Super tax risk

Business owners who operate self-managed super funds should watch out – 10,000 will be audited this financial year. By TERRY HAYES of Thomson Legal & Regulatory.

By Terry Hayes

Superannuation is a hot topic these days, and SMEs are not immune from all the changes. Many SMEs will operate self-managed super funds (also known as DIY funds). These are small funds with fewer than five members where all members of the fund are also the trustees responsible for controlling the administrative and investment decisions of their fund.

The tax office took over the regulation of self-managed super funds (SMSFs) in October 1999 and has since then been taking a much closer look at their operation. The tax office says it will take firm action where funds are deliberately attempting to flout the law.

What the taxman will look at in 2007-08

For 2007-08, the tax office’s superannuation compliance program is expected to involve around 10,000 SMSF audits (up from 4500 for 2005-06, and 3500 in 2004-05). The tax office intends to triple its casework for SMSFs and SMSF auditors over the two-year period from 2007-08, and it is also using additional funding to increase to 590 the number of tax officers engaged in active SMSF compliance.

The tax office will audit funds at high risk of not complying with the law. It will also examine the links between SMSFs and other related entities. Where the tax office has questions about SMEs meeting their tax obligations, it will also examine whether the related individual is managing their SMSF correctly and meeting its superannuation, income tax and regulatory obligations.

The chances of an SMSF trustee being subject to tax office compliance activities (and possibly enforcement) have never been higher. This increased risk is highlighted by the following factors.

• Additional funding for compliance.
• The tax office says it will increasingly apply the range of sanction and penalties at its disposal to those SMSFs it believes are not responding to its educative efforts.
• It intends to call a number of SMSF trustees and tax agents to ask about various superannuation obligations and to request documents by fax to support claims or information provided in returns, statements or reports. These “real time” reviews will usually focus on current or recent events, and may be quite specific in nature. The tax office will be seeking the prompt provision of the material requested to identify problems as they emerge. Such reviews are expected to take about an hour and the records sought will be few in number. However, when the matter is unable to be verified to its satisfaction, the matter will be forwarded to tax office desk and field areas for a more detailed review.
• Since July 2004, approved auditors of SMSFs have been required to notify the tax office of any compliance breach that may affect the interests of fund members. While the tax office granted an amnesty in respect of following up certain contraventions during 2004-05 (for example, where an SMSF’s assets were not recorded appropriately in the name of the fund), it has now warned that it will follow-up such breaches.

The tax office will also:

• Check SMSF member contributions statements to ensure that personal contributions are reported correctly for super co-contribution payment purposes.
• Review high-risk regulatory issues, such as breaches of the in-house asset rules, the acquisition of assets from related parties, the personal use of fund assets and fund ownership of assets.

Trustees of SMSFs who think they might escape under the tax office’s audit radar because their compliance issue only involves a small amount of revenue may need to think again. The tax office’s SMSF compliance activities are not necessarily targeted at protecting revenue (as is often the case with its income tax compliance activities). Rather, in the SMSF environment, the taxman is also concerned with maintaining the integrity of the superannuation system.

Key compliance targets

Like all regulated superannuation funds, to be eligible for concessional tax treatment, an SMSF must be maintained for the sole purpose of providing benefits to a member upon retirement or in respect of a member upon her or his death.

This is known as the “sole purpose test” and is one of the tax office’s key compliance targets. The tax office says some trustees do not appear to appreciate the importance of the sole purpose test. For example, trustees who are regular golfers and invest fund money in a golf club membership with playing rights attached would raise questions under the sole purpose test. The tax office has also identified breaches of the sole purpose test where trustees are paying for children’s tertiary education through the fund.

The tax office takes the view that if an SMSF is running a business, it is not being administered for the sole purpose of providing retirement benefits to members and beneficiaries. Further, where a fund claims amounts at the salary and wages label on the fund’s income tax return, it may indicate that the fund is running a business and potentially not meeting the sole purpose test.

A supporting requirement to the sole purpose test is that any dealings between an SMSF and its members or related parties (where permitted) must be conducted at arm’s length – that is, they must be at prevailing commercial or market rates. This can be a trap that is easy to fall into.

Some funds that have been examined by the tax office did not have an investment strategy, or if they did, they were not investing in accordance with it. The tax office says trustees are required to formulate and give effect to an investment strategy. Although it may be revised for changing circumstances, these changes should be documented.

The law allows SMSF trustees to invest 100% of the fund’s assets in “business real property”. However, trustees should be aware that the tax office takes the view that residential property rarely fits the conditions necessary for it to be considered “business real property”.

Keep on top of what’s required

From 1 July 2007, all new SMSF trustees (whether it is a new fund, or a new trustee of an existing fund) are required to sign a declaration form stating they understand their obligations and responsibilities. The declaration form must be signed within 21 days after becoming a new trustee or director of a corporate trustee.

However, it does not need to be completed by a trustee or director appointed before 1 July 2007. The approved form does not need to be sent to the tax office but kept with the fund’s other records for inspection by the tax office or an approved auditor.

SMSFs can be a very efficient method for SMEs to provide for their superannuation. But there are strict rules applying to them that fund trustees must be aware of. With the tax office paying increasing attention to these funds, SMSF trustees simply must be on the ball as to their obligations and responsibilities under the law. The penalties for not doing so are harsh.

Terry Hayes is the senior tax writer at Thomson Legal & Regulatory , a leading Australian provider of tax, accounting and legal information solutions.

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