CHANGING FACE OF SMSFs

Transcription

1 CHANGING FACE OF SMSFs December 2014 Helping professionals grow their SMSF business

2 Contents General Advice Warning... 2 FSI Final Report... 3 Direct borrowing by superannuation fund... 3 Reforming excess non-concessional contributions tax... 5 Determination & Election... 5 No election, no release... 7 Associated Earnings... 7 Example... 8 Release amounts from super... 9 Full release example Commissioner s discretion if value of superannuation interest is nil Example SMSFD2014/1 TRIS commutation and counting towards payment amounts Example SIRN Update on related party LRBAs & Non-arm s length income Purpose of the Superannuation Industry Relationship Network (SIRN) Scope Issues raised Outcome Comment ATO update - inability for SMSFs to cross-insure from 1 July Example Grandfathering ATO update ability for SMSF trustees to maintain electronic records Minimum timeframes Recent Cases Deputy Commissioner v. Graham Family Superannuation Pty Ltd [2014] FCA Changing Face of SMSFs June

3 General Advice Warning This presentation provides general advice only. No direct or implicit recommendations are given in this presentation. This means that the general advice provided has not been prepared taking into account any individual s financial circumstances (i.e. investment objectives, financial situation and particular investment needs). The SMSF Academy Pty Ltd believes that the information in this presentation is correct at the time of compilation but does not warrant the accuracy of that information. Save for statutory liability which cannot be excluded, The SMSF Academy disclaims all responsibility for any loss or damage which any person may suffer from reliance on this information or any opinion, conclusion or recommendation in this presentation whether the loss or damage is caused by any fault or negligence on the part of presenter or otherwise. This document has been prepared based on information available to 10 December The SMSF Academy, 2014 Changing Face of SMSFs June

4 FSI Final Report Direct borrowing by superannuation fund Recommendation 8: Remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds. Concerns about the growing use of leverage inside superannuation raised the attention of the Financial Systems Inquiry (FSI) Panel, in particular focusing on the increase in risk on Australia s financial system that direct borrowing provides. With Australia s retirement system built on a foundation of savings, not leverage, the recommendation by the FSI Panel is to remove section 67A of the SIS Act prospectively. This reference aims to reinstate the existing borrowing provisions contained within section 67 to simply short term liquidity management purposes (e.g. settlement of securities and payment of benefits). The FSI panel has noted the continued interest and growth of limited recourse borrowing arrangements, with total amounts borrowed increasing from $497 million in June 2009 to $8.7 billion in June The recommendation seeks to address the issue that the FSI Panel believes that whilst leverage is in its infancy within superannuation, further growth of direct borrowing would overtime, increase risk in the financial system. The limited recourse nature of these borrowing arrangements delivered protections for superannuation monies by limiting the exposure of member s retirement savings to the acquired asset. However, because of these higher risks associated with such lending, lenders had the ability to charge higher interest rates and frequently required personal guarantees from trustees. Even with mechanisms in place to limit a fund s exposure, the Panel highlighted that under financial duress with these arrangements, it is likely that the trustees will sell other assets of the fund to repay the lender, particularly where a personal guarantee is involved. As a result, LRBAs are generally unlikely to be effective in limited losses on one asset from flowing through to other assets, either inside or outside the fund. The fact that this potential downside is effectively being underwritten by taxpayers through the Age Pension system is also of concern. Stability of Australia s largely unleveraged superannuation system was important throughout the global financial crisis (GFC). The absence of leverage broadly benefited fund members and enabled the superannuation system to have a stabilising influence on the broader financial system and economy during the GFC. Although the level of direct leverage is relatively small, if left to continue to grow at current rates (18 times growth over last 5 years) it could pose a risk to the financial system in the future. The Reserve Bank of Australia (RBA) stated that The Bank endorses the observation that leverage by superannuation funds may increase vulnerabilities in the financial system and supports the consideration of limiting leverage. In addition, such direct borrowing could also compromise the retirement incomes of individuals. The Australian Prudential Regulation Changing Face of SMSFs June

5 Authority (APRA) was of the view that the risks associated with direct leverage are incompatible with the objectives of superannuation and cannot adequately be managed within the superannuation prudential framework. Overarching these concerns, the Panel also expressed the view that borrowing by some superannuation funds also provided scope for members to circumvent contribution caps and accrue larger assets in the superannuation system in the longer term. As a result, the FSI Panel has concluded that direct borrowing by superannuation funds should cease and be restored to the original prohibition (prior to 24 September 2007). It is inconsistent with the objectives of superannuation to be a savings vehicle for retirement income, would preserve the strengths and benefits of the super system and limit the risks to taxpayers. Whilst acknowledging proposed alternatives to reduce the risks surrounding borrowing, it was found that such alternatives would impose additional regulation, complexity and compliance costs on the superannuation system. Should the Federal Government look to implement this recommendation, funds with existing borrowings should be permitted to maintain those borrowings. Funds disposing of assets purchased via direct borrowings would be required to extinguish the associated debt at the same time. Further details about this recommendation can be found in the FSI Final Report: Changing Face of SMSFs June

6 Reforming excess non-concessional contributions tax In what is seen as one of the final pieces to reforming the excess contribution tax puzzle, we have now seen draft legislation introduced into Parliament to reform excess non-concessional contributions tax as outlined in the Federal Budget. Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014 amends the Income Tax Assessment Act 1997 (ITAA 1997) and the Taxation Administration Act 1953 (TAA 1953) to make the taxation treatment of individuals with excess non-concessional contributions fairer. These reforms introduce measures that will allow an individual the option of withdrawing contributions made in excess of the non-concessional contribution cap made after 1 July 2013, with an associated earnings amount to be taxed to the individual at their marginal tax rate. The new law proposes to: Allow for an individual who has excess non-concessional contributions ("NCC") from the financial year or later to elect to release an amount equal to the NCC amount, plus 85% of the associated earnings amount for those contributions from the super fund. The full associated earnings are to be included in the individual's assessable income in the year the excess non-concessional contribution arose and will be taxed at the individual s marginal tax rate. The individual will be entitled to a 15% non-refundable tax offset on the associated earnings that are included in their assessable income. No excess contributions tax ("ECT") will not be imposed on these excess contributions to the extent that they are released from super, or where the value of the individual's remaining superannuation interests is nil (i.e. no super account balance). For any amounts not released, ECT will apply to the non-concessional contributions at the top marginal tax rate, unless the Commissioner has directed that the value of an individual's superannuation interests is nil (which would prevent any unreleased amounts from being treated as excess non-concessional contributions). It is important to note that there is no change to the amounts that are non-concessional contributions or to the way that an individual's non-concessional contributions cap is worked out - i.e. bring forward rule still applies to those under age 65. Commissioner discretion will continue to exist to disregard NCC amounts or allocate them to another financial year in special circumstances and where doing so is consistent with the object of the excess non-concessional contributions tax regime. Determination & Election As is with the existing ECT framework, it will be the Commissioner who must make a written determination for individuals who exceed their non-concessional contribution cap during a financial year. The determination will: state the amount of the excess contributions, Changing Face of SMSFs June

7 the associated earnings amount for those excess contributions; and the total release amount. The total release amount is the amount of the excess contributions plus 85% of the associated earnings for those contributions, and the total release amount. The total release amount is the amount that may be released from the individual s superannuation interests. A notice of determination is given to the individual by the Commissioner, who may amend this determination. Following this determination, the notified individual can elect to: to release the total amount stated within the determination, that is, the amount of the excess contribution plus 85% of the associated earnings amount, from superannuation; not to release any amount from superannuation because the value of all their superannuation interests is nil; or not to release any amount from superannuation for another reason The election must be made by the individual in the approved form. The fund trustee must release both the excess contribution and the associated earnings amounts to the maximum extent possible. Only 85% of the associated earnings amount must be released, as the fund may have already included the earnings on investments made with the excess contributions in the fund s assessable income and had been taxed on those earnings (at 15%). Individuals cannot elect to release only part of the total release amount stated in the determination. Individuals whose superannuation interests are valued at less than the total release amount stated in the determination must still elect to release the total amount to avoid excess non-concessional contributions tax. The Commissioner must be notified within 60 days of the date of issue of the determination (or further period if allowed the Commissioner). Once made, the election is irrevocable for the total release stated amount in the determination. An election to release the total amount must specify one or more superannuation providers that hold an interest for the individual from which the total amount is to be released - where more than one provider is specified, this must include the amount to be released from each provider. An individual may elect not to release an amount from superannuation because the value of all of their superannuation interests is nil. This may occur for example, if the individual has met a condition of release and has received all of their superannuation as a superannuation lump sum benefit before the Commissioner issues the excess non-concessional contributions determination. If the individual does in fact have money in superannuation but still makes this election, the election is invalid and taken not to have been made. Where an individual has commenced an income stream and continues to have an interest in the pension, they are not taken to have a superannuation interest with a value of nil. This is regardless Changing Face of SMSFs June

8 of whether the individual has the ability to commute to a lump sum. This is also regardless of whether such a commutation (or partial commutation) in order to release an amount in accordance with a release authority issued in relation to an excess non-concessional contributions determination for this measure proves problematic or otherwise undesirable for the individual or the fund. An individual can also elect to not release an amount for another reason. This election will be irrevocable in relation to the total release amount stated in the determination. In these circumstances the individual s amount of excess non-concessional contributions is the amount by which their non-concessional contributions for the financial year exceed the cap. The Commissioner will issue an assessment to the individual for excess non-concessional contributions tax in this case. No election, no release If an individual chooses not to make an election, then no amount can be released from superannuation. The individual's amount of excess non-concessional contributions is the amount which their NCCs exceed their cap. As a result, the Commissioner will issue the individual within an ECT assessment. Where the relevant election was made and the Commissioner gives notice to the individual that the super fund did not release the specified amount, the individual will be able to make a further election to release the unreleased amount from another superannuation interest. This must be made within 60 days of the notice of the further period allowed by the Commissioner. Excess non-concessional contributions tax is not imposed where the amount released is equal to the amount of excess contributions. However, excess non-concessional contributions tax will generally be imposed where the full amount is not released from superannuation (unless the value of all of the individual s superannuation interests nil). Associated Earnings An associated earnings amount that approximates the amount earned from investing the released excess contributions whilst they were in the super fund is included in the ECT determination. This earnings amount is included within the assessable income of the individual for the financial year in which the excess non-concessional contributions were made. Elections made to release are for the total of the excess non-concessional contribution amount and 85% of this associated earnings amount. This recognises that earnings within superannuation may already be taxed at a rate of up to 15%. Where the amount of the excess contributions is released from superannuation or the Commissioner determines that the value of the individual s superannuation interests is nil, the associated earnings amount is included in the individual s assessable income. This removes a taxation benefit that would be obtained by making contributions in excess of the cap despite having them released under this regime or otherwise being removed from superannuation. Changing Face of SMSFs June

9 The Commissioner will include 100% of the associated earnings amount in the individual s assessable income for the financial year in which they exceeded their cap. The earnings amount is subject to tax at the individual s marginal tax rate. However, the individual is entitled to a tax-offset equal to 15% of the associated earnings amount included in their assessable income to account for the tax liability of the super fund on these earnings. This offset is not refundable. The associated earnings amount is calculated using an average of the General Interest Charge (GIC) rate for each of the quarters of the financial year in which excess contributions were made and compounds on a daily basis. Section 8AAD of the TAA 1953 specifies how GIC is calculated. The TAA 1953 sets the GIC rate as the 90 day bank bill rate plus a 7% uplift factor. For the financial year the average GIC rate for the 4 quarters was 9.66% and a daily rate of % for the purposes of calculating the associated earnings amount. The Inspector General of Taxation's review into the ATO's compliance of excess contributions tax noted some challenges in determining a methodology in dealing with the application of earnings from these excessive amounts. To avoid complexity that would be imposed on individuals and super fund if an actual earnings amount for the period was to be applied, an approximation is used applying a general interest charge rate instead. Hence, the associated earnings calculated may be higher or lower than the actual earnings from the investment made with the excess nonconcessional contributions by the fund. As GIC is on average higher than average superannuation fund returns, it incorporates a small but appropriate disincentive for individuals to exceed their non-concessional contribution caps. The legislation does allow for the Treasurer to be able to specify an alternate proxy that is lower than the default rate (or indeed a zero rate) for any specified contributions years. For example, this would allow the Treasurer the option of setting a lower rate, possibly zero, where superannuation funds on average have made significant losses, such as those occurred during the global financial crisis (GFC). The period that the associated earnings amount is calculated for commences on 1 July of the financial year where the excess contributions occurred (contributions year) and ends on the day that the Commissioner makes the first determination of excess non-concessional contributions for the relevant contributions year. This is similar to the period used for the excess concessional contributions charge (ECCC) for excess concessional contributions. To understand this further, let s take a look at the following example: Example Jane's non-concessional contributions for the financial year exceed her nonconcessional contributions cap by $100,000. The Commissioner issues Jane an excess non- Changing Face of SMSFs June

10 concessional contributions determination on 1 November She is taken to have associated earnings calculated as follows: % x ($100,000 plus the sum of the earlier daily proxy amounts) for the 489 day period from 1 July 2013 until 1 November The result of this formula is that the associated earnings equal $13,814. The total release amount stated in the determination for Jane is $111,741, being the excess amount of $100,000 plus 85% of the $13,814 associated earnings. If Jane elects to release the total release amount, her super fund provider would pay her $111,741 in response to the release authority issued by the Commissioner. The Commissioner will amend Jane s income tax assessment to include $13,814 as extra assessable income which will be taxed at her marginal tax rate. Jane will be entitled to a 15% non-refundable tax offset of $2,073. If Belinda s marginal tax rate for this income was 37% and she was liable for the 2% Medicare levy, then she would pay overall $3,314 in extra income tax ($5,387 in tax on earnings less the $2,073 tax offset). Where the Commissioner issues a direction that the value of all of an individual s interests remaining in superannuation is nil, then the full amount of associated earnings in the determination will still be included in the individual s assessable income, subject to taxation at the individual s marginal tax rate (less the 15% non-refundable tax offset). This will ensure that the integrity of the measure is maintained in relation to the treatment of associated earnings amounts. Release amounts from super Where an individual makes an election to release the excess contribution from their fund, the Commissioner must issue a release one or more release authorities to either the superannuation providers that the individual specifies in their election or any other provider the Commissioner considers is holding a superannuation interest for the individual (or both). This will facilitate the release of as much of the release amount stated within the determination as possible. Each release authority will state the amount to be released by the provider. The trustee will be required to pay amounts of superannuation from the individual's account. Making these payments from a superannuation interest to the individual could otherwise be considered an early release of superannuation (Regulations will ensure that a condition of release will be satisfied). A fund that receives a release authority must pay to the individual the lesser of: the amount stated in the authority; and the sum of the maximum amounts that can be released from interests it holds for the individual Changing Face of SMSFs June

11 within 21 days of the date of issue of the release authority or a further period allowed by the Commissioner. The Commissioner may allow for a longer period of time where it is fair and reasonable to do so taking into account all relevant circumstances. Where the fund has multiple interests for the individual and the value of those exceed the amount specified in the release authority, the trustee can determine which interests to release the money from. The trustee may seek instructions in this regard from the individual. The fund trustee will be required to notify the Commissioner of the amount released and any amounts unable to be released or where the provider does not need to comply with the release authority. The notification must be made in the approved form and within 21 days of the date of issue of the release authority or a further period as allowed for by the Commissioner. The fund will be required to also notify the individual of an amount released within 21 days of the date of issue of the release authority or such longer period as allowed for by the Commissioner. A penalty will apply for failing to comply with this requirement. This notification will not require any information to be provided to the individual about any unsuccessful release. The Commissioner will notify the individual if the provider did not release the full amount stated in the release authority. At the same time, the Commissioner will ask the individual to make a further election in respect to the unreleased amount. The individual may nominate another superannuation fund that holds an interest for them to which a release authority may be issued for the unreleased amounts or elect not to release the unreleased amount as the value of the remaining superannuation interests is nil. The individual must notify the Commissioner within 60 days of the date of the Commissioner issuing the notice of unsuccessful release. The proportioning rule will not apply to any release amounts this is consistent with payments made in accordance with other release authorities. The amount paid to the individual by the fund in accordance with a release authority is a super lump sum benefit, but the amount itself does not have any tax consequences, i.e. it is non-assessable nonexempt income. However, the associated earnings amount is still included in the individual's assessable income. Full release example In the financial year Mark makes non-concessional contributions that result in him exceeding his non-concessional contributions cap by $100,000. The Commissioner gives him a notice of excess non-concessional contributions determination stating his excess contributions amount of $100,000, an associated earnings amount of $19,000. The Commissioner gives Mark a notice of excess non-contribution contributions determination stating his excess contributions amount of $100,000, his associated earnings of $19,000, and a total release amount of $116,150 (being the excess contribution plus 85% of the associated earnings). Changing Face of SMSFs June

12 Mark makes a valid election to release the total of $116,150 from his superannuation interests by notifying the Commissioner and specifying his SMSF that holds an interest for him. The Commissioner issues Mark's SMSF with a release authority requiring the provider to make a payment to Mark of $116,150. That amount is paid to Mark by the SMSF trustee in compliance with the release authority. The amount is non-assessable non-exempt income in his hands. The SMSF trustee notifies the Commissioner and Mark of the payment of $116,150 made in accordance with the release authority. As a result of the release Mark no longer has excess non-concessional contributions, and so is not liable for excess non-concessional contributions tax. The associated earnings amount of $19,000 is included within the assessable income for the financial year for Mark and is taxed at his marginal tax rate. Mark is also entitled to a 15% non-refundable tax offset of $2,850, being 15% of $19,000. Commissioner s discretion if value of superannuation interest is nil Circumstances may arise where an individual who makes non-concessional contributions in excess of their cap for a financial year may have already been paid some or all of their superannuation benefits (as a lump sum) by the time they receive a determination from the Commissioner. Once those benefits are paid from the super system they will no longer receive concessional tax treatment. The Commissioner must make a direction if he is satisfied that the value of all the individuals remaining superannuation interests is nil following the release of any amount stated in an excess non-concessional contributions determination, or where the individual elects not to release any amount from superannuation because the value of their superannuation interests is nil. The direction will mean an individual will not have excess non-concessional contributions that will be subject to excess non-concessional contributions tax for the financial year to which the determination relates. Where this direction is made the full associated earnings amount for the excess non-concessional contributions calculated by the Commissioner is included in the individual s assessable income. This is done to reduce any tax benefit obtained by an individual breaching the non-concessional contributions cap. The individual will be entitled to a non-refundable tax offset equal to 15% of the associated earnings amounts included within their assessable income. It is important to note that this direction is separate and in addition to the Commissioner's existing discretion under section of the ITAA 1997 to disregard an individual's non-concessional contributions or allocate them to a different financial year in special circumstances, consistent with the object of excess non-concessional tax. Changing Face of SMSFs June

13 Example In the financial year Rachel makes non-concessional contributions that result in her exceeding her non-concessional contributions cap by $100,000. The Commissioner gives her a notice of excess non-concessional contributions determination stating her excess contributions amount of $100,000, associated earnings amount of $16,150, and a total release amount of $116,150. Before receiving the determination Rachel was paid a superannuation lump sum benefit of her entire balance of her only superannuation interest. Rachel makes a valid election to not release any amount from superannuation as the value of her superannuation interests is nil. The Commissioner is satisfied that the total value of all Rachel's superannuation interests is nil, and notifies Rachel that he has directed her excess non-concessional contributions are nil. As a result of this Rachel does not have an excess non-concessional contributions tax liability for the financial year. The amount of associated earnings calculated by the Commissioner of $19,000 is included within Rachel s assessable income for the income year and taxed at her marginal tax rate. She is entitled to a non-refundable tax offset of $2,850, being equal to 15% of the amount included within her assessable income. Changing Face of SMSFs June

14 SMSFD2014/1 TRIS commutation and counting towards payment amounts The Australian Taxation Office (ATO) has released SMSFD 2014/1, a determination seeking to clarify the commutation rules for transition to retirement income streams (TRIS) where a member has unrestricted non-preserved benefits available to commute the pension. Last year, we saw the Commissioner finalise his views on when a pension commences and ceases (TR 2013/5), along with confirming through determination TD 2013/2 that where a commutation occurred from an Account Based Pension, that any withdraw, whether elected to be taxed as a lump sum would count towards the member s minimum pension obligations for the income year. The Commissioner makes it clear within TD 2014/1 that the previous determination (SMSFD 2013/2) does not apply to Transition to Retirement Income Streams. The ruling confirms that a payment made a result of a partial commutation of an account based pension that is a transition to retirement income stream counts towards the minimum annual payment amount required during an income year (SISR 1.06(9A)), unless the payment is rolled over within the superannuation system on or after June Such payments that are rolled over prior to this date will count towards the minimum annual amount. A payment made as a result of a partial commutation of a TRIS does not count towards the maximum annual amount allowed to be paid from the pension account under subparagraph (b)(ii) of the transition to retirement income stream definition within SISR 6.01(2), where the payment was made on or after 16 February Such amounts before this date will count towards the maximum annual amount. It is important to distinguish here that a payment made as a result of a full commutation of a TRIS cannot count towards the minimum annual amount or the maximum annual amount as that pension ceases before the payment is made (refer to the commutation requirements contained within TR 2013/5). To understand this further, let s take a look at the following example: Example Max has reached his preservation age (55) and has satisfied a condition of release (Item 110, Schedule 1, SIS Regs attaining preservation age) to commence a transition to retirement income stream from his balance in the ABC Super Fund (SMSF). On 1 July 2013, Max s account balance was $300,000, which included $25,000 of unrestricted nonpreserved benefits. The trustees calculated minimum annual amount of $12,000 (4%) to be withdrawn for the income year, along with a maximum annual payment of $30,000 (10%). On 1 May 2014, Max requested from the fund trustee to partially commute his TRIS to take an amount of $20,000, electing in accordance within ITAR to have the amount taxed as a lump sum. He was eligible to receive this payment from his unrestricted non-preserved benefits. Changing Face of SMSFs June

15 The trustees accordingly paid the $20,000 to Max on 3 May 2014 as a partial commutation payment from his unrestricted benefits. As a result of the partial commutation payment, this amount will count towards the minimum annual amount required to be paid for the income year. As this amount is greater that the prescribed minimum payment ($12,000), Max will have satisfied his minimum pension obligations for the financial year. Following this payment, Max requests a further amount to be paid of $15,000 to be paid as an income stream payment. As the partial commutation payment of $20,000 does not count towards the maximum annual amount, this pension payment is allowable even though Max has now received $35,000 for the income year more than 10% of the allowable maximum annual payment of his transition to retirement income stream. For the income year, Max has received: $35,000 towards his minimum annual payment; and $15,000 towards his maximum annual payment As both amounts fall within the minimum and maximum, the pension does not cease and will be allowed the claim a tax deduction for exempt current pension income (ECPI). Reference: SMSFD 2014/1, Changing Face of SMSFs June

16 SIRN Update on related party LRBAs & Non-arm s length income The Superannuation Industry Relationship Network (SIRN) met via teleconference on 19 November 2014 with 24 attendees from the SMSF Industry and the ATO. The purpose of this meeting was to seek clarity from the Australian Taxation Office (ATO) following their response in private ruling , which significantly altered the Commissioner s views on Non-Arms Length Income (NALI) for non-commercial related party loan arrangements. A summary of the topics discussed is provided below. Purpose of the Superannuation Industry Relationship Network (SIRN) The purpose of the meeting was to discuss any industry feedback on two draft ATO Interpretative Decisions (ATOIDs), distributed to members in October, on the application of section of the Income Tax Assessment Act 1997 (the NALI provision) with respect to non-commercial LRBAs. The consultation forum follows on from the meeting on 29 May 2014 where concerns about several edited versions of private binding rulings on that subject were initially discussed between the ATO and industry. Scope The Chair, Assistant Commissioner Matthew Bambrick, advised that the purpose of the meeting was as described above. Issues raised Assistant Commissioner (Senior Tax Counsel) David Schabe led the discussion by addressing the issues raised in the feedback provided by the industry participants of the SIRN. Issues discussed included: whether the holding trust is necessarily a bare trust and whether that makes any difference when applying the NALI provision in the present context whether, for the purposes of applying subsection (5), the scheme may be identified as including the establishment and operation of the loan further explanation as to why the ATO considers that it might be expected that no income would be derived by the super fund as beneficiary of the holding trust if the parties to the scheme had been dealing with each other at arm s length the history of predecessor provisions to NALI applying to non-arm s length funding of an investment by a superannuation fund whether the mischief of these arrangements should be addressed by a legislative fix whether the ATO could provide further practical guidance in this area. Changing Face of SMSFs June

17 Outcome Industry noted the meeting clarified for them aspects of the ATO s views (as set out in the draft ATOIDs) in this area, which were not previously clearly understood from PBRs issued. The ATO agreed to fine-tune the ATOIDs to make its views even clearer on a couple of issues discussed during the meeting. The ATO also agreed to consider providing some general guidance on various factors to be looked at when considering whether the terms of the borrowing, taken together, are consistent with what an arm s length lender would accept in relation to the particular borrowing. The ATO is looking to finalise these interpretative decisions prior to the end of the calendar year. Comment The current views expressed by the Commissioner for non-commercial limited recourse borrowing arrangements are not changing. Consistent with the views now expressed with private rulings (of recent times), such arrangements, in particular zero interest loans will be treated as Non-Arm s Length Income (NALI) and taxed accordingly. The Commissioner is also clear that any discount applied to an arm s length interest rate will not be a contribution, unless a circumstance arises where debt is forgiven (see TR 2010/1). Changing Face of SMSFs June

18 ATO update - inability for SMSFs to cross-insure from 1 July 2014 The concept of cross member insurance for individuals who have entered into a limited recourse borrowing arrangement to reduce or eliminate debt in the event of a member s death was a popular strategy with non-tax dependant relationships within an SMSF. This was because it provided a more palatable alternative, rather than a potential forced sale of an asset in the event of the death of a member, such as a business partner. However, as of 1 July 2014, new insurance rules were introduced aligning any insurance policies with a condition of release (with nil cashing restriction) outlined in Schedule 1 of the SIS Regulations. The Australian Taxation Office recently confirmed on their website that a cross-member insurance strategy cannot be taken out from 1 July 2014: Regulations that came into operation on 1 July 2014 do not permit cross-insurance on any new insurance products. These types of insurance arrangements are not permitted because the insured benefit will not be consistent with a condition of release in respect of the member receiving the benefit. Source: ATO, To understand the basis for cross-insurance, let s consider the following example: Example Larry, Curly and Moe are members of an SMSF (and business partners) and who is the title holder of the Business Real Property (BRP). They decide to cross-insure over the lives of each member to ensure that the debt can be paid out in the event of one or more members passing away. Changing Face of SMSFs June

19 Moe passes away. The policies held by Curly and Larry over the life of Moe are paid and credited into their member account balances. With the cash flow received from these policies, $120k is applied for Moe s death benefit, with the remainder applied to pay out the SMSF loan. The resultant outcome of the member s cross-insuring over the life of Moe is: the debt was extinguished No shortfall in liquidity to pay the death benefit It avoided a forced sale of the business premises No requirement to use discretion to transfer insurance proceeds to a reserve which would be subject to crediting rules and have potential concessional contribution cap issues in the future. The insurances premiums using a cross-insurance strategy were not deductible. Grandfathering Whilst this strategy can no longer be conducted inside an SMSF from 1 July 2014, existing arrangements in place prior to this date are allowed to continue, as they are grandfathered. For cross-member arrangements that have been implemented since 1 July 2014, you will need to consider the relevant compliance issues of this arrangement, as a breach of the operating standard, SISR 4.07D(2) can result in significant penalties. Putting in place an appropriate contract of insurance for one or more members remains as critical ingredient within the fund s investment strategy. However, for non-tax dependant relationships such as business partners and adult/child consideration will now be required about insurance arrangements outside of superannuation rather than within. Changing Face of SMSFs June

20 ATO update ability for SMSF trustees to maintain electronic records In today s digital world, the use of electronic storage for photos, documents, and other important content is very common. Superannuation law requires SMSFs trustees to keep accurate SMSF records for specified time periods. Through the use of electronic storage, it can be not only more convenient, but can reduce the cost of maintaining these records. To enable SMSFs to take of advantage of potential cost savings, the Australian Taxation Office (ATO) has updated their record-keeping requirements to allow for records to be kept electronically by fund trustees. It is important to note that records kept electronically must be easy to access and verify. Trustees are responsibilities for proper and accurate tax and super records. Taking minutes of investment decisions can help insure against trustees taking action for failed investments. Such records are must also be made available for the fund s approved auditor and the ATO, if requested. Trustees should take minutes of all investment decisions, including: why a particular investment was chosen whether all trustees agreed with the decision. Circumstances can arise where one trustee (or director of the corporate trustee) could take action against another trustee for an SMSF investment that fails on the basis that the trustee/director failed to be diligent in their duties. However, where investment decisions are recorded in meeting minutes that are signed by the other trustees/directors, these records will show that the other parties had mutually agreed with the investment strategy decisions. Minimum timeframes The following records are required to be maintained for a minimum of five years: accurate and accessible accounting records that explain the transactions and financial position of your SMSF an annual operating statement and an annual statement of your SMSF s financial position copies of all SMSF annual returns lodged copies of any other statements you are required to lodge with the ATO or provide to other super funds. The following records need to be maintained for a minimum of 10 years: minutes of trustee meetings and decisions (if matters affecting your fund were discussed, for example, you reviewed the fund s investment strategy) records of all changes of trustees trustee declarations recognising the obligations and responsibilities for any trustee, or director of a corporate trustee, appointed after 30 June 2007 members written consent to be appointed as trustees Changing Face of SMSFs June

21 copies of all reports given to members documented decisions about storage of collectables and personal-use assets. In addition to the above items, trustees must also ensure that the fund s income tax record-keeping requirements are also maintained in particular, documents on deductions, capital gains and losses. All records should be kept in writing and in English. Where a trustee decides to keep electronic records, they must be capable of verification by the Australian Taxation Office (as Regulator) and be in a form that they can access and understand. Changing Face of SMSFs June

22 Recent Cases Deputy Commissioner v. Graham Family Superannuation Pty Ltd [2014] FCA 1101 A recent Federal Court decision of the Deputy Commissioner of Taxation (Superannuation) v Graham Family Superannuation Pty Limited [2014] FCA 1101 is a timely reminder for SMSF trustees to understand the importance of their trustee responsibilities, in particular the sole purpose test. In this case, the Graham Family Superannuation Fund ( SMSF ) made 80 loans to members totalling $134, between 11 July 2008 and 30 June The Regulator successfully sought pecuniary penalties on the trustees for contraventions of the sole purpose test (s.62, SIS Act), lending money to members (s.65), in-house asset rules by making loans to members (s.84) and arm s length dealings (s.109). Judge Buchanan order penalties of: $40,000 against the respondents $28,000 for breaches of loan to members (s.65) and $12,000 for in-house asset breaches with the residential property; and $10,000 towards the legal costs of the Assistant Commissioner. The penalties were applied as $35,000 towards Ian Graham and $15,000 against Carolyn Graham, suggesting that one trustee may have been the more dominant party in many of the dealing within the SMSF. Following rollovers of the member s superannuation benefits in October 2006 ($216,047) and August 2007 ($273,113) respectively, the fund acquired a residential property, which was subsequently leased to the fund member s son fully furnished until February Throughout this time, no rent was paid by the son, accruing $60,762 of rental arrears. In addition, the fund was used to purchase a caravan, two motor vehicles, and cattle none of these items derived any income, yet insurance and other costs of these assets were paid from the SMSF. The case provides a timely reminder for trustees to ensure that the use of their SMSF is for the sole purpose of retirement. Such circumstances can only lead to the Regulator taking a heavy-handed approach to ensure that this message of non-compliance acts as a deterrent for what is a wellfunctioning industry. Changing Face of SMSFs June