• What's ahead for SMSFs?

    James O’Halloran, Deputy Commissioner Superannuation, ATO

    Address to CPA Australia, National SMSF Conference, Southbank, Melbourne, 12 August 2016

    Introduction

    Thank you for giving me the opportunity to speak at your national SMSF conference today. It is a good event to share with you some observations and common issues we will need to work together on this financial year and particularly at such an interesting stage in the development of superannuation policy in Australia.

    Superannuation reforms

    So let’s get onto the most topical part of developments in Superannuation – the Federal Government’s proposed reforms from the May 2016 Budget.

    As you are well aware the measures cover a range of proposed policy changes and these are still under development through governmental, consultative and legislative processes. For this reason there is some limitation on commentary that I can make today, however, what I can say is that the proposed measures do of course indicate an enshrining of the objectives of superannuation, reforms to concessional and non-concessional caps plus related changes intended to introduce flexibility for the movement and access to superannuation for the community.

    As this process unpacks, it does seem more than reasonable to assume that there will be reform in a number of areas, which are likely to lead to law changes which you’ll need to appreciate to give your clients advice. As a consequence the ATO in its role as the regulator of SMSFs will need to find ways to provide ongoing certainty, transparency and at the same time undertake active monitoring of the SMSF sector in a year of significant transition and change.

    We are seeing evidence of an increased interest and appetite for client level and industry information. People want information in relation to superannuation contributions made to funds by members. While not a new request the level of interest is certainly growing.

    We have already seen some examples of these increased expectations emerging with respect to the announcement of the $500,000 lifetime cap for non-concessional contributions. Since the announcement on budget night we have received an increase in enquiries either from individuals or tax professionals on behalf of their clients for calculations of non-concessional contributions. To date we have received some 8,000 phone calls or written requests which, while a relatively small number given some 9 million calls to the ATO annually, is a spike in interest which is likely to continue.

    In terms of the information that we provide, the ATO is in a unique position to bring together member contributions, income tax deductions and adjustments including any excess contributions, provided that lodgments are up-to-date. We currently hold information up to 30 June 2015. As you would appreciate, Member Contribution Statements are not due until 31 October 2016 for APRA funds and 15 May 2017 for SMSFs, so our data for non-concessional contributions of members for 30 June 2016 will not be complete until then. For the latest contribution data beyond 30 June 2015 members will need to check with their fund.

    The interest in superannuation will no doubt grow and it is evident the ATO will need to progressively move to service and of course monitor account balances and how they need to be managed. We recognise the need to be responsive in the coming financial year to assist you, the industry and superannuants – but it will take time.

    It is clear that emerging administrative design principles for us will include a recognition and understanding of the expectations of early advice and ideally improved visibility on superannuation information and advice from which people can make informed decisions and ensure they can comply with any legislative changes or consequences for their individual investment decisions.

    We do also recognise that advisors and clients will expect to be able to see in as timely way as possible how they are tracking towards the range of ‘caps’ and timing issues which may impact on their ability to access various concessions and to avoid excess contribution penalties. What this highlights for us is the need to step up how we interact with the community and make this information available through the use of technology. This will not be easy but it is on our radar. We will be speaking to industry about how this may be done or what we could do together.

    The new measures, as currently presented, will require the Commissioner to provide as much ‘early certainty’, to the superannuation industry as to how we will apply the law in our role as administrator for SMSF’s and the matters that will attract out attention. Naturally we are aware that most (all but 1) of the proposed new measures take effect as announced from 1 July 2017 so implementing the new measures will become a priority for us.

    A key part of our preparation to assist practitioners and advisors will be to work with our co- regulators, including ASIC, and industry stakeholders to understand the impacts of these measures. We want to continue to build on existing strong and informed relationships to deliver a positive client experience for all of those impacted by the work we do.

    To support the introduction of the new measures we will develop and release what we now refer to as Law Companion Guidelines. These guidelines, when finished, are public rulings and will provide our view of how the law applies. An outline of this approach is contained in Law Companion Guideline 2015/1 and such Guidelines are usually developed at the same time as the drafting of the Bill. A Law Companion Guideline will normally be published in draft form for comment when the Bill is introduced into Parliament and will be finalised soon after the Bill receives Royal Assent. It provides early certainty in relation to the application of the new law.

    Such guidelines provide insight into the practical implications or detail of recently enacted law in ways that may go beyond mere questions of interpretation. For example, a Guideline might set out factors that the ATO will be looking at as indicating a high or low risk of non-compliance. Taxpayers that apply the guideline in good faith will be able to rely upon such material.

    Productivity Commission review

    Another common matter of interest across the Superannuation Industry is the Productivity Commission inquiry into the efficiency and competiveness of the superannuation systemExternal Link.

    On 3 August the Productivity Commission released its draft proposed framework to assess the efficiency and competitiveness of Australia's $2 trillion superannuation system for community feedback. The draft report outlines a very comprehensive framework so this will be a most influential study.

    The report does recognise that the SMSF sector is a substantial component of Australia’s superannuation system. Specifically the indicators developed in this review (i.e. at chapters 5 and 6) would be potentially applied consistently across all the elements of the superannuation system, including the SMSF sector.

    According to the proposed framework report comparisons between the SMSF and APRA-regulated sectors may be useful for assessing system-wide efficiency and competitiveness.

    SMSFs observations

    Let’s now turn the focus to SMSFs, with some background information to set the scene and our observations in the last 12 months from our interactions with the sector through case work, education and support and risk assessments.

    Based on the 2015-2016 financial year we now have nearly 600,000 SMSFs and slightly more than one million members who rely on sound investment management to meet their financial needs in retirement. Therefore the importance of SMSF professionals cannot be underestimated. The number of funds is growing rapidly and as an example we receive about 2,500 new registration applications each month.

    Our focus for the year ahead

    As the theme of this conference is ‘Ensuring Advisory Excellence’ I know you will be interested about our year ahead.

    General compliance activities

    Our overall philosophy is to deal with minor contraventions in a collaborative way to help trustees rectify them. This applies the principles of empowering the individual to work with us to promote voluntary compliance.

    For less serious infringements, especially if it is the first time, we apply these principles in our approaches. For example, we accept enforceable undertakings or issue education or rectification directions. For more serious, deliberate or persistent regulatory breaches, such as if a trustee refuses to fulfil the terms of an undertaking or fails to respond to a direction, we will take firm action.

    During the course of 2015-16 we saw a 38 percent reduction in the number of funds with enforceable undertakings. Conversely, there was a 70 percent increase in the number of rectification directions issued by the ATO. We also saw an increase of total liabilities raised from slightly over $24 million to nearly $33 million plus one significant case.

    Pleasingly, there was a small reduction in the number of trustees disqualified and a significant reduction in the number of funds made non-compliant; however, there was an increase of 54 percent educational directions. These figures and compliance outcomes for 2015-16 reflect an increasing use of our new enforcement tools for regulatory breaches after 1 July 2014.

    To date, we have adopted a judicious approach in applying administration penalties, with a few hundred funds being affected.

    Let’s now discuss Retirement Planning Arrangements

    Dividend stripping – Taxpayer Alert 2015/1

    Dividend stripping is where a private company with accumulated profits channels franked dividends to a fund instead of to the company's original shareholders.

    As a result, the original shareholders escape tax on the dividends, and the original shareholders (or individuals associated with them) benefit as fund members from franking credit refunds to the SMSF.

    These arrangements concern us because they are intended to shield dividend income at a low or zero rate of tax, rather than ‘top-up’ tax being paid at the individual shareholder’s marginal rate, and the fund being entitled to a refund of franking credits.

    The potential issues with these arrangements include Part IVA, Division 7A and CGT implications as well as regulatory breaches.

    In seeking to be clear about our concerns, in November 2015 we offered trustees who had implemented dividend stripping arrangements, as described in Taxpayer Alert 2015/1, to voluntarily disclose and self-amend their annual returns in exchange for reduced or nil penalties.

    Pleasingly responses to this offer have already resulted in the unwinding of approximately 17 arrangements, the repayment of some $3 million of incorrectly claimed franking credit refunds and prevented future payment of some $2.7 million franking credit refunds from 2015 onwards.

    Income tax related issues

    While we acknowledge that SMSF auditors are not obligated to report income-tax related issues; these arrangements can raise potential regulatory issues (e.g. in-house assets, valuations and the sole-purpose test) and auditors do need to take them into consideration.

    Indeed we currently have 53 cases on hand at various stages of investigation, involving an estimated $24 million in franking credit offsets claimed arising from potential dividend stripping cases.

    Diversion of personal services income (PSI) - Taxpayer Alert 2016/6

    Another area to draw attention to is the diversion of personal services income (PSI). These are arrangements where income for services undertaken by an individual are paid to their fund, either directly or through one or more entities.

    They concern us because their intention is to shield personal services income earned by an SMSF member at the lower or zero rate of tax applicable to super funds, instead of at the marginal tax rate of the individual who earned the income.

    Potential issues with these arrangements are whether it is ordinary or personal services income, and if the fund is meeting its SISA obligations, including whether or not it is being maintained for purposes other than providing retirement benefits for members or death benefits for their dependants.

    Non-lodgment of SMSF Annual Returns

    The non-lodgment of annual returns is a focus area for good governance. In 2015-16 we conducted activities to deal with funds that had never lodged or had multiple outstanding annual returns.

    In one example a trustee failed to lodge superannuation annual returns (SAR’s) for 6 years of income and failed to enter into a payment arrangement for the fund’s income tax debts. The trustee did not maintain appropriate accounting records in regard to the $100,000 in assets held from 2009. The same trustee also had a personal income tax debt with a history of failing to lodge personal income tax returns – overdue for 6 years. This trustee is now an undischarged bankrupt and we made the fund non-complying resulting in a raised default assessment for approximately $50,000 and a further $35,000 in penalties.

    If trustees are not willing to engage with us to bring lodgments up-to-date and rectify any fund irregularities, then this strongly indicates that the fund should be exited from the system. Our response is to facilitate this and in many cases the trustees will be disqualified.

    Addressing technical issues and irritants

    This year we have been working with the industry to ensure that you have a say on technical issues and we addressed the key irritants you've told us about. Recent initiatives include:

    • in late May this year we introduced a new early engagement and voluntary disclosure process specifically for SMSF trustees to resolve issues early on. This service provides a single entry point for trustees and professionals to engage early with us about unrectified contraventions. More on this later.
    • we provided certainty regarding ‘safe harbours’ for limited recourse borrowing arrangements (LRBAs). We worked with a small group of your peers to develop safe harbour guidelines about when we will accept that an LRBA is structured on terms consistent with an arm’s length dealing.

    Trustees whose LRBAs are structured on terms consistent with the safe harbour guidelines can be certain they will not be subject to the Non-Arm’s Length Income (NALI) provisions, which result in relevant income being taxed at the highest marginal rate of 47 per cent rather than the lower rates that ordinarily apply to income of SMSFs.

    It should be noted that the ATO is now allowing SMSF trustees additional time until 31 January 2017 to ensure that any LRBAs that their fund has are on terms consistent with an arm’s length dealing, or alternatively are brought to an end. Trustees will not be subject to compliance action before this date.

    Serious enforcement action

    We sensibly but with intentionality take strong action against serious non-compliance. Rather than talk about what we can do, perhaps of interest is what behaviour we have had to take action against, albeit in a very small number of instances.

    A recent matter in the Federal Court resulted in an SMSF trustee being fined $40,000 in penalties and barred from acting as trustee for serious contraventions involving unauthorised withdrawals (Deputy Commissioner of Taxation v Rodriguez). The court found the trustee had a history of making unauthorised withdrawals including 12 unauthorised withdrawals in the 2010/11 financial year, totalling $70,930, which were for the personal benefit and use of the respondent.

    In another matter, during an investigation in 2015–2016, we identified the sale of multiple properties which were owned by the fund. We believed that the proceeds of those sales [over $5 million] was diverted offshore to personal accounts and not returned to the benefit of the SMSF. Some of the properties remained in the SMSF, and the trustees were pursuing the sale of those properties. We took action under s264 of SISA to freeze the remaining assets of the SMSF, which was in the order of some millions of dollars in value. We formally disqualified and removed the trustees from the fund and facilitated the appointment of an independent trustee.

    Considering there are about 600,000 SMSFs, the number of funds that we make non-complying is relatively small. This reflects our approach of reserving this action for the most serious cases, given its punitive impact.

    Super scheme smart

    While we take the matters I have just discussed seriously, our preference is to provide proactive help, education and support.

    Through traditional and social media coverage, you may have noted two weeks ago we launched the ‘ATO Super scheme smart’ Initiative aimed at educating advisers and individuals about the potential pitfalls of retirement planning schemes.

    Of course I encourage you to review the material available on our website and consider it in your dealings with clients. Based on initial reactions, it has been pleasing to see both tax and SMSF professionals have retweeted and actively supported the initiative and its messages.

    The program forms part of the ATO’s broader focus on tax avoidance schemes – and seeks to provide targeted information for financial planners, accountants, and other advisers to help them identify, avoid and report illegal schemes.

    As an awareness package people most at risk of being targeted are pre-retirees who are looking to put significant amounts of money into retirement, particularly SMSF trustees, self-funded retirees, small business owners, company directors and individual property investors.

    These schemes which seem attractive normally have one or more of the following features in common:

    • artificially contrived with complex structures, usually connected to an existing or newly created SMSF
    • a significant amount of ‘paper shuffling’
    • designed to give the taxpayer minimal or zero tax, or even a tax refund
    • aim to give a present-day tax benefit
    • if it sounds ‘too good to be true’, it normally is.

    Support and Assist

    In addition to campaigns such as Super scheme smart, we challenge ourselves within the ATO on what more we can do to support those willing to comply.

    The two most recent main initiatives are the early engagement and voluntary disclosure service; and a more targeted approach to ATO engagement with funds that have Auditor Contravention Reports (ACRs) lodged.

    Early engagement and voluntary disclosure service

    As I mentioned earlier, the early engagement and voluntary disclosure service is for trustees to resolve issues early on and was launched on 30 May 2016.

    To expand on this point, early engagement is in a trustee’s best interest because it is taken into account when considering the level of enforcement action and penalty remissions. Since this service has been introduced we have received 31 voluntary disclosures. To date, the type of contravention reported most often via this service relate to loans and pension payments. To use this service all you need to do is download and submit the form, or submit a written application with supporting documentation via email, fax or post. During the next year we will build on this tool by ensuring that issues which can be resolved by a phone call are not elevated into ‘paper wars’.

    Targeted ATO engagement with SMSFs where ACRs identify regulatory issues

    As the ATO has stated on many occasions, regulatory violations reported to us through Auditor Contravention Reports are a key source of intelligence about compliance levels for each fund and we consider every ACR that is submitted. This will not change over the next year; however, our response will change under some circumstances.

    In 2014-15 there were 22,000 breaches reported in 8,200 funds. From these, over 50 per cent had been rectified when reported in the ACR. Previously, after receipt of an ACR and a review of risk models and fund attributes, if a fund was assessed as high risk, it would automatically be selected for a comprehensive audit.

    However, this year we will be changing our approach. Instead, where trustees are willing to engage with us, they will be supported to self-correct and rectify compliance issues through the early engagement and voluntary disclosure model and/or from targeted mail outs. Again, this reflects our principles of empowering the individual to voluntarily comply.

    This shift in emphasis leaves us to concentrate more intensive compliance activities on the most serious of breaches.

    Broader Integrity approaches

    With respect to auditor independence and the quality of audits undertaken it is now three years into SMSF auditor registration, which introduced clear requirements and standards for SMSF auditors. We work very closely with ASIC as the co-regulator of SMSF auditors and our collective efforts continue to produce good outcomes for the benefit of the sector.

    While ASIC is responsible for determining eligibility requirements, setting competency standards and taking enforcement action where appropriate, we have continued our role of monitoring SMSF auditor compliance and referring non-compliant auditors to ASIC. In the last calendar year we have referred 7 SMSF auditors to ASIC which have contributed to 17 misconduct actions undertaken by ASIC such as disqualification or suspension orders.

    To engage with industry we co-chair a stakeholder liaison group with ASIC comprised of representatives from relevant associations (including CPA Australia) and practitioners. It provides regulators with an opportunity to engage with the SMSF audit industry to explore how to better support auditors and ensure standards are maintained.

    We are currently focussed on those auditors not operating within professional standards in regards to independence and the quality of audits.

    Auditor Independence

    When it comes to independence, historically a significant component of our work has focused on some very fundamental cases of independence risks identified through data holdings and intelligence. For instance, an auditor audit’s their own or a relative’s fund. Pleasingly, since the start of SMSF auditor registration, we have seen a decrease in these types of cases from about 90 in 2013-14 to about 50 in 2015-16.

    In 2015-16 we expanded our focus on SMSF auditor independence to review instances where our data and intelligence indicated that the auditor of a particular fund also acted as the tax agent for the same fund.

    We contacted about 360 auditors identified as being both the tax agent and auditor, asking them to complete a questionnaire providing details about any other services they provide to their SMSF audit clients. We were particularly interested in understanding whether these auditors also prepared the financial statements and accounts for their SMSF clients, which would create a clear self-review threat.

    It should of course be noted that 17 per cent (61 of the 360) had taken action to manage their independence.

    Our analysis of the responses suggests that 25 per cent (90 of the 360) require further scrutiny. We will soon be contacting these auditors with a view to undertaking a more detailed review of their audit activities and, dependent on outcomes, we will make referrals to ASIC for possible enforcement action.

    Not surprisingly, a large number of SMSF auditors have their own SMSF. We have begun analysing the extent to which auditor’s audit their auditor’s SMSF – that is, reciprocal auditing arrangements. An early indication is that almost 1,000 auditors (or 500 reciprocal arrangements) could be involved in this type of arrangement.

    We will now liaise with industry on this issue. We will be contacting these auditors to outline our concerns and asking them to cease this practice to ensure they fully meet their independence requirements.

    SMSF audit quality low-cost auditors

    A key component of our program of work for 2016-17 is directed towards reviewing audit quality, with a focus on ‘low-cost auditors’. This follows industry concerns about whether the quality of audits from some low-cost providers is sufficient to meet industry standards.

    We appreciate the number of factors that could explain the prevalence of low-cost providers, such as a competitive market, economies of scale, and systemisation or automation of elements of audits and offshoring arrangements.

    Where low-cost audits result in quality work, we’re pleased that funds have these price options available. However, we have listened to industry concern that some low-cost providers may not be conducting quality audits – if they are really conducting any audit at all – so it is these behaviours that we intend to identify and treat.

    To date, we have found that even though advertised low costs are widespread, many auditors only advertise low fees as a starting point for basic audits which rise on a sliding scale for more complex work.

    We’re more concerned with auditors who guarantee low-cost audits that don’t consider a fund’s complexity. We become even more concerned where this is coupled with guaranteed short turnaround times. It’s these features that alert us to conduct compliance checks.

    No doubt it is in all our interests to ensure that auditors are undertaking quality and independent audits. Where we identify a low-cost auditor not completing quality audits we will take further action. We don’t want to see diligent auditors losing clients to these sorts of operators.

    Working with co-regulators, government agencies and industry partners

    Working across and with our co regulators is important to find ways to have complimentary strategies as we are conscious of the potential impact and indeed costs of regulation.

    One focus area this year will be a content review of the exam that is part of the registration process to ensure it remains relevant and appropriate to industry standards and working together to identify and act on opportunities to update or expand guidance material.

    We’ve also been working with external stakeholders, particularly with SMSF audit software providers such as MyWorkPapers (previously Auditflow) and Caseware, to understand what impact their products have on the audit process and how that might affect costs.

    Co Design with you

    As part of the ATO’s transformation, we take seriously stakeholder collaboration and information exchange.

    To this end we engage with the SMSF sector and relevant professional associations, such as the CPA, in a number of ways:

    • our peak external consultative forum is the Superannuation Industry Stewardship Group, which concentrates on strategic superannuation issues in the national interest
    • ongoing and specific consultations about specific and emerging technical issues. For example, a Superannuation Industry Relationship Network working group on the LRBA safe harbour issue as previously mentioned.

    Conclusion

    In closing, it would be remiss of me not to mention how the ATO has been working to transform how we interact with you and your clients. We have been challenging ourselves to give all Australians the best possible experience of the tax and super systems. To help shape our change journey blueprint we sought input from thousands of people. Our starting point was to ask stakeholders how they interact with us and what they want. They told us we should fix the basics, provide certainty, tailor services to their needs and help them navigate the system. This formed the basis of the ATO’s change journey.

    We have since been transforming our services to make things easier and better for you. This underpins our vision to be a contemporary and client-oriented organisation known for expertise and acting with integrity. Specifically for SMSFs we are working on more streamlined services to make it easier to navigate the registration and wind-up processes. We are also laying the foundations for better online experiences – for example online SMSF registration and change of details.

    A central part of our change agenda is the increased importance we place on building confidence in our role as regulator and administrator for the tax and super systems. This approach is expected to lift voluntary compliance by placing greater emphasis on collaboration and transparency with our stakeholders. We recognise that we are ‘all in this together’, that is, equal and interdependent stakeholders to protect and promote the retirement savings of all Australians.

    The ATO is always pleased to participate in events such as this as they play an important role in generating debate, promoting understanding of often complex issues and ultimately contributing to the common good in numerous ways.

    I look forward to the outcomes of today's discussions and to the common purpose that would seem to be likely to be identified from the conference.

    Thank you.

      Last modified: 15 Aug 2016QC 49889