Stronger Super measures for SMSFs: Bills introduced

Superannuation Legislation Amendment (Reducing Illegal Early Release and Other Measures) Bill 2012

Income Tax Rates Amendment (Unlawful Payments from Regulated Superannuation Funds) Bill 2012

The Superannuation Legislation Amendment (Reducing Illegal Early Release and Other Measures) Bill 2012 (the Bill) and Income Tax Rates Amendment (Unlawful Payments from Regulated Superannuation Funds) Bill 2012 (the Rates Bill) have been introduced into the House of Reps. The Bills seek to implement the following Stronger Super measures for the Self-Managed Superannuation Fund (SMSF) sector:

·         Administrative penalties for SMSF trustees;

·         Promoter penalties for illegal early release schemes;

·         Taxation of unlawful superannuation payments;

·         Roll-overs to SMSFs - AML/CTF obligations.

Penalties for SMSF trustees

The Bill will establish an administrative penalty regime for SMSF trustees for certain contraventions of the SIS Act. Broadly, the proposed new penalty powers are designed to provide the FCT with a "smaller stick" (via an ATO administrative decision) to "encourage" recalcitrant SMSF trustees to quickly remedy defects, rather than rely purely on the existing heavy-handed enforcement powers.

If a trustee/director of an SMSF contravenes one of the SIS Act provisions listed in proposed section 166 of the SIS Act, the person will be liable to an administrative penalty as follows:

·         60 penalty units - sections 65(1), 67(1), 84(1), 106(1);

·         20 penalty units - sections 106A(1), 34(1);

·         10 penalty units - sections 35B, 103(1), 103(2), 103(2A), 104(1), 104A(2), 105(1);

·         Five penalty units - sections 124(1), 160(4), 254(1), 347A(5).

Note: From 28 December 2012, a penalty unit will be set at $170 (up from $110). Accordingly, the administrative penalties for SMSF trustees will range from $850 to $10,200.

Any costs imposed under the proposed administrative penalty regime will be payable personally by the person who has committed the breach (and cannot be paid or reimbursed from assets of the SMSF): proposed section 168 of the SIS Act. The FCT will be able to impose the administrative penalty on an SMSF trustee using the existing machinery provisions for penalties in Division 298 of Schedule 1 to the TAA.

Rectification and education directions

The FCT will also be given the power to issue SMSF trustees with "rectification directions" and "education directions" for contraventions of the SIS Act and SIS Regulations.

A rectification direction may be given if the FCT "reasonably believes" that an SMSF trustee (or a director of the corporate trustee) has contravened the SIS Act or Regs in relation to the fund: proposed section 159 of the SIS Act. A rectification direction may require the person to take a specified action to "rectify" the contravention and to provide the ATO with evidence of the person's compliance with the direction. "Rectify" will generally involve putting into operation managerial or administrative arrangements that could reasonably be expected to ensure that there are no further contraventions of a similar kind.

  

A person to whom a rectification direction is given will be required to comply with the direction before the end of the period specified in the direction. Failure to comply with a direction will be a strict liability offence (10 penalty units). In deciding whether to give a person a rectification direction, the FCT is required to have regard to any financial detriment that might reasonably be expected to be suffered by the fund and the nature and seriousness of the contravention.

Education directions

An education direction may require a person to undertake a specified approved course of education within a specified time frame and provide the ATO with evidence of completion of the course. Trustees and directors of corporate trustees will also be required to sign or re-sign the SMSF trustee declaration form to confirm that they understand their obligations and duties as SMSF trustees. The ATO will be able to approve courses of education for the purposes of the education direction. However, a fee must not be charged for an approved course.

A person may object against a decision of the ATO in the manner and timeframe set out in Part IVC of the TAA. Unlike enforceable undertakings where a person is not limited to the undertaking it may offer the ATO, a rectification direction given by the FCT will be restricted to rectifying contraventions of the SIS Act or SIS Regulations. However, a rectification direction will not affect the operation of enforceable undertakings under section 262A of the SIS Act.

Date of effect

The amendments will apply to contraventions that occur on or after 1 July 2013.

Tax rate for unlawful payments

The Rates Bill will amend the Income Tax Rates Act 1986 to tax the "unlawful early payment remainder" of superannuation benefits received in breach of the legislative requirements at 45% (instead of the individual's marginal rate).

Date of effect

The amendments to the Income Tax Rates Act will apply to assessments for the 2013-14 income year and later income years.

Roll-overs to SMSFs

The Superannuation Legislation Amendment (Reducing Illegal Early Release and Other Measures) Bill 2012 proposes to include a roll-over to an SMSF (from a superannuation fund that is not an SMSF) as a "designated service" under section 6(2) of the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (AML/CTF Act).

Under the AML/CTF Act, a reporting entity which offers a "designated service" to a customer must first carry out a procedure to identify and verify the customer before providing a designated service to the customer. The trustee of a superannuation fund (other than an SMSF) effecting the roll-over is the provider of the designated service. The customers of this designated service are the member of the transferring fund who requests the roll-over and the SMSF that is receiving the roll-over.

Accordingly, superannuation funds transferring benefits (roll-overs) to SMSFs will be required to comply with a range of AML/CTF obligations, such as:

·         Customer identification and verification of identity;

·         Record-keeping;

·         Establishing and maintaining an AML/CTF program;

·         Ongoing customer due diligence; and

·         Reporting (suspicious matters, threshold transactions and international funds transfer instructions).

Date of effect

This measure will apply to roll-overs to SMSFs made on or after 1 July 2013.

Copyright © 2013 The Institute of Chartered Accountants in Australia

Sick Fall Back on Super

By Sue Dunlevy

Tens of thousands of Australians had to raid more than $100 million from their superannuation savings to pay for medical bills in the past three years after health funds and Medicare failed to cover the full cost of treatment.

Department of Human Services data obtained by The Sunday Mail show 14,000 Australians applied to access superannuation savings to pay for medical costs and 8000 people were given access to $79 million in payouts.

Another 1700 people with a terminal illness claimed a further $19 million in early superannuation payouts and $12 million was paid to allow more than 1000 people with a disability to modify their homes or vehicles.

The growing call on superannuation savings to pay medical bills has laid bare a growing health funding crisis.

Breast cancer patient Leonie Havnen, who had to raid her superannuation to pay $31,000 in medical bills, has written to health Minister Tanya Plibersek complaining about the six-month fight she faced to access the money.

"It was an extremely distressing time," she wrote.

"To have to deal with the bureaucratic red tape was exhausting which caused me great anxiety."

She is asking the minister to streamline the process for sick people applying for superannuation funds to be released.

And she says the government must introduce a medical safety net so "people like myself do not have to access their superannuation, extend home mortgages, take out personal loans or declare bankruptcy in meeting the spiralling costs of life-saving treament who go through the private health."

George Institute academic Beverley Essue, who has been studying the way health costs are forcing some people into poverty, says there should be incentives to get specialists to bulk-bill and suggests the Medicare and pharmaceutical safety nets need improving.

Consumers Health Forum chief Carol Bennett said it was a "sad indictment" on the health system that people were being forced to use their lifetime retirement savings.

SMSF limited recourse borrowing arrangement – Fact Sheet

What is an SMSF limited recourse borrowing arrangement?

An SMSF limited recourse borrowing arrangement typically involves an SMSF taking out a loan from a third party lender or from a related party, such as a member of the fund. The SMSF then uses the loan, together with its own available funds, to purchase a single asset (normally a residential or commercial property) that is held in a separate trust.

The SMSF trustee acquires a beneficial interest in the asset with the trustee of the separate trust being the legal owner of the asset. The SMSF trustee has a right to acquire legal ownership of the asset by making one or more payments.  Any investment income received from the asset goes to the SMSF and if the SMSF defaults on the loan, the lender’s rights are limited to the asset held in the separate trust. This means there is no recourse to the other assets held in the SMSF.

What are the key benefits?

Leverage your superannuation savings – An SMSF limited recourse borrowing arrangement allows your SMSF to borrow for investment purposes. Borrowing to invest or “gearing” your superannuation savings in this manner enables your fund to acquire a beneficiary interest in an asset that your fund may not otherwise be able to afford (it could be a business premise you own or operate your business from).

Although your SMSF is not the legal owner of the asset, your SMSF acquires a beneficial interest in the purchased asset, meaning your fund is entitled to receive all of the income (such as rental income) derived from the asset. Your SMSF is also entitled to receive any capital gains when the asset is sold.

Tax concessions – Investment income received by your SMSF, including any income received because your fund holds a beneficial interest in an asset acquired under a limited recourse borrowing arrangement, is taxed at the concessional superannuation rates.

If your fund is in the accumulation phase, this means the income received from the asset will be subject to no more than 15% tax. This could result in your fund paying considerable lower rates of tax on the income received compared with owning the asset in your own name or under a company or trust structure.

Furthermore, if the income received from the acquired asset is being used to support the payment of one or more superannuation income streams from your fund, the income, including realised capital gains, is exempt from tax in your fund.        

Asset protection – Generally superannuation assets are protected against creditors in the event of bankruptcy. This protection extends to assets that the superannuation fund has acquired a beneficial interest in. Therefore, structuring the acquisition of an asset under a limited recourse borrowing arrangement may provide greater asset protection benefits than may otherwise be the case.

What are the key risks?

Only certain assets can be acquired – Only assets that the SMSF trustee is not otherwise prohibited from acquiring can be purchased under a limited recourse borrowing arrangement. Generally, this means assets that you or a related party currently own cannot be acquired under a limited recourse borrowing arrangement. However, some exceptions do apply to business premises and listed securities that you or a related party own.

It is also a requirement that the asset acquired under a limited recourse borrowing arrangement is a single asset. This generally means shares in a single company that have identical legal rights or a property that has been constructed on a single legal title. In some situations properties constructed across one or more legal titles can still be considered a single asset under a limited recourse borrowing arrangement but only if there is a physical object (such as a building), or there is a State or Territory Law that prevents the separate legal tiles from being sold separately.

If an SMSF acquires an asset that does not meet the above rules, the SMSF trustees may be required to sell the asset at a substantial loss to the SMSF. The SMSF trustees may also be subject to monetary penalties and other sanctions for breaching the superannuation borrowing rules.

Property alterations and funding improvement costs – Assets acquired under a limited recourse borrowing arrangement cannot generally be replaced with a different asset. In a practical sense this means, during the life of the loan, alterations to a property acquired under a limited recourse borrowing arrangement cannot be made if it fundamentally changes the character of the asset. For example, property alterations that have the effect of changing the character of a property from a residential to a commercial property during the life of the loan are not permitted. However, alterations or improvements to the property that have the effect of improving the functional efficiency of the asset, but do not change the character of the asset, are permitted provided they are not funded by borrowed funds.

Maintenance and repair costs associated with the acquired asset can be funded from borrowed funds, including a drawdown from the loan used to acquire the asset.

SMSF trustees may be subject to monetary penalties and other sanctions if the replacement asset rules are breached. 

Cost  – There may be additional costs associated with acquiring an asset under a limited recourse borrowing arrangement that otherwise do not apply. For example, an SMSF limited recourse borrowing arrangement requires a separate trust to be established and the drafting of separate legal instruments such as trust deeds and company constitutions (if the trustee of the separate trust is a corporate trustee). Financial institutions may also charge for vetting your fund’s trust deed, and the limited recourse nature of the loan can mean a higher rate of interest.   

Liquidity – Loan repayments are required to be deducted from your fund. That means your fund must always have sufficient liquidity to meet the loan repayments. Careful planning is needed to ensure contributions and the fund’s investment income is sufficient to meet the loan repayments and other existing and prospective liabilities as they fall due. This is particularly important if the property is not able to be leased for any period of time, or one or more members are in the pension phase (due to the requirement for the fund to also meet minimum pension payment requirements).

Even for members in the accumulation phase, the contribution caps impose limits on the contributions that can be made on a tax concessional basis. This may limit the tax effectiveness of the limited recourse borrowing arrangement if non-concessional contributions are required to fund the loan repayments because the member’s concessional contribution cap has been utilised already.

It is also important for SMSF trustees to consider the need for life insurance should one or more contributing members of the fund die.  Careful drafting of the fund’s trust deed is required to ensure the proceeds of a life insurance policy, in this scenario, can be used by the SMSF trustee to repay the loan.

If the SMSF trustee defaults on the loan, the lender may take possession of the asset and sell the asset with the SMSF trustees receiving the sale proceeds less the outstanding loan amount.  If there is a shortfall between the outstanding loan amount and the sale proceeds received, the lender will not have recourse to any other assets of the SMSF. However, a guarantor (if there is one) may be called on to make up the shortfall.

Loan documentation and purchase contract – The Australian Taxation Office has become aware that certain limited recourse borrowing arrangements entered into by SMSF trustees have not been structured correctly. Some of these arrangements cannot simply be restructured or rectified and unwinding the arrangement could require that the property be sold, causing a substantial loss to the fund.

To comply with the rules, the asset purchased under the limited recourse borrowing arrangement must be acquired in the name of the Security Trust with the SMSF trustee acquiring a beneficial interest in the asset pursuant to the terms of the Security Trust Deed. The terms of the loan must be on a limited recourse basis with the lender having no access to assets of the fund if the SMSF trustee defaults on the loan.

Tax losses and capital gains – Any tax losses which may arise because the after-tax cost of the property exceeds the income derived from the property are quarantined in the fund. This means the tax losses cannot be used to offset your taxable income derived outside the fund. Similarly, the value of a property acquired under a limited recourse borrowing arrangement cannot be used as security for other loans, meaning the value of the property, including the equity built up over time, cannot be used to purchase further properties outside the fund.

Governing rules and other matters - Trustees should always consider the quality of the investment they are making and whether entering into a limited recourse borrowing arrangement is consistent with the investment strategy of the fund. The governing rules of an SMSF must allow the trustee of the fund to borrow before any limited recourse borrowing arrangement can be entered into. Investments that are not consistent with the fund’s investment strategy, or are not permitted by the fund’s governing rules, could result in an action for recovery of loss or damage suffered by a person with a beneficial interest in the fund.

SMSF Legislation Change

The government has announced as part of its mid year economic outlook today that it will introduce legislation amending the tax ruling TR2011/D3 whereby the taxation exemption will now continue post death on assets supporting a superannuation pension until such time as the superannuation death benefit is paid out.

This would remove the issue from the previous tax ruling that CGT would be incurred on death if assets were sold to pay a death benefit as the pension was deemed to have ceased at the date of death.

SMSF Investment Strategy Regulation Change

The Australian Taxation Office (ATO) has introduced measures on 7^th August 2012 as part of the suite of measures announced within the Stronger Super legislation. These measures are intended to address potential risks and strengthen the regulatory framework in which self-managed superannuation funds (SMSFs) operate. In short, these measures mean that all self-managed superannuation funds are required to:

• conduct a review of the fund's investment strategy on a regular basic
• consider insurance for fund members as part of the fund's investment strategy
• value the fund's assets at market value for the purposes of preparing financial accounts and statements

The obligation requires money and other assets of the fund to be kept separate from any money or assets held personally by the trustee or by a standard employer-sponsor or an associated standard employer-sponsor is now a prescribed operating standard. Therefore ensure they are complied with at all times. The ATO has the power to enforce compliance of these operating standards.

What this means for trustees

During each income year from 2012-13, you must review your fund's investment strategy to ensure it continues to reflect the purpose and circumstances of your fund and its members. These reviews should occur on a regular basis and could be evidenced by documenting decisions made in the minutes of meetings held during the income year. Insurance should be considered for all members.

All assets will need to be revalued to their market value for the first time in the SMSF in the 2012-13 income year.

How we will help?

Investment Strategies of the past have documented the needs of your changing circumstances and life-stages but have not considered insurance for the fund members as part of that investment strategy. In order to satisfy the regulation we intend to review and input this new requirement into the Investment Strategies for all our clients.

The auditor of your fund will be required to review the investment strategy to provide an unqualified audit report moving forward.

We can also provide you with guidance relating to meeting your compliance requirements to value your fund assets at market value for the 2012-13 year accounts and statements.

Insurance in SMSF

Ignorance about life insurance is a massive problem in the self-managed super fund (SMSF) sector, with two-thirds of trustees unaware of recent legislative changes requiring that they consider this provision.

AIA Australia head of business development group insurance Craig Extrem said that the insurer's recent survey of more than 400 financial advisers showed 66 per cent of trustees were not educated about life insurance within SMSFs.

On August 14, amendments to the Superannuation Industry (Supervision) Act 1993, S4.09 (2) (d), required "trustees of self managed superannuation funds (SMSFs) to consider insurance for their members as part of the fund's investment strategy".

The next most prevalent reason, 22 per cent, for SMSF trustees not having such insurance within the fund was that it was held either in another super fund or privately.

Knowledge of how to apply for cover prevented 12 per cent of SMSF trustees from doing so, and cost prevented 7 per cent (some trustees had more than one reason for not having this insurance in the fund).

Extrem said life insurance premiums paid by an SMSF were about 20 per cent less that if an individual owned the policy.

How to rollover your super

Many do-it-yourself superannuation funds start their existence with a rollover – a transfer of super savings – from a larger fund. Often the transfer is between an employer-sponsored or industry fund to the DIY fund.

Tax treatment

When super is rolled from one fund to another, the money generally goes across as a cash transfer, although it has the same tax components as it had in the larger fund. If it was 20 per cent tax-free in the large fund, for example, then that money in the DIY fund will have the same profile.

Another consideration is the age of the member and whether the transfer arises because the member has ceased a working arrangement.

Cash benefits

Super benefits paid in cash from a fund where the benefits are mainly the result of concessionally taxed contributions and concessionally taxed investment earnings should be tax-free for those who are 60 and over.

To access these savings, you need to have retired and reached your preservation age – the age where you are able to access your super if you satisfy one of the conditions that allows this to happen – the conditions of release.

One of these conditions is reaching the age of 60 and ceasing an employment arrangement. If this happens after you reach 60 you are considered to have retired from a particular job and can withdraw all your previously preserved money from the super fund as a tax-free benefit. The benefit becomes non-preserved with no restrictions on withdrawing it. That’s the only condition you need to satisfy.

Business implications

The fact that you also have your own business where you earn income as a director will not complicate any withdrawal from the larger fund that was supported by super contributions from previous employment.

Even if the business has its own DIY super fund, this will not complicate any entitlements from the larger fund.

This includes a circumstance where the money is rolled over into the DIY fund.

Where this happens, the super will retain its status as a benefit that has satisfied a condition of release and for this reason can be accessed again in the future as an unrestricted and non-preserved benefit.

In this case it is important for the rollover documentation to state that the transfer payment does have unrestricted non-preserved status.

Other sums

But it’s a different story for any super either in the fund before the rollover or money added after the rollover. Similarly, it is also different if the money is cashed out of the larger fund and recontributed to the DIY fund.

That’s like putting new money in or taking money out of the super system and then starting again with this.

The important thing is being eligible to make contributions, which you can do without any work test between 60 and 64.

In these subsequent situations, any new or recontributed super (as distinct from super that has been rolled over) is regarded as a preserved benefit that must meet a further condition of release before it can be withdrawn. The condition can be a decision to stop any work arrangement that is linked to the DIY fund contributions, such as no longer being a director of the business. Or it can be reaching the aged of 65 where super ceases to be preserved regardless of the work situation.

Withdrawals and recontributions

You need a fresh condition of release to be able to make withdrawals. An alternative strategy where money is required from the fund before a fresh condition of release has been satisfied is to start a transition to retirement pension that allows withdrawals of up to 10 per cent of the balance of the account that is paying the pension.

There can be good reasons why someone may wish to withdraw a benefit from a larger fund and recontribute this as an after-tax contribution.

The contribution limits for after-tax contributions can be as much as $150,000 a year or $450,000 if three years of such contributions are brought forward into one.

These contributions are also regarded as amounts that will be added to a fund’s tax-free component where they will retain this status after the fund has moved into pension phase.

It’s a useful feature to have as much of a super benefit classified as a tax-free component as possible. Where such components are part of an eventual super death benefit, for example, they maintain this tax-free status if they are inherited by a beneficiary who might ordinarily be up for 16.5 per cent tax on a taxable super component.

This could be an adult child who is not financially dependent on their superannuated parent.

Only beneficiaries regarded as tax dependants, such as a spouse or someone who is financially dependent on the late super member, are entitled to receive a taxable super benefit tax-free.

There are other reasons why money may be withdrawn from the larger fund and then recontributed in the DIY fund. It could be to give the money to a partner to allow them to make a contribution to super.

Any tax-free super contributed to the DIY fund could also be used to start a pension by someone eligible to do so, an income stream that would retain its highly concessional status. If a pension is started with tax-free super, all the investment earning will be tax-free.

This account will also have value as a future death benefit. Another condition of release for a super benefit is the death of a member.