Self-managed super funds – beware of risk areas

Self-managed super funds (SMSFs), also known as DIY super funds, have been in the news lately regarding their alleged propensity for borrowing to invest in property.

Proponents of both sides of the argument have put forward their case and, needless to say, the sector will continue to come under scrutiny from the regulators, including the ATO and ASIC.

For its part, as the main regulator of SMSFs, the Tax Office says it tries to help super fund trustees and the professionals who assist them to understand their obligations (and there are plenty of those!) and comply with these voluntarily.

While the ATO considers that SMSFs “generally operate in a well-run market”, ATO assistant deputy commissioner in charge of superannuation Stuart Forsyth says there are however a number of risk areas it is keeping an eye on. These include:

• Trustees and SMSF professionals who fail to understand SMSF obligations
• Trustees who fail to voluntarily comply with their SMSF obligations, including lodgement of returns
• Approved SMSF auditors who fail to undertake audits appropriately or fail to report contraventions of the rules to the ATO
• Trustees who intentionally take inappropriate actions with their SMSFs, such as setting them up for illegal early release or down the track obtaining early access to money in the fund without meeting a condition of release
• Professionals who promote and assist in the establishment of SMSFs for inappropriate reasons

SMSFs have a myriad of rules to comply with. These include reporting of payments of fund member benefits, appointing an approved auditor, and maintaining the appropriate records. In the current environment, perhaps the most notable requirement is complying with the numerous investment restrictions that the law imposes, for example:

• The ‘sole purpose test’ – the law requires an SMSF to be maintained solely for at least one of the legislated core purposes, i.e. the provision of benefits upon retirement, attaining age 65 or death.
• Trustees of an SMSF are prohibited from intentionally acquiring assets from fund members or a related party (although some limited exceptions apply).
• An SMSF is generally restricted from having more than 5% of its total assets invested in so-called ‘in-house’ assets – these include a loan to a related party, an investment in a related trust of the fund, and an asset of the fund subject to a lease with a related party.

The law generally prohibits funds from borrowing money, but there is an exception for so-called limited recourse borrowing arrangements (e.g. instalment warrants). Assets acquired with these borrowings must be kept separate from other assets of the fund. Money borrowed under these rules can be used in maintaining or repairing an asset. An SMSF trustee looking to acquire property via a limited recourse borrowing arrangement should obtain independent advice in relation to the borrowing agreement and the establishment of the holding trust structure.

Forsyth said the ATO is planning more comprehensive audits and closer scrutiny of annual returns and auditor contravention reports. He said the annual independent SMSF audit is a critical factor in the ongoing tax concessional treatment of SMSFs, satisfying the government and the community that SMSFs are meeting their obligations.

Forsyth said SMSF trustees should comply, lodge on time and (reflecting the comments made above) ensure that transactions such as limited recourse borrowing arrangements are undertaken with care. Limited recourse borrowing is an area where there are risks of breaches which can be very expensive and may not be easily rectified if professional advice had not been sought, he said.

SMSF fund trustees should check and understand the deed of the fund to ensure they are clear in what it allows and does not allow.

The ATO will review breaches of trustee obligations reported to it by approved SMSF auditors.

Other issues for SMSF trustees to be aware of are that they are now are required to value their fund’s assets at market value. They must also regularly review the fund’s investment strategy, and should consider the needs of insurance for members. The ATO is sure to be checking on these requirements.

One of the main changes affecting SMSF trustees this year has been that, from July 1, 2013, auditors have had to be registered with ASIC to undertake an SMSF audit. Forsyth said that from now on, when an SMSF annual return is lodged with the ATO, the ATO will check that the return has an SMSF auditor number (SAN) on it and that the number has been registered by ASIC. If there is no SAN or the number is not recognised as a registered auditor, the ATO will not accept the lodgment. SMSF trustees need to be particularly careful about this requirement.

From July 1, 2014, large and medium employers (those with more than 20 employees) will start paying super contributions using the new superannuation data and payment standard. SMSFs receiving contributions from these employers will need to receive them using the new standard. This requires being able to receive electronic contribution payments (paid to a nominated bank account) and messages (sent to a nominated electronic address). The ATO intends to publish more detailed information explaining the standard, how it applies to SMSFs and what trustees need to do to comply.

The attractions of SMSFs mean we are seeing continuing strong growth in these types of super funds. The many rules and regulations surrounding the running of these funds however should not be overlooked or underestimated.

Terry Hayes is the Editor-in-Chief of tax news reporting at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.