moving on from the transitional year there will generally only be a few circumstances where an SMSF needs to get an actuarial certificate to claim ECPI, these are:

    • where the SMSF is paying a pension that is not an account-based pension, eg a lifetime pension
    • where the SMSF is required to use the proportionate method because of the disregard small fund assets provision, or
    • where the SMSF has accumulation- and retirement-phase interests and chooses not to use the segregated method.

    We’ve recently updated our web guidance to ensure clarity on this and to confirm our compliance approach for the 2016-17 income year, reflecting feedback that some industry practices based on the pre-reform system were inconsistent with our view of the ECPI provisions.

    SuperStream for SMSFs

    Pleasingly earlier in the year, the government announced the extension of SuperStream to include rollovers to and from SMSFs. We’re working closely with industry in the design and implementation build and it’s expected to start in late 2019.

    To date, only rollovers between two APRA funds can be transferred electronically using SuperStream. This reform will allow SMSF members to initiate and receive rollovers electronically. The benefits include:

    • reducing compliance costs for SMSF and APRA fund trustees by reducing manual, paper based processes
    • processing rollovers from APRA funds to SMSFs within days rather than months
    • improving the integrity of the super system with the mandatory use of the ATO SMSF verification service which verifies all the SMSF data provided to APRA funds before the rollover can be processed.

    SMSFs that want to participate will need to consider their own ability to interact digitally, including obtaining an electronic service address (ESA).

    This is an important opportunity for all SMSFs, whether they’re newly established or have been running for some time, to pause and consider their digital capability. There’s a lot of exciting work being done in this space to automate and streamline record-keeping and reporting processes, which can deliver cost savings as well as heighten visibility and insight into the SMSF’s operations.

    The ability of businesses, funds, and government agencies to interact digitally is becoming an increasing focus, as the work in SuperStream demonstrates, and I would encourage you to consider how your SMSF clients are preparing to be a part of this.

    Recent budget announcements

    As part of the last Federal Budget, the government made announcements intended to create greater flexibility for SMSFs and to improve and refine the super system in general. We’re still working through the details of these announcements but we will, as usual, work with industry to consult broadly and ensure that any industry concerns and practical issues are worked through in designing the law and our administrative approach.

    In relation to SMSFs, some announcements of interest include:

    • extending SuperStream to include SMSF rollovers (as already mentioned)
    • a three-year audit cycle for SMSFs with a good compliance and lodgment history. Consultation is currently underway with industry on this proposal, with submissions due to Treasury by 31 August
    • increasing the maximum number of SMSF members from four to six.

    Conclusion

    Thank you for the opportunity to speak with you today.

    Participating at events such as these is particularly important and we value the support that the SMSF Association provides us in our role as regulator and tax administrator of SMSFs.

    We also acknowledge the efforts that you provide in supporting SMSF trustees and the sector more broadly.

      Last modified: 10 Oct 2018QC 56685