Heffron | ECPI - What is different in 2017/18?

Death of a spouse when both members of a couple have pensions – how are these managed?

The 1 July 2017 changes to superannuation pensions introduced a new rule of thumb – most people can only convert $1.6m to a retirement phase pension over their lifetime (this is the limit known as the Transfer Balance Cap or TBC).  Unfortunately the new rules also included provisions that ensured people who inherited their spouse’s superannuation as a pension would have this amount counted towards their $1.6m limit as well.  The timing and amount depends on whether the deceased spouse’s pension was reversionary or non-reversionary but one way or another it counts eventually if it is received by the survivor as a pension.

A challenge many practitioners have run into already is understanding exactly how this works when the spouse’s pension was reversionary and so immediately passed over to the surviving spouse on death.  Won’t that mean the survivor potentially has two large pensions in place at the same time – resulting in an excess with dire tax consequences? In fact, no – providing the right action is taken at the right time.

It is easiest to explain the mechanics using examples.  In all the examples below, we will assume that both members of the couple (Graham and Judy) originally had retirement phase pensions at 1 July 2017 of $1.6m in their SMSF (so both have “used up” their TBC).  A few years on, Graham’s pension is worth $1.7m and he dies in July 2019.  Judy’s pension is worth $1.75m at the time – the slight differences reflect different drawings they have made over the intervening years.  The pensions were reversionary to each other.

When a pension reverts to a surviving spouse on the death of the original recipient, the income stream continues seamlessly to the survivor.  In our example, this means that on Graham’s death, his pension immediately switches to Judy in July 2019.  So:

  • The fund will continue to receive a tax exemption on the proportion of its assessable income that is earned on assets supporting retirement phase pensions.  If neither member had an accumulation account immediately before Graham’s death, then the entire fund continues to be exempt from tax on investment income.
  • The trustee will have to ensure that a minimum payment is taken from both Judy’s own pension and the one she inherited from Graham during 2019/20.  These amounts will initially have been calculated as at 1 July 2019 when Graham was still alive (so the minimum for his pension should be based on his age and balance at 1 July 2019).  These minimum amounts will only be adjusted if Judy makes some changes to the pensions during 2019/20 (eg switching them off, cashing them out entirely etc).  Her age and the balance at 1 July 2020 will determine the minimum amounts for the 2020/21 year.

For a time, then, Judy will be receiving two large pensions from her SMSF at the same time – apparently in contravention of the new rules.  Won’t she receive an excess notice telling her that she has breached her Transfer Balance Cap?

Remember, however, that there are special rules for reversionary pensions when it comes to the TBC.  Importantly, Judy will not have any amount checked against her TBC for Graham’s pension until the anniversary of his death in July 2020.  That means she can actually continue running both pensions for the rest of 2019/20 – the full year’s minimum payments will be made from both pensions and the fund will receive a tax exemption on all its investment income throughout the year.  If it looks like next year will see some large withdrawals from superannuation, this might be the year in which to sell some of the fund’s assets!

Judy’s SMSF must report the fact that she has inherited his pension to the ATO via a Transfer Balance Account Report (or TBAR).  This SMSF is probably required to lodge its TBARs quarterly and the deadline for this report will be 28 October 2019 – note that the timing is based on the date Graham’s death occurred (July 2019), not the date on which his pension will count towards Judy’s Transfer Balance Cap (July 2020).  The amount to be reported is the value of Graham’s pension at the time of his death, no matter what it has grown (or shrunk) to by July 2020.

If Judy takes no action at all she will have a problem in July 2020 – the running tally of her Transfer Balance Cap amounts (known as her “Transfer Balance Account”) will look like this:

1 July 2017 – Judy’s original pension

$1.6m

July 2020 – the pension she inherited from Graham a year earlier in July 2019

$1.7m

Total (checked against her $1.6m cap)

$3.3m

In fact, what Judy will probably do immediately before the anniversary of Graham’s death is “roll back” some or all of her own pension (switch it off).  This will make “space” for her to inherit Graham’s pension without breaching her $1.6m limit.  This is becoming a common strategy for people with large balances because it allows Judy to leave the whole amount in her SMSF.  Under current law she can switch off her entire pension and leave it in an accumulation account for as long as she likes.  (Don’t forget that the usual rules for commuting pensions apply – if the whole pension is to be commuted, the pension must be paid up to date first, even if the payment is only small because the new financial year has only just started.  Even if the pension is only partly commuted, the trustee must ensure the amount remaining is enough to pay the full year’s minimum pension.)

Her choices with the super she has inherited from Graham, however, are far more limited – she can either let it continue as a pension or cash it out of super entirely.  Leaving it accumulating in the fund is not an option.

If Judy did decide to roll back her own super to solve her Transfer Balance Cap problem identified above, she would only need to do so with $1.7m.  If her pension account was worth more at the time (let’s say $1.8m), she could leave the extra $100,000 in her pension account.  The situation is more problematic if her pension account has shrunk.  Let’s say returns are poor during 2019/20 and she has only $1.65m in her pension account by the time she takes action in July 2020.  The balance is Graham’s pension account is even lower at $1.6m. 

A few points are relevant here:

  • It doesn’t matter that Graham’s pension account is now lower than it used to be when he died.  There will still be $1.7m added to Judy’s Transfer Balance Account in July 2020.
  • Even if she rolled back ALL of her pension account, she still wouldn’t be able to “balance the books” – she needs to be able to report a commutation from “somewhere” of $1.7m.
  • But she can achieve this if she also reports a commutation from Graham’s pension account – it’s just that this amount would need to be paid out of super entirely, not just rolled back to accumulation phase.  In other words, it’s a real transaction that will have to be made before the deadline in July 2020, it’s not just paperwork.

The picture could then be as follows:

1 July 2017 – Judy’s original pension

$1.6m

Early July 2020 – Judy’s original pension being switched off

($1.65m)

Early July 2020 – an additional (cashed out) commutation from Graham’s pension

($0.5m)

July 2020 – the pension she inherited from Graham a year earlier in July 2019

$1.7m

Total (checked against her $1.6m cap)

$1.6m

Note that all of these amounts would be reported in Judy’s name – even the $0.5m commutation from Graham’s pension.  The reporting would just need to be clear that this related to a pension other than her own.  This is why the forms used for this reporting require trustees to give each pension a specific account number.  The ATO use this to match up commutations etc to the original pensions. 

Importantly, it doesn’t matter (and in fact in this case it was important) that Judy reported a commutation from Graham’s pension before the $1.7m had officially become part of her Transfer Balance Account.

What if Graham’s pension was not reversionary to Judy? 

Under these circumstances the situation would have been completely different.  Most significantly, his pension would have stopped as soon as he died.  There would be no need to report her immediate inheritance of this income steam for TBC purposes in July 2019.

Graham’s pension account would only become a pension for Judy if the trustee chose to pay his death benefit that way – either using normal discretionary powers or at the direction of a binding death benefit nomination (if the binding death benefit nomination said that the pension was to be reversionary and automatically continue to Judy then the situation would be as for reversionary pensions above).

Importantly:

  • Until the trustee decided how to deal with Graham’s death benefit, the fund would continue to receive a tax exemption as if his account was still in pension phase (in this regard the situation is much the same as if the pension was reversionary).  The only caveat here is that the trustee must deal with Graham’s death benefit “as soon as practicable” to comply with the superannuation rules about cashing death benefits.  The ATO generally interprets this as six months unless there is a good reason for the process to take longer.
  • No minimum payment would be required from Graham’s account – the pension has stopped.
  • An amount would only be reported for Judy’s Transfer Balance Cap if the trustee specifically chose to pay some or all of Graham’s account to her as a pension. If they do this, however, the amount reported will count towards her TBC immediately – there is no automatic 12 month delay.  The amount will also be “whatever is given to her as a pension” – not the value of Graham’s pension at the time he died.  If this is less than the full amount of Graham’s account at the time the decision is made, anything leftover must be paid out of the fund as a lump sum death benefit.
  • If a new pension starts for Judy from Graham’s old pension account, the usual rules for minimum payments will apply from that time.

Under these circumstances, it will of course make sense for Judy to re-organise her own affairs before receiving any of Graham’s account as a pension.

Overall, very similar strategies and opportunities are available regardless of whether pensions are reversionary.   The difference is important when it comes to timing, exact amounts and the precise process of dealing with the death benefit.  Some trustees and practitioners will prefer reversionary pensions and others will not.  The key is to ensure that all those involved in the planning know exactly what they have and take the right action at the right time.

 

Join us at our upcoming Heffron Super Intensive Day.  We’ll be exploring these issues as well as the many other death benefit complexities which have come to light since the 1 July 2017 changes.  For details and to register, click here.

 

You’re welcome to share, re-post or replicate our content on your site or social channels, but please ensure that the content is always credited to Heffron SMSF Solutions - www.heffron.com.au

Recent changes to excess concessional contributions and the TSB limit

Can an SMSF receive excess concessional contributions when a member has reached the $1.6m total super balance limit? SMSF Magazine featuring our own Meg Heffron explains the fine details.

While the rules surrounding excess contributions have remained relatively stable for some time now, recent changes to non-concessional contribution limits for those with large superannuation balances have muddied the waters regarding the total superannuation balance (TSB).

In particular, what happens when excess concessional contributions are made for someone whose TSB is above the critical $1.6 million threshold?

Firstly, it is worth noting concessional contributions can still be made for someone in this position. This includes both employer contributions and personal contributions for which the individual claims a tax deduction.

If those contributions exceed the $25,000 concessional contributions cap, they are initially dealt with just like any other excess concessional contribution:

  • the total contribution amount will be reported to the ATO as part of the fund’s annual return (let’s say the contributions occurred in 2017/18 and are included in the 2017/18 annual return),
  • the ATO will determine there is an excess (let’s say this amount is $5000),
  • the ATO will add the $5000 to the individual’s 2017/18 assessable income and recalculate their income tax for that year. Their new tax position will be calculated including this $5000 and allowing for a 15 per cent tax offset (to reflect the tax already paid by the superannuation fund), and
  • in addition, interest will be applied to this extra tax bill from 1 July in the year in which the contribution was received, in this case 1 July 2017 (this interest component is known as the excess concessional contributions charge). If the extra tax bill is $1000, interest will be applied to the $1000, not the full $5000 excess.

The ATO will also advise the individual they can elect to release up to 85 per cent of the excess contributions (85% x $5000 = $4250) from their superannuation fund. If this election is made, the ATO will send a release authority to the member’s nominated superannuation fund.

If they choose not to release the excess, the full amount of $5000 will count towards the individual’s non-concessional contributions cap (for 2017/18 in this example).

This is where things potentially get tricky. If the individual’s TSB was $1.6 million or more at the previous 30 June, in this case 30 June 2017, their non-concessional contributions cap is $0. Does that mean it is illegal to create an excess in this way? Are individuals in this position forced to refund their excess concessional contributions?

In fact, no. Providing they meet the usual superannuation rules, for example, they are under 65 or between 65 and 75 but have met a work test, any individual in this position can still make non-concessional contributions. They can also have one created via an excess concessional contribution that is not refunded.

But any non-concessional contributions will be in excess of their $0 limit.

In this example, the $5000 excess will be treated just like any other excess non-concessional contribution. It will trigger a determination from the ATO that sets out the excess $5000 plus an amount of associated earnings, effectively the interest on the excess. Again, the interest applies from the beginning of the financial year in which the contribution was received, 1 July 2017 in this case. The individual then has two choices:

  1. Take the relevant amount out of superannuation (the excess of $5000 plus 85 per cent of the associated earnings). In this case, the individual will just pay extra income tax on 100 per cent of the associated earnings and will receive a 15 per cent tax offset in 2017/18.
  2. Pay excess non-concessional contributions tax. In this case, just the excess amount of $5000 is taxed at 47 per cent.

Since 1 July 2018, in the absence of the member telling the ATO they don’t want money released from superannuation, the ATO’s default will be to issue a release authority so the relevant amount can be paid out of super.

The new $1.6 million limit on non-concessional contributions has not really changed anything here. It simply means anyone in this position should definitely refund their excess concessional contributions. Importantly:

  • no refunding of excess contribution amounts should happen until the determination and release authority is received from the ATO. If any amounts are refunded earlier, they are effectively benefit payments. If the member is not yet eligible to withdraw amounts from superannuation, it will be an illegal early release of superannuation money, and
  • even though the member’s TSB in this example was over $1.6 million, the excess concessional contribution, which in turn created an excess non-concessional contribution, was not illegal; it simply had tax consequences.
This article appeared in SMSF Magazine on August 8th 2019. You can view it here.

How can my client have an excess non-concessional contribution determination when their Total Superannuation Balance was below $1.6M on 30 June 2017?

When Transfer Balance Caps and Total Superannuation Balances (TSB) came into effect in June 2017, some little known transitional arrangements for calculating TSB were in place that has resulted in pensions started on 1 July 2017 being double counted. Don’t panic – it’s fixable.

Some pension members of SMSFs stopped and restarted their pensions on 1 July 2017 as part of their planning for the introduction of the new rules. There are many reasons for doing this, commonly to merge accumulation balances into retirement phase pensions.

We have started getting calls from accountants and administrators wondering why their client’s pension seems to have been double counted for the TSB purposes. It’s to do with how the ATO are calculating TSB in the commencement year, and it’s taken many by surprise.  

Let’s use an example to illustrate.

Joe had a total of $1,400,000 in his super fund on 30 June 2017 which was correctly reported via the SMSF Annual return. This was made up of:

Accumulation Phase Value     $400,000

Retirement Phase Value     $1,000,000

He commuted the pension on 1 July 2017, merged it with his accumulation account, and started a new pension for the full $1,400,000.

The following was reported:

  1. Closing balance of the superannuation accounts reported via the SMSF return: $1,400,000
  2. The opening pension balance on 1 July 2017 (TBAR): $1,000,000
  3. The commutation of the pension on 1 July 2017 (TBAR): -$1,000,000
  4. The commencement of the new pension on 1 July 2017 (TBAR): $1,400,000

During the year, he made an NCC of $100,000 and has recently received an excess NCC determination. How is this possible, when his TSB was under the $1.6M level?

TSB is calculated by adding together the accumulation phase value (APV) and the retirement phase value (RPV) of a person’s superannuation interests. Generally, the 30 June balances of each are reported to the ATO via the SMSF Annual Return and that’s that.

In 2017, however, the ATO were more interested in recording the values of APVs and RPVs as they were to continue from the day after 1 July 2017 as opposed to how they were on 30 June. Hence, they had in place a transitional method for calculating RPVs which is explained here:   

https://www.ato.gov.au/Individuals/Super/In-detail/Growing-your-super/Super-contributions---too-much-can-mean-extra-tax/?anchor=TotalSuperannuationBalance#TotalSuperannuationBalance

Under the transitional arrangements, a members’ transitional transfer balance at the end of 30 June 2017 is equal to the sum of their transfer balance credits just after the start of 1 July 2017. In other words, they ignore 1 July debits and don’t want to know about the original pension opening balance.

Because of the TBAR reporting, Joe’s transfer balance credits totaled $2,400,000 being:

  • the opening pension balance on 1 July ($1,000,000) plus
  • the new pension on the same day ($1,400,000)

resulting in TSB on 30 June 2017 being greater than $1.6M and, hence, the excess NCC determination.

What should have been reported is:

  1. Closing balance of the superannuation accounts reported via the SMSF return: $1,400,000, and
  2. The commencement of the new pension on 1 July 2017 (TBAR): $1,400,000

The pension already in place and the commutation of that pension should not have been reported at all. If those two “events” had not been reported, the members transfer balance account would correctly show $1,400,000 on 1 July.

The APV on 30 June 2017 is then calculated as the difference between the closing account balance from the SMSF Annual Return ($1,400,000) and the value of the member’s transfer balance account for the SMSF at 1 July 2017 ($1,400,000).

APV = $1,400,000 - $1,400,000 = nil.

TSB for 30 June 2017 becomes APV + RPV = 0 + $1,400,000 = $1,400,000

To rectify the situation for Joe, the administrator needs to lodge:

  1. Cancellation TBAR for the existing pension on 1 July 2017.
  2. Cancellation TBAR for the commutation.

Note this only applies to the 2017 year. From 30 June 2018, the TSB should be simply be the closing balances reported via the SMSF return, so this problem effectively fixes itself in future years.

Do I need to go back and cancel TBARs for all clients who stopped and restarted pensions on 1 July 2017?

Not necessarily. This will only be picked up for those whose double counting of pensions resulted in a TSB of over $1.6M AND the member made NCCs in the 2017/2018 year. For all other members, there is no impact, so you might choose to just leave those ones as is. 

Big changes in superannuation laws always causes additional headaches and work for administrators – this one is no different. A client can get very distressed when they get an unexpected excess contribution determination, so being armed with the knowledge when they call is a powerful thing.

 

You’re welcome to share, re-post or replicate our content on your site or social channels, but please ensure that the content is always credited to Heffron SMSF Solutions - www.heffron.com.au

What happens to my client’s superannuation when they die?

While most practitioners would be aware that superannuation is not covered by the deceased’s will and can only be paid to a limited group of beneficiaries, the practicalities of handling superannuation death benefits, particularly in SMSFs, are often still quite opaque.  In this article, we have explored some of the common issues we find in practice.

Death is the one event in superannuation where the trustee is forced to “do something” with the deceased’s balance.  By law, it must be paid out as a lump sum, used to start a pension (only some beneficiaries have this option) or some combination.  Importantly the money cannot just stay accumulating in the fund – this is often something not well understood by clients who imagine leaving their superannuation to their children once both members of a couple have died.

In fact when it comes to lump sums there are even rules about how many can be paid – one interim lump sum and one final payment.  Fortunately this limit applies for each account and for each beneficiary – so someone who dies with two pension accounts that are to be divided equally between three children could have their overall superannuation paid out in 12 payments - two lump sums for each child from each pension.  If the death benefit is being paid as a pension, there is no limit on the number of pensions that can be established.

It is well known that death benefits can be paid to the deceased’s estate (when it will be subject to their will) or various beneficiaries.  These normally include their spouse, children (regardless of age), anyone with whom they were in an interdependency relationship and anyone otherwise dependent on them (often this means they were financially dependent on the deceased). 

However, as mentioned earlier, only some of these beneficiaries are allowed to take the deceased’s benefit as a pension.  Technically this includes the spouse, minor children or children between 18 and 25 who were dependent on the deceased at the time of death (and in both cases, the pension must stop when the child reaches 25) and other people who were dependent on (or in an interdependency relationship with) the deceased.  Generally older children can only receive a pension from their parent’s superannuation if they are profoundly disabled.

Given the requirement to “do something” with the superannuation on death, clients without a spouse often find that their only option is to pay the balance out of the fund. This triggers the inevitable challenges about selling assets.  Remember that lump sum benefits (including death benefits) can be transferred directly to a beneficiary to settle the benefit – they do not have to be sold (often a good thing for assets clients want to keep in the family).  But in the case of death this brings its own challenges.  For example, adult children generally pay tax on some, if not all, of the superannuation they inherit from a parent.  If they receive the asset (but no cash) they will have to fund the tax personally.  And the tax can be high!  A parent who dies at 70 leaving a $500,000 superannuation benefit to adult children can give rise to a tax bill of up to $75,000 (plus medicare if applicable) – tricky to pay if the “inheritance” was a $500,000 property transferred directly from the SMSF.

These days, even those leaving behind a surviving spouse may be in this position.  Since the transfer balance cap of $1.6m applies to inherited pensions as well as the surviving spouse’s own superannuation, it is entirely possible that those with large balances in superannuation (particularly where the deceased has more than $1.6m in superannuation) may find that some of the couple’s combined superannuation must be paid out of their SMSF when the first one of them dies.

Given the complexities, much of the focus when it comes to superannuation estate planning is making sure the benefit ends up with the right beneficiary.  But this presents another complexity – there are many ways to leave superannuation to a specific beneficiary (reversionary pensions, binding death benefit nominations, special clauses in the superannuation fund trust deed etc).  But if they contradict each other, which one wins?  Of course the simplest answer is to make sure they all say the same thing!  But when this inevitably does not happen, the answer as to which one directs the payment of the death benefit will depend on the specific fund’s trust deed.  Some specify that a binding death benefit takes priority, some put the reversionary pension first and some are unclear.  Even this issue can present some interesting challenges:

  • Unlike a will, a reversionary pension arrangement, binding death benefit nomination or special superannuation clause is not automatically invalidated by key life events such as marriage.  This means it is entirely possible that changes to important life circumstances are not reflected in superannuation estate planning.
  • Tax rules change regularly – the best outcome for the deceased’s beneficiaries today might not be the ideal outcome in the future.  Even where all members of the family are united in wanting a particular outcome, they can be thwarted by poorly thought out (or out of date) superannuation documentation.

Perhaps where the SMSF comes into its own when it comes to estate planning is that it provides some invaluable controls and flexibility:

  • Any decisions not directed by the deceased will be made by the fund’s trustee.  Given that this can be controlled to include family members who are the same people the deceased wished to inherit their superannuation, this can be extremely valuable and reassuring.
  • Either the trustee or even the deceased (subject to the trust deed) can decide not only the amount that is paid to each beneficiary but also the way in which the payment is made – eg transferring specific assets, making payments via the estate where there is a large tax bill (because estates do not pay medicare)

Not surprisingly, estate planning is still one of the major reasons many people with large amounts in superannuation still prefer SMSFs.

 

You’re welcome to share, re-post or replicate our content on your site or social channels, but please ensure that the content is always credited to Heffron SMSF Solutions - www.heffron.com.au

Parliament resumes – Superannuation measures introduced

The Government has introduced two bills to the House of Representatives; one that had previously lapsed when the Federal Election was called, and one containing a long overdue improvement to salary sacrificing.

During this week’s sitting of Parliament, two superannuation related bills were introduced:  

  • Treasury Laws Amendment (2018 Superannuation Measures No.1) Bill 2019
  • Treasury Laws Amendment (2019 Tax Integrity and Other Measures No.1) Bill 2019

Treasury Laws Amendment (2018 Superannuation Measures No.1) Bill 2019

This bill reintroduces measures that lapsed due to the calling of the Federal Election. It contains three superannuation measures:

1. Super Guarantee Opt Out

This was proposed in the 2018/19 Budget and allows employees to opt out of Superannuation Guarantee (SG) obligations when they receive super contributions from multiple employers that will result in them breaching their concessional contribution limit.  Once the proposal commences, employees will be able to apply to opt out of the SG regime with an employer and negotiate to receive alternative remuneration. The employee will need to apply for an ‘employer shortfall exemption certificate’ which will mean the employer will not have an SG shortfall if they do not make SG contributions for the period.

Whilst the measure was due to commence from 1 July 2018, the due date for lodging an application will be 60 days before the first day of the quarter to which the application relates.  Practically speaking this means the measure may not be available until the December 2019 quarter at the earliest unless the Commissioner defers this due date.

2. Non-Arm’s Length Income

Originally proposed in the 2017/18 Budget, this measure ensures that the non-arm’s length rules apply in situations where a superannuation entity incurs non-arm’s length expenses in gaining or producing income. In other words, undercharging expenses (eg interest on an LRBA) can also result in the income from the arrangement being treated as non-arm’s length income (NALI) and subject to tax at 45%.  Furthermore, where a fund acquires an asset for less than market value through non-arm’s length dealings, the revenue generated by that asset may be NALI as well as net capital gains on disposal.

Whilst it has always been thought this would be the case, it has been a little unclear, so this Bill provides more certainty. 

3. Limited Recourse borrowing arrangements

Also announced in the 2017/18 Budget, this measure amends the total superannuation balance (TSB) rules to ensure that, in certain circumstances involving limited recourse borrowing arrangements (LRBA) and funds with less than 5 members, the outstanding loan balance will be taken into account in working out an individual member’s TSB. The measure only applies to members who:

  • have satisfied certain conditions of release (eg reaching age 65, retirement), or
  • whose balance is backed by assets subject to an LRBA with a related party.

Under the proposal, the member’s TSB will be increased in equal proportion to the outstanding balance of the LRBA. This proportion is based on the individual’s share of the asset subject to the LRBA and the increases only apply in respect of LRBAs that commenced on/after 1 July 2018.

SMSFs are currently required to report each member’s share of the outstanding balance of an LRBA in the fund’s 2018/19 SMSF Annual Return regardless of whether or not the LRBA will be caught by this Bill.  The ATO are expected to update their instructions if the Bill is passed as they will otherwise have no way of correctly calculating the member’s TSB.

Treasury Laws Amendment (2019 Tax Integrity and Other Measures No.1) Bill 2019

Salary Sacrifice Integrity

This bill is largely focused on non-superannuation matters, however tucked away inside it is a measure that was first announced by the Minister for Revenue and Financial Services in July 2017 to ensure that an individual’s salary sacrifice contributions cannot be used to reduce an employer’s minimum SG contributions.  This measure had previously been included in a Bill before the last Parliament but it also lapsed when the Federal Election was called.

From 1 July 2020, salary and wages that have been salary sacrificed will be included in the base for calculating an employer’s SG obligations.  In addition, contributions made under a salary sacrifice arrangement won’t be counted as contributions that reduce an employer’s SG charge.

Currently, salary sacrificed amounts count towards employer contributions that reduce an employer’s mandated SG contributions. In addition, employers can calculate SG obligations on a (lower) post salary sacrifice earnings base. Currently, employees who salary sacrifice to boost their superannuation savings can end up with lower superannuation contributions than they expect.

These bills were introduced into the House of Representatives on 24 July 2019. They are not controversial issues, so there’s no reason to think they won’t get passed, but as always, it is best not to act on proposals that have not been legislated.

 

You’re welcome to share, re-post or replicate our content on your site or social channels, but please ensure that the content is always credited to Heffron SMSF Solutions - www.heffron.com.au

Contribution Caps for 2019/20 Financial Year

With a new financial year upon us, you may be thinking about what contribution caps apply for the 2019/20 financial year.

Concessional Contributions

The concessional contributions cap remains at $25,000 for the 2019/20 year.  

However, new rules allow an individual’s concessional cap for the 2019/20 year to be increased by the unused portion (if any) of their concessional cap for the 2018/19 year.  This increased cap amount may be utilised in the 2019/20 year provided the individual’s total superannuation balance was less than $500,000 at 30 June 2019.

Broadly speaking, total superannuation balance is all of the money an individual has in superannuation across all superannuation funds to which they belong.  Importantly, it is not just the amount in their SMSF.

The concessional contribution cap captures both employer contributions (including superannuation guarantee and salary sacrifice contributions) and personal contributions where a tax deduction is being claimed.

Non-concessional Contributions

The non-concessional contributions cap for the 2019/20 year remains at $100,000 for individuals who had a total superannuation balance of less than $1.6m at 30 June 2019.  Individuals who had a total superannuation balance of $1.6m or more at 30 June 2019 are unable to make any non-concessional contributions in the 2019/20 year without exceeding their cap (ie their cap is $nil).

The non-concessional cap captures personal contributions where a tax deduction is not claimed or contributions are made for a spouse.

As you may be aware, in certain situations, it is possible to “bring forward” the non-concessional contributions cap from a future year and use it in the current year.  The bring forward amount and periods are shown in the table below.

Total Superannuation Balance on 30 June 2019

Bring Forward Amount if triggered in 2019/20

Bring Forward Period if triggered  in 2019/20

Less than $1.4m

$300,000

3 years

≥ $1.4m but less than $1.5m

$200,000

2 years

≥ $1.5m but less than $1.6m

$100,000

n/a

$1.6m or more

$nil

n/a

Downsizer Contributions

Since 1 July 2018, some individuals have been eligible to make a new type of contribution called a “downsizer contribution”. 

Generally speaking, an individual is eligible to make a downsizer contribution if they are over age 65 when the contribution is made, they sell their home on or after 1 July 2018, and they owned the home for at least the last 10 years.

Importantly:

  • there is no maximum age limit (rather the contributor must simply be aged 65 or over),
  • there is no requirement to satisfy a work test, and
  • unlike non-concessional contributions, downsizer contributions can be made regardless of the size of the individual’s total superannuation balance.

But:

  • the contribution must be made within 90 days of the change of ownership (generally settlement date), and
  • a downsizer contribution form must be lodged with the fund at the time of making the contribution (or before).

Downsizer contributions are limited to the lesser of:

  • $300,000 per person (eg $600,000 combined if both members of a couple are eligible), or
  • the capital proceeds from the disposal of the dwelling.

Meg Heffron provides more information about downsizer contributions and their potential uses here https://www.heffron.com.au/blog/article/a-new-opportunity-to-top-up-super-for-those-over-65-downsizer-contributions

If you are unsure if you are eligible to make contributions to superannuation or use bring forward mode, or would like further information on downsizer contributions or the new carry forward concessional contribution rules, please give us a call to discuss.

 

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My SMSF owns premises which it leases back to my business.  What do I need to do to make sure the arrangement complies with the superannuation law?

Approximately 10% of SMSFs own commercial property and often this commercial property is leased to a related party (eg a business owned by the members of the fund).  If you have employed a similar strategy with your SMSF, there are a number of rules to follow to ensure the arrangement complies with the superannuation/tax laws.

Commercial Lease Arrangement

Where property is leased to related parties, it is vital to ensure the lease arrangement between the fund and the related party is on arm’s length terms and conditions.  This simply means that the terms and conditions of the transaction must be the same as they would have been had the parties not been related. 

To ensure your lease arrangement meets the rules, as trustee of your fund, you would generally need to:

  • before the arrangement commences, obtain a third party written opinion of the market rental to be charged on the property,
  • enter into a written lease agreement with the related party on normal commercial terms.  For example, the agreement should:
  • specify the term of the lease agreement
  • require the payment of rent as per the third party opinion obtained,
  • specify how often rent should be paid (usually monthly) and what action will be taken if rent is not paid on time,
  • specify who (eg lessor or lessee) will be responsible for the payment of rates, insurance etc (the third party opinion obtained will usually specify who should be responsible for these costs), and
  • specify when the rental amount should be increased with CPI or reviewed to market etc,
  • ensure all transactions are in accordance with the lease agreement.  For example:
  • if the lease requires rent to be paid on a monthly basis, the fund trustee should ensure the fund receives the rent on a monthly basis,
  • if the lease requires costs such as rates, insurance etc to be met by the lessee, the fund should not ultimately bear these costs, and
  • if the lease requires the rent to be increased with CPI on each anniversary of the lease, the rent should be appropriately increased.
  • ensure any insurance policies over the property are registered in the name of the fund, or where in the name of the lessee, the fund should be noted as an interested party on the policy, and
  • if appropriate, renew the lease agreement on its expiry based on an up-to-date third party opinion of the market rental to be paid etc.

As part of the annual audit process, the fund’s auditor will generally wish to review the lease agreement and the third party written opinion of the market rental.

Business Real Property

SMSFs are generally not permitted to lease real property to related parties (eg members of the fund, relatives of members, entities controlled by members/relatives) unless the property is used “wholly and exclusively” in a business.  “Wholly and exclusively” means there generally can’t be any personal use of the property, although there are some exceptions for property used in a primary production business.

You need to ensure the property continues to be used wholly and exclusively in a business throughout the duration of the fund’s lease arrangement with the related party.

Importantly, property like plant, equipment, motor vehicles, water rights that can be dealt with separately from the land etc are not “real property”.  If these sorts of assets are owned by an SMSF and leased to related parties, they are called “in-house assets”.  The total amount an SMSF invests in in-house assets is not allowed to exceed 5% of the total value of the fund’s assets. 

 

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I have never worked – can I access my superannuation?

Normally any conversation about accessing superannuation is linked to retirement. But in superannuation, only people who have worked at some point can actually retire – the definition of retirement hinges on ending what’s known as “a gainful employment arrangement” (basically paid work). This quirk means that to retire, one must work first. 

This is probably a by-product of the history of superannuation – once upon a time, it was very much linked to work.  In fact, there was a time when people who didn’t work couldn’t build up superannuation in the first place.  These days the rules about putting money into superannuation have broadened to include people who don’t work but there are still some hangovers from the old days when it comes to getting it back out again.

So how does someone who has never had a paid job access their superannuation?

Firstly, anyone who reaches their preservation age (between 55 and 60 depending on when they were born) can access their superannuation via what’s known as a transition to retirement pension.  These are superannuation pensions that are quite restricted (there is an upper and lower limit on the amount that can be taken out each year).  Most importantly they are available to people who have not retired.

Secondly, anyone who is at least 65 can access their superannuation in any way they wish – they can take all the money out, use it to start a completely unrestricted pension (known as a retirement phase pension), leave it building up in their fund or some combination.

So at worst someone who has never worked will be able to do anything they wish with their superannuation when they get to 65.

But it’s worth being absolutely sure of the facts before assuming that superannuation will not be completely accessible until age 65. There are two definitions of retirement.  One of these is that the person:

  • Had a paid job at some point that has ended, and
  • Never intends to work 10 or more hours per week in the future.

To meet the first limb of this definition, it’s actually not important that the work was recent.  All that matters is that it occurred at some point and it was paid.

So someone who worked in their teens but never again will still meet the requirement. If they are also over their preservation age and can state truthfully to the trustee of their super fund that they don’t intend to have another paid job in the future, they will be classified as retired despite not having worked for decades.

 

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Heffron has been awarded the SMSF Adviser – SMSF Administrator of the Year 2019

A clear majority of SMSF professionals voted Heffron SMSF Administrator of the Year 2019. Heffron's Head of Customer & Partnerships, Andrea Connor and Head of Operations, Mark Wawszkowicz were presented the exclusive award in Sydney on the 4th of July.

Asked why she believes advisers enjoy working with Heffron, CEO Meg Heffron replied: "We have the same purpose: at the end of the day, we all want the best outcomes for the end client. We recognise the valuable role advisers play in improving retirement outcomes for Australians, which is why we’ve centred our services around supporting them in what they do. Our aim is to be that source of technical knowledge that advisers can rely on."
 

 

Thinking about changing SMSF administration partner? Choose the best in class.

Changing your SMSF administrator is simple with Heffron's expertise. We ensure the transition from your previous SMSF administrator is a seamless experience and takes the pressure off you. Let us do the work.

What makes Heffron unique:

  • We see ourselves as part of your team. 
  • We aim to be your partner when it comes to the management of your clients’ SMSFs.  That means we’re not just blindly accounting for transactions, we’re offering solutions to any compliance or strategy issues you might run into, flagging where there might be another approach, sharing our ideas and practical knowledge which is informed by two decades’ experience of similar issues with other clients.
  • We cater for all your administration needs. 
  • We cover the full spectrum of SMSF needs, apart from the investment advice delivered by you. Advisers who work with us for their administration not only have all the usual services at their disposal (accounting, tax, documents, actuarial certificates) but can also get help via technical support over the phone, market leading education and access to a host of newsletters and articles written by us. 
  • We’re known for unmatched technical expertise with a practical overlay.
  • We are entirely independent.


Contact our friendly team to discuss your fund transfer to Heffron.

PH | 1300 Heffron
Email | sales@heffron.com.au

Super Thresholds for 2019/20 Financial Year

With a new financial year almost upon us, it is time to make ourselves familiar with the various superannuation related thresholds applying for the 2019/20 financial year.

Our 2019/20 Facts & Figures publication will be available shortly, but in the meantime, some of the more commonly used thresholds are detailed below:

Name of Threshold

Total Super Balance at 30 June 2019

Amount for 2019/20 Financial Year

Concessional contributions cap

not applicable

$25,000

Unused concessional cap carry forward

$500,000

Amount unused from 2018/19 concessional cap

Non-concessional contributions cap – standard

less than $1.6m

$100,000

$1.6m or more

$nil

Non-concessional contributions cap – bring forward mode

less than $1.4m

$300,000

(3 year bring forward period)

at least $1.4m but less than $1.5m

$200,000

(2 year bring forward period)

CGT cap

not applicable

$1.515m

Downsizer contribution cap

not applicable

$300,000

Low rate cap

not relevant

$210,000

Transfer balance cap

not relevant

$1.6m

Defined benefit income cap

not relevant

$100,000

Of course, don’t forget not everyone is eligible to make contributions, use bring forward mode or draw benefits from superannuation  If you think you’d benefit from a refresher on the fundamental rules around superannuation, take a look at our SMSF Fundamentals on-line course https://www.heffron.com.au/heffron/training/smsf-fundamentals

 

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My client has used a contribution reserving strategy in the 2018/19 financial year but he’s the sole member of his SMSF.  Is such a strategy for him “above board”?

Historically the validity of contribution reserving strategies had been the subject of much debate, with many advisers doubtful they passed the “sniff test” particularly for single member funds. 

However, a number of years ago the Australian Taxation Office (ATO) confirmed the validity of the strategy under both tax and super laws, provided the various legal requirements are met. 

So let’s backtrack, what is a contribution reserving strategy?

Contributions are eligible for deductibility in the year they are received by a superannuation fund, however they are not counted towards the member’s contribution cap until they are allocated to the member [TR 2010/1, TD 2013/22]. 

In most cases, contributions are allocated to members on the day of receipt so they are eligible to be claimed as a tax deduction and cap tested in the same year.  However trustees of SMSFs do not need to allocate contributions to members until the 28th day after the end of the month in which the contribution is received [SIS Reg 7.08(2)]. 

This means that if a contribution to an SMSF is received in June 2019 but not allocated to the member until July 2019, it will:

  • be eligible for deductibility in the 2018/19 year, but
  • count towards the relevant cap in the 2019/20 year.

This process of making a contribution in one financial year but allocating it to the member in the following financial year is commonly called a “contribution reserving strategy”.  However, that name is a bit of a misnomer as unallocated amounts are not reserves from a superannuation law perspective and a reserving strategy is not needed.  A more appropriate name would be a “deferred allocation strategy”.

When would such a strategy be used?

In terms of concessional contributions, a deferred allocation strategy may be appropriate whenever an individual wishes to bring forward a tax deduction.  For example where an individual’s taxable income is unusually high in a year (eg a one-off capital gain is received) but they have little need for a contribution deduction in the following year.

The ATO provides a couple of examples in https://www.ato.gov.au/Forms/Request-to-adjust-concessional-contributions/.

What are the Legal Requirements?

Where a member of an SMSF wishes to utilise a deferred allocation strategy, it will be essential to ensure:

  • the fund’s trust deed does not require contributions to be allocated immediately on receipt, and
  • the contribution is allocated within the 28 day requirement.

Trustees should also keep documentation including:

  • evidence of the receipt of the contribution
  • a trustee resolution detailing the trustee’s decision to defer the allocation of the contribution until a later date
  • a trustee resolution detailing the trustee’s decision to subsequently allocate the contribution
  • section 290-170 contribution notice and acknowledgement (where applicable)

In respect of concessional contributions, trustees should also ensure the ATO is notified of the use of the strategy by completing and lodging a “Request to Adjust Concessional Contributions” [NAT 74851] by the time the fund’s SMSF Annual Return and the individual’s income tax return are lodged.  In the case of non-concessional contributions, trustees will need to write to the ATO.  Otherwise, as the contributions will be reported in the SMSF Annual Return in the year in which they were received, the ATO may believe the individual has excess contributions.

If you need our assistance in documenting a deferred allocation strategy, please do not hesitate to contact our tech team.

 

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To tax, or not to tax – that is the question?

As the dust settles on the election and everyone steels themselves for the 46th Parliament to commence, it gives us some space and time to reflect on some of the important issues that were thrown around in the heat of the election campaign but not really debated.

For example, is Australia a high taxing country or not?

As with most complex subjects, there are a few ways of looking at this. If we are to take the simple view and look at the proportion of GDP governments take in tax revenue compared to similar countries, we are a modestly taxed country at best.

Consider the following table (the red line is Australia, the blue line is the rest of the OECD):

Source: OECD

On the basis of this simple measure, any objective commentary would have to conclude that the tax burden on the community is relatively low - Australia (red line) is quite a bit below the blue line (rest of the OECD).

That being the case, why is it that so many Australians feel so highly taxed? Are we a selfish bunch with no community spirit or is there something more to it?

Consider this table (again, the red line is Australia and the blue line is everyone else):

 Source: OECD

There is an extraordinary dichotomy here.

As a nation we are modestly taxed but as workers, small business people, non-superannuation savers and investors we are very highly taxed on our income and profits compared to the rest of the OECD. No wonder those Australians currently in the work force or founding businesses feel hard done by when politicians talk about taxing them even more.

And remember that retirees pay very little tax in Australia thanks to the generous tax regime applying to superannuation benefits and the superannuation funds themselves. 

The fact that our income tax system is also highly progressive means that this tax is also borne by a relatively small group of people - we end up with roughly the top 10% of taxpayers paying nearly 50% of all personal income taxes and the bottom third paying less than 5%. 

This means a very high proportion of Federal Government revenue is reliant on a very small number of individuals.  It may be how a progressive tax system is designed to operate but it also means we are very exposed to that cohort simply deciding to live and work elsewhere.  In an era where both labour and capital are more mobile than ever before, this is risky.

The latest data published by the ATO (from 2016/17) shows something similar for our corporate income tax base – like our personal taxes, our company taxes depend on a relatively small number of taxpayers.  The big four banks (CBA , Westpac, NAB, and ANZ), two biggest miners (BHP Billiton, Rio Tinto), two supermarket giants (Wesfarmers, Woolworths), and Telstra and AMP Limited paid a combined $20.8bn in corporate tax in 2016-17 – representing 45% of all corporate tax paid in Australia.

All in all, then, this is the skeleton in the cupboard that lends itself to the reasonable assertion that Australia’s tax base is far too narrow.

However, none of this answers the obvious question as to why we are a relatively low taxing country when we have such high rates of income taxation.

A large part of the answer is in the table below (the red line is Australia, the blue line is the rest of the OECD):

Source: OECD

The proportion of revenue that we raise from indirect taxation in Australia is extraordinarily low (at less than 20% of revenue).

In France (a high taxing country), for example, the proportion of government revenue raised from indirect taxes (mostly VAT) is around 50%.

So there you have it.

Overall, we are a modest to low taxed country but raise most of our revenue via a progressive income tax system that results in a dangerously narrow tax base. Workers, companies, small business owners and savers understandably feel quite highly taxed - because they are.

Most of us know and feel the income tax that we pay but maybe less aware of how little tax we pay elsewhere in our lives. This results in the public and political debate getting skewed into a debate about income taxes.

Unless we are able to broaden the public and political debate on taxation away from income taxes and onto other potential sources of government revenue, we are at risk of being stuck in this groundhog day debate for some time about whether we are a highly taxed country or not.

 

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My client makes superannuation contributions for its employees via the ATO’s Small Business Superannuation Clearing House.  When are the contributions deductible to the employer?

When the clearing house receives the money? Or when the respective superannuation funds receive the money from the clearing house?

Tax Deductibility

A superannuation contribution is only able to be claimed as a tax deduction in the year in which it is “made”.  A contribution is not made until it is “received by the fund” and when that happens depends on the manner in which the contribution is made [ITAA 1997 s.290-60(3), ITAA s.290-150(3), TR 2010/1 paras 181-182].

Some employers make payment of their required superannuation contributions via a clearing house.  In these cases, rather than an employer making individual contributions to individual funds for each employee, an employer would make a single contribution to the clearing house for all employees, and the clearing house would electronically transfer the contributions to the relevant superannuation fund for each employee. 

In this situation, the contribution is not “made” at the time the clearing house is credited with the monies from the employer, rather the contribution is made (and therefore deductible) when the superannuation fund’s account is credited with the monies following an electronic transfer of money from the clearing house [Colless and Commissioner of Taxation [2012] AATA 441].

Note, it can take many days for payments to be processed by the clearing house and received by the superannuation funds.  In respect of the 2018/19 year and the ATO’s clearing house, the ATO has advised that payments must be received by the clearing house by COB Monday 24 June 2019 to be assured of reaching the underlying superannuation funds by 30 June 2019.

Contribution Caps

In relation to cap testing, a contribution is not counted for cap purposes until the contribution is received by the fund and then allocated to the member’s account.  Trustees of SMSFs are required to allocate contributions to members within 28 days after the end of the month in which the contribution is received [SIS Reg 7.08(2)].  In contrast, trustees of non-SMSFs are required to allocate contributions to members no later than 3 business days after receiving both the contribution and the relevant information in relation to that contribution [SIS Reg 7.07H(2)].

Superannuation Guarantee (SG) Obligations

For SG purposes, an employer who makes contributions via an approved clearing house (eg the ATO’s Small Business Superannuation Clearing House) is treated as having satisfied its SG obligations when the monies are received by the clearing house [SGA s.23B(a)]. 

For example, North Qld Mangoes Pty Ltd has 15 employees.  To simplify its payroll systems, the company makes its SG contributions via the ATO’s Small Business Superannuation Clearing House.

On 28 June 2018, the company electronically transferred $10,125 to the clearing house representing SG contributions for that quarter.  This amount was received by the clearing house the next day (ie 29 June 2018).

On the following day (ie 30 June), the clearing house made the following electronic transfers:

$2,125 to Fund A in respect of 13 employees, and

$10,000 to Fund B in respect of 2 employees.

These monies were credited to the respective superannuation funds and allocated to the members the next day (ie 1 July 2018). 

From a timing perspective, North Qld Mangoes Pty Ltd is treated as having satisfied its June 2018 quarter SG obligations on 29 June 2018.

However, for all other purposes (eg deductibility and cap testing), the contributions were not made until 1 July 2018.

 

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What is it with politicians and policy reviews?

Is it just me or do we have a policy review on some topic or another announced every five minutes?

In addition, every other review announced seems to be retirement income related. One of the first things Josh Frydenberg did after the Coalition’s shock election win last week was to express his support for the Productivity Commission’s recommendation of (yet another) review into our retirement incomes system.

Whilst the industry’s collective sigh and eye roll could be heard in all four corners of our great southern land, it is clear to me that many things could be improved. Unfortunately, however, a review into retirement incomes in isolation is at risk of missing the point.

The societal challenge of an ageing population is well known and has been widely discussed. However, I think it’s also fair to say that despite all of this, few countries around the world have effectively nailed a portfolio of adequate policy responses.

The increase in longevity creates three separate but linked high level needs:

  • Health care
  • Aged care (including accommodation)
  • Retirement income provision

In most developed countries these three needs are partly funded by the state and partly funded by the individual.  Often, the proportion of public versus private funding depends on an individual’s means. At any rate, all three needs are increasingly expensive and complex areas for state and citizen alike that require strong co-ordinated policy responses. Sadly, this co-ordination is currently lacking in Australia.  

Of all the countries impacted by the 21st century aging phenomenon, Japan is at the leading edge of the problem. Here are some of the headlines:

  • Over 28% of Japan’s population is older than 65
  • There are 1.6 jobs for every job seeker
  • Debt to GDP ratio is approaching 250% of GDP (and we think we have problems)
  • By 2050, there will be as many non-working people in Japan as working people

Given all that, it is insightful to look at some of their policy responses.

Potentially, one of the most important of Japan’s responses is the creation of a strong Ministry for Ageing with wide powers, including retirement incomes.  In Australia, we have a Minister for Aged Care and Senior Australians but this minister is not in cabinet and works within the auspices of the Health Ministry so has very proscribed powers that are focussed on care and health.

At least the Productivity Commission’s recommendation was to look at retirement incomes holistically rather than just superannuation but given the nature of the problem, we need to be even broader than that and look at the problems presented by aging overall. If we are going to go through the time, expense and pain of another review, wouldn’t it be great if we engaged with the problem at the right altitude and in a coordinated fashion?

Federal Election 2019 - where are we now?

It seems few are more surprised than Scott Morrison that the Liberal / National Coalition will be forming Government after the 18 May election.

However, the ALP’s policies which have worried many superannuation savers would appear off the table for now.

The campaign was largely characterised by negativity on both sides.

The Coalition focussed on the risks of a change in Government, Bill Shorten’s personal popularity (or lack thereof) and the negative impacts of Labor’s new tax measures without presenting a compelling story about how we tackle some of the major issues of our time (climate change, housing affordability in our major cities and the related issue of underinvestment in our regions, our aging population etc).

The ALP made it clear that they had big plans for the Government to do more (around issues such as dental care, childcare, medicare, climate change, housing affordability) but rather than doing so with visionary plans to increase the size of the economy, they would focus on redistribution – largely extracting more money from savers (with changes to franking credits, negative gearing and trusts).  While the ALP would have liked to call these “closing loopholes for the big end of town” it would seem the electorate judged them to be “demonising people who have worked and saved hard”.

When it comes to superannuation, the broad take away from a Coalition win is that we should see less tinkering and probably the execution of their remaining superannuation agenda which is largely positive for SMSFs (increasing possible member numbers from 4 to 6, modest extensions to the timeframe for making contributions from 65 to 66 etc).

While not directly impacted by the outcome of the election, it will be interesting to see what the result does for industry funds.  In our view, industry funds play a vital role in providing a streamlined, scaled, low cost superannuation option that is completely appropriate for the vast majority of superannuation savers at some point in their lives.  The sector’s influence on Australia’s superannuation landscape is huge and largely positive. But recent moves towards using their influence to prosecute agendas that are not necessarily in line with maximising their members’ retirement savings has been worrying.  Shareholder activism is fine when you’re playing with your own money.  Not when you’re doing it with someone else’s.  It is likely to be less feasible with the continuation of a Coalition Government. 

The 2019 election campaign has been an interesting ride and as usual has served to highlight something that should worry us all as superannuation savers, taxpayers and citizens.   Our retirement savings system (headlined by superannuation) is still treated as a political plaything.  That means any respite we feel today will probably last for three years at best.

Family Law Payment Splits of a Retirement Phase Pension Account – reporting for Transfer Balance Cap purposes

When a superannuation interest in retirement phase is subject to a family law split, there are two ways to report the Transfer Balance Account debit “event” depending on the type of payment split.  Unfortunately, the ATO’s instructions are somewhat ambiguous and could lead to the wrong form being completed.

1. Commutation of retirement phase income stream

This is the most common case, especially for SMSFs: a couple separate, and the superannuation balance is subject to a payment split by transferring an amount (specified as either a dollar amount or a percentage of the balance) out of the member-spouse’s account and paid to the non-member spouse (either as a lump sum or as a rollover to the non-member spouse’s super account).

Where the amount is to be paid from the member-spouse’s pension account, the pension will need to first be fully or partially commuted.  The commutation is reported as a debit to the member’s Transfer Balance Account (TBA) under the general rules via a Transfer Balance Account Report (TBAR). Answer “A different transfer balance cap event” at Question 11, and “Member Commutation” at Question 14.

If the non-member spouse uses the member’s lump sum to start a new superannuation income stream, the new income stream will result in a credit to the TBA of the non-member spouse – also reported under the general rules via a TBAR.

For example, Don and Judy are trustees and members of their SMSF. Don is in receipt of a pension from the fund and his transfer balance is $1,000,000. In March 2019, he is required to transfer $500,000 to Judy as a result of their relationship breaking down – he transfers it from his pension account to her new account in a retail super fund.

Don’s transfer balance is debited by $500,000 and now stands at $500,000. Judy decides to commence an income stream with the full amount she receives, and receives a $500,000 credit in her transfer balance account. This is all reported on the general TBAR – Don’s event is a Member Commutation, Judy’s is a commencement of a new income stream.

2. Splitting of the pension payments

Less commonly, the family law payment split might split the income payments, as opposed to the underlying balance. The member-spouse retains complete ownership of the superannuation interest, but a portion of each payment they receive is directed to the non-member spouse.  We expect this would be rare in an SMSF.

In this case, the fund is not responsible for reporting the event via a TBAR.  Instead, the member is required to report it on a “Transfer Balance Event Notification” form available for download from the ATO website here: https://www.ato.gov.au/Forms/Transfer-balance-event-notification-form-instructions/

 

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Do you have a client with an SMSF paying a capped defined benefit income stream?  Have they met their Pay As You Go reporting and withholding obligations?

The Australian Taxation Office (ATO) are concerned that a number of SMSFs paying capped defined benefit income streams haven’t met their Pay As You Go obligations and are writing to affected SMSFs (or their agent).

A “capped defined benefit income stream” is a concept which was introduced on 1 July 2017 and captures:

  • lifetime pensions regardless of when they commenced
  • lifetime annuities commenced prior to 1 July 2017
  • life expectancy pensions and annuities commenced prior to 1 July 2017
  • market linked pensions (otherwise known as term allocated pensions) and annuities commenced prior to 1 July 2017

Like any other retirement phase pension, a capped defined benefit income stream counts towards the recipient’s $1.6m Transfer Balance Cap. But unlike account based pensions, they cannot be partly or wholly commuted (eg rolled back to accumulation phase or cashed out as a lump sum) if they cause an individual to exceed that cap. This means they can create a problem (exceeding the cap) but can’t adopt the normal solution to that problem (commuting some or all of the pension).

For this reason there are special rules that allow recipients of capped defined benefit pensions to exceed their Transfer Balance Cap as long as the only income stream causing them to do so is their capped defined benefit pension.

In recognition of the fact that they are allowed to exceed their cap, people in this position have their tax concessions for these types of pensions limited in a different way. Individuals aged 60 years old or over (or receiving a reversionary defined benefit income stream and the deceased died at 60 years old or over) whose income from their capped defined benefit income stream exceeds $100,000 per annum (known as the defined benefit income cap), may have additional tax liabilities.  For example, for pensions paid from a taxed source (which includes all SMSFs and virtually any other superannuation fund except certain public sector schemes), 50% of their annual income stream amount over the defined benefit income cap will be taxed at their marginal rate.

To allow the ATO to identify the individuals subject to this additional tax, a superannuation fund must issue a Payment Summary to any individual receiving a capped defined benefit pension if:

  • the individual is aged 60 or over
  • the individual is under age 60 but is receiving a reversionary pension and the deceased died age 60 or over

This rule applies to all superannuation funds, including SMSFs, regardless of the amount of pension paid.  For example, a fund paying a pension of only $20,000 per annum from a capped defined benefit income stream would need to issue a Payment Summary to that individual.

In addition, if the amount paid will exceed the defined benefit income cap for a particular year, the fund trustee is also required to withhold tax using the usual tax tables https://www.ato.gov.au/rates/schedule-13---tax-table-for-super-income-streams/

 

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What’s the point of Transition to Retirement Income Streams post 1 July 2017?

The Government’s 1 July 2017 tax changes caused Transition to Retirement Income Streams (TRIS) to fall out of favour with many advisers and their clients.  But, depending on the client’s circumstances, they can still be a valuable tool.

If the fund is not entitled to a tax exemption on the earnings of a TRIS balance, why not simply leave the monies in accumulation phase?

Many individuals did in fact stop their TRIS and roll their benefits back to accumulation phase effective 30 June 2017 given the 1 July 2017 loss of the tax exemption. However, for some individuals, there can still be benefits to maintaining/commencing a TRIS including:

  • Most people under age 65 who have not yet met a retirement definition are unable to access their super. However, if they have at least reached their preservation age, they can commence a TRIS and draw up to the 10% maximum pension limit each year.  For those at least age 60, the pension payments will be tax free.  For individuals with cash flow difficulties, commencing/maintaining a TRIS can be a valuable option.

The cashflow generated from the TRIS pension payments can even be used to make deductible contributions to superannuation (assuming all the relevant criteria/caps are met). 

  • Where large tax free contributions are to be made to superannuation (eg CGT cap contributions, non-concessional contributions using the bring forward rule), it may be appropriate to isolate the contribution into a pension account to maintain its status as a 100% tax free proportion pension.  For those not yet 65/retired but at least preservation age, a TRIS is the only type of pension account available to them. 

Isolating the tax free contribution this way may have advantages for those not yet age 60 or on the death of the individual, and can act as a hedge against future changes in the law.

Note, this strategy is only possible where the contribution hasn’t been added to an accumulation account containing taxable components before the TRIS is commenced.

But isn’t the balance of a TRIS limited to $1.6m?

No.  The balance of a TRIS is not counted towards the $1.6m Transfer Balance Cap (and no TBAR is lodged) until the TRIS becomes a retirement phase pension.  This will generally be when the individual reaches age 65 or notifies the trustee of their retirement.  Until this time, the balance of the TRIS is unlimited.

Conceptually it makes sense for the Government not to limit the amount in a TRIS until age 65/retirement because the fund is not receiving a tax exemption on the earnings on the TRIS balance until that time.

Depending on the client’s needs, commencing/maintaining a TRIS of more than $1.6m may be appropriate.  The important thing will be making sure the balance is reduced to no more than the Transfer Balance Cap just before the TRIS becomes a retirement phase pension (eg at age 65, notification of retirement).

 

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Banning franking credit refunds - is there another way

With the Federal election looming, the Australian Labor Party’s policy to prevent many taxpayers from receiving a refund for their franking credits has certainly become a dominant issue for many retirees, particularly those with SMSFs.  

While we have no idea how easy it will be to get it passed, it does seem likely to remain firmly on the agenda unless the ALP is defeated.

The logic for this policy is, broadly speaking, “rich people shouldn’t get tax refunds, they should effectively pay more tax” on their personal and SMSF investments.  Importantly, the language supporting the policy is about people paying tax but the proposed changes would implement it via the entities in which their assets are held.

Initially that seems like an esoteric point.  But consider the difference in outcomes between two identical people who have both saved for their retirement through superannuation but are different in only one respect : they belong to different superannuation funds.

Let’s say one of our imaginary people is receiving a superannuation pension from his large industry fund or bank-owned master trust.  Because that fund has other members that are bringing in contributions (income that gets taxed), it is likely that he will receive the full value of the franking credits attached to the shares supporting his pension account. 

How does this happen? 

Smart industry funds, master trusts and wrap accounts already have systems in place to make sure that the tax paid to the ATO is calculated at the fund level, taking into account all the income and costs for the whole fund.  That tax bill is then divided up fairly between all their members. 

They will simply use the same systems to make sure that something like this happens:

  • let’s say the dividends received on assets notionally held for our pensioner included a $5,000 franking credit.
  • there was also income of $100,000 from all the assets notionally held for the other members (which would normally result in a $15,000 tax bill : 15% x $100,000). 
  • the fund would end up paying tax of only $10,000 ($15,000 less $5,000 franking credits).  It hasn’t had a refund of its franking credits but it has been able to use them in full.
  • the fund trustee would then break that down to be fair to the members,
  • it’s likely the trustee would increase the earnings given to the pensioner’s account by $5,000 (to reflect the franking credit) and reduce all the other members’ accounts by (combined) $15,000.  This is fair – the pensioner effectively created the $5,000 tax saving and so should receive the benefit of it.
  • what has really happened is that the fund has not officially received a refund of its franking credits (so is not hurt by the ALP policy) but the member has. 

Overall, the members who are creating the taxable income that is using up the franking credits will receive no benefit from them.  Fancy (but completely fair and in fact common) internal accounting techniques will ensure that all that benefit goes to the member that “owns” them – our imaginary pension recipient.

But now let’s look at a member with precisely the same size and type of superannuation investments in a small fund that doesn’t have enough other taxable income to use the franking credits.  This could be an SMSF but equally it could be a small corporate fund, a fund with most of its members in pension phase or even a small industry fund.  This person will be in a very different position to our “large fund member” above.  They will experience the full force of the change and find they simply lose a valuable tax refund. Their retirement assets will grow more slowly (or shrink more rapidly) and they will be worse off.  This is completely consistent with the intent of the ALP’s policy.

What’s interesting here is that the measure is promoted this as a fairness measure between people and yet the implementation will be precisely the opposite.  It will treat two identical people (same amount of money, held in the same environment – superannuation, and same assets) differently simply because they have made different choices about which superannuation fund should house their retirement assets.  In fact by adding a late adjustment to protect SMSFs that had a person receiving the age pension at a particular (arbitrary) date from this change, the ALP has reinforced the message that this is about people paying the right amount of tax.

So could the ALP achieve their objective some other way?

Absolutely. 

They could apply the refund ban at a member level.  Simply ask the large fund in our example above to work out the franking credit amounts that were created by our hypothetical pension member ($5,000 in this example) and make sure they are only used to reduce tax on his account.  If there is no tax to pay on his assets, set the value of those franking credits to $nil.  This is exactly what would happen under the ALP’s policy if he was the only member of his fund and it received no other income.  The Fund would then pay $15,000 in tax and this would be shared between the other members (it would have no impact on them).

That would put people on a level playing field.

Personally I think this would be foolish but then I think the whole idea of taking away franking credit refunds is misguided.  Franking credit refunds were introduced to ensure that company profits were ultimately taxed at the tax rates of the people who received them via dividends.  Since companies already pay tax at a relatively high rate (30%) and this is taken out of the dividend before it is given to the investor, it makes sense that some of the overpaid tax needs to be given back as a refund.  That’s what we’ve done now for many years.

If Australia must increase its taxes (and that’s entirely possible), then put up the tax rates.  Let’s not artificially introduce a distortion into the tax system to hide what is really happening.

If supporters of the policy are doing so on the basis that some people really should pay more tax, my counter suggestion should be extremely palatable.  It would mean that everyone, no matter who else belongs to their superannuation fund, is treated in exactly the same way.

Division 293 tax – when is it paid?

Division 293 tax is the name given to a special extra tax (15%) paid on some or all of the concessional superannuation contributions made for high income earners.  For this purpose, a high income earner is anyone who earns $250,000 or more and this amount includes their concessional contributions within the concessional contributions cap.

While the tax relates to superannuation contributions, it is actually levied on individuals rather than their superannuation funds.  They are, however, allowed to access money from their superannuation to pay it.

An emerging challenge for those subject to this tax is : when can money be withdrawn from superannuation to pay it?

Like a number of other special superannuation taxes, there is a specific process to follow when it comes to Division 293 tax.

Even where an individual knows full well that their concessional contributions will be taxed at 30% (both the normal 15% tax rate plus the extra 15% that applies under Division 293), this is not reflected at the time their superannuation fund’s annual return is lodged.

Instead, the ATO uses the information in the fund’s annual return and the individual’s personal tax return to work out that Division 293 applies.  If it does, a determination is then issued to the individual showing the amount of extra tax that needs to be paid.

An individual can then choose to:

  • pay it themselves from their personal bank account, or
  • use a special release authority that accompanies the determination to pay it out of their superannuation fund.

Importantly, it is only at this point that money can be released from the superannuation fund to pay the tax.  Releasing it earlier is effectively paying a superannuation benefit to the member.  This might well be illegal if the member is not yet old enough to take money out of their fund.

The fact that Division 293 tax is a personal tax charge rather than one levied on the fund means that any tax instalments that the fund has paid during the year won’t count towards the Division 293 bill.  It also won’t be a way of using the fund’s franking credits – because it’s not a tax on the fund, it’s a tax on the individual.

Any amount released from superannuation to pay it is technically a special type of superannuation benefit. This provides some interesting opportunities in that:

  • if the member has multiple accounts (an accumulation account and one or more pensions), the payment could be withdrawn from whichever one has the highest taxable proportion on the basis that it makes no difference to the tax treatment of the withdrawal but may maximise the tax-free amount left in the member’s superannuation account.  This is the case even if the concessional contributions were actually made to a different account or even a different superannuation fund,
  • if the payment is to be withdrawn from a retirement phase account-based pension, the member could partially commute the pension to pay the excess (clawing back some of the Transfer Balance Cap).

Division 293 tax affects relatively few people, and this is perhaps one of the reasons it remains complex for practitioners.  Perhaps the single most important thing to remember is, if a superannuation fund is to pay the tax (either to the ATO or to reimburse the member), to act on the release authority from the ATO, and not before.

Election Special: The key differences in policies when it comes to retirement savings

And they’re off!  The long-awaited election campaign is now finally in full swing and babies are being kissed, working families praised and the nightly news shows too many politicians.

Both of the major protagonists believe they have a portfolio of policy promises that will build a strong economy and deliver on the much referenced but never specifically defined “fair go” for Australians.  However, the means by which these two goals are to be achieved are starkly different between the two parties at almost every level, from climate change to taxation.

But what are the key differences between the two majors when it comes to retirement savings?

In a nutshell, the trend for both sides of politics over the recent past has been to change the tax system in a way that reduces the return on private savings whilst making policy decisions that increase the cost of providing state funded retirement incomes. If there was a metric that was able to measure the support given by government to those who fund their own retirement incomes vs those who rely on the state for a portion their retirement income, the dial has recently been moving decisively in favour of the state funded retiree.

The difference between the two largely comes down to the degree to which they do this.

Australian Labor Party (ALP)

The ALP aims to reduce the return on private savings by:

  • decreasing the tax deductions available to investors (eg, reducing the ability of investors to negatively gear some of their investments),
  • increasing the taxes that are paid by investors (removal of refundable franking credits, increase in capital gains tax increases and changes to the taxation of trusts and trust beneficiaries, additional restrictions on tax exemptions for superannuation funds providing pensions), and
  • reducing the ability for Australians to save via superannuation (lower contribution caps).

These proposals have had a lot of publicity but perhaps most importantly, they are collectively all targeting investment and saving. If all proposals are eventually legislated the incentive to save and invest in Australia will have taken a further hit.  It would be reasonable to expect household savings ratios to fall even further than their current very low levels as the Commonwealth Government’s desire to take an ever-increasing slice of the existing return simply encourages people to minimise their personal savings.

Given the cost of the ageing population, this doesn’t bode well for Australia’s longer-term economic future.

The Liberal-National Coalition (Coalition)

In contrast, the Coalition’s retirement incomes policies are fairly benign. Given they have been in government for the past 5 and a half years that isn’t surprising because the major changes they wanted to make have all been made. Most dramatically, when it comes to superannuation, we saw the imposition of the $1.6m cap on retirement phase pensions and significant reductions to personal contribution caps from 1 July 2017. These measures effectively increased the tax on savings either directly (the pension changes) or indirectly (the contribution cap changes – by limiting access to a concessionally taxed retirement savings vehicle).

Both parties have agreed to shelve the planned increase in Age Pension age from 67 to 70. Maybe this reflects bipartisan support in Canberra for some retirement income master plan where all the increases on private savings are used to fund what is effectively an increase in the Age Pension.  If not, it looks like a move that effectively increases the cost of providing the age pension (relative to starting at 70) at the same time as private savings are being attacked on all fronts. 

Summary

Overall, the ALP’s election promise and the Coalition’s enacted policies represent further blows to those within the community who wish to fund their own retirement.

Meanwhile, we have around $4 trillion of wealth invested in owner occupied housing that is exempt from tax and very generously treated in the government benefits means tests….and we wonder why house prices are so high…

My client has excess concessional contributions and their Total Super Balance exceeds $1.6m.  What happens now?

While the rules surrounding excess contributions have remained relatively stable for some time now, the 1 July 2017 changes to non-concessional contribution limits for those with large superannuation balances have understandably muddied the waters.

In particular, what happens when excess concessional contributions are made for someone whose Total Superannuation Balance is above the critical $1.6m threshold?

Firstly, it is worth noting that concessional contributions can still be made for someone in this position.  This includes both employer contributions and personal contributions for which the individual claims a tax deduction. 

If those contributions exceed the $25,000 concessional contributions cap, they are initially dealt with just like any other excess concessional contribution:

  • The total contribution amount will be reported to the ATO as part of the fund’s annual return (let’s say the contributions occurred in 2017/18 and are included in the 2017/18 annual return).
  • The ATO will determine that there is an excess (let’s say this amount is $5,000).
  • The ATO will add the $5,000 to the individual’s 2017/18 assessable income and re-calculate their income tax for that year.  Their new tax position will be calculated including this $5,000 and allowing for a 15% tax offset (to reflect the tax already paid by the superannuation fund).
  • In addition, interest will be applied to this “extra tax bill” from 1 July in the year in which the contribution was received (1 July 2017) (this interest component is known as the excess concessional contributions charge).  If the extra tax bill is $1,000, interest will be applied to the $1,000 not the full $5,000 excess.

The ATO will also advise the individual that they can elect to release up to 85% of the excess contributions (85% x $5,000 = $4,250) from their superannuation fund.  If this election is made, the ATO will send a release authority to the member’s nominated superannuation fund.

If they choose not to release the excess, the full amount ($5,000) will count towards the individual’s non-concessional contributions cap (for 2017/18 in this example).

This is where things potentially get tricky.  If the individual’s Total Superannuation Balance was $1.6m or more at the previous 30 June (30 June 2017 in this case), their non-concessional contributions cap is $nil.  Does that mean it is illegal to create an excess in this way? Are individuals in this position forced to refund their excess concessional contributions?

In fact no.  Providing they meet the usual superannuation rules (for example, they are under 65 or between 65 and 75 but have met the work test), any individual in this position can still make non-concessional contributions.  They can also have one created via an excess concessional contribution that is not refunded.

But any non-concessional contributions will be in excess of their $nil limit.

In this example, the $5,000 excess will be treated just like any other excess non-concessional contribution.  It will trigger a determination from the ATO which sets out the excess ($5,000) plus an amount of “associated earnings” (effectively, interest on the excess).  Again, the interest applies from the beginning of the financial year in which the contribution was received (1 July 2017 in this case).  The individual then has two choices:

  1. Take the relevant amount out of superannuation (the excess of $5,000 plus 85% of the associated earnings).  In this case, the individual will just pay extra income tax on 100% of the associated earnings (and will receive a 15% tax offset) in 2017/18, or
  2. Pay excess non-concessional contributions tax.  In this case just the excess amount ($5,000) is taxed at 47%.

Since 1 July 2018, in the absence of the member telling the ATO that they don’t want monies released from superannuation, then the ATO’s default will be to issue a release authority so the relevant amount can be paid out of superannuation.  This release authority will be sent to the fund with the highest reported account balance.

The new $1.6m limit on non-concessional contributions has not really changed anything here.  It simply means that anyone in this position should definitely refund their excess concessional contributions!  Importantly:

  • No refunding of excess contribution amounts should happen until the determination and release authority is received from the ATO.  If any amounts are refunded earlier, they are effectively benefit payments.  If the member is not yet eligible to withdraw amounts from superannuation it will be an illegal early release of superannuation money.
  • Even though the member’s Total Superannuation Balance in this example was over $1.6m, the excess concessional contribution (which in turn created an excess non-concessional contribution) was not illegal, it simply had tax consequences.

Franking Credit Refunds

Top of mind for many SMSF trustees – particularly retirees - is the upcoming Federal Election and the Australian Labor Party (ALP) policy on refunds of excess franking credits. 

Despite a parliamentary inquiry recommending against the policy and strong backlash from various sectors, the ALP remain committed to the measure.  This means it has a reasonable chance of becoming a reality (in some form) if Labor wins the Federal election.

So what should SMSF trustees be doing now?

Whilst we don’t advocate making radical changes based on a proposal by a party that isn’t even in power, it’s always a sensible idea to plan. The place to start is to get a feel for how your SMSF is likely to be impacted.

Overview of the policy

In general terms, Australia’s imputation system currently allows companies to pass on the benefit of tax paid at the corporate level to its shareholders by attaching a “franking credit” on dividends paid.  In the shareholders’ hands, the franking credit could be used as an offset to reduce their tax liability with any excess franking credits being refunded to the shareholder.

What the ALP policy proposes is that individuals and super funds will no longer receive a refund of any excess franking credits. In other words, if you don’t use your franking credits to offset tax on taxable income, they are effectively lost. This change is proposed to start from 1 July 2019.

Is anyone exempt?

As a result of strong backlash to the proposal when it was first announced more than a year ago, the ALP proposal was amended (the “Pensioner Guarantee”) to allow the following classes of shareholders to continue to receive refunds of any excess franking credits:

  • Age Pensioners and Centrelink allowance recipients, and
  • SMSFs with at least one member who was in receipt of an Age Pension or Centrelink allowance before 29 March 2018.

Impact on SMSFs (who don’t qualify for the Pensioner Guarantee)

Probably the largest group to be affected, and certainly the most vocal, are SMSFs. Why? SMSFs with retired members and paying pensions generate tax exempt income. Their franking credit refunds often form a crucial part of funding pension liabilities and covering expenses.

However, pension paying SMSFs aren’t the only ones that will be affected. Funds with only accumulation members will also need to be aware.  If the members are not contributing much or at all, and the only taxable income of the fund is investment income and realised capital gains, there’s a good chance that the fund is not going to generate enough taxable income to allow for all of their franking credits to be used up.

The size and membership of an SMSF will be a strong factor in determining the extent to which this policy will affect it, as will the amount of taxable contributions being made and the asset allocation of the investments.

Let’s look first at an SMSF with retirement phase pension accounts totaling $1M, no accumulation balances, and no further contributions are planned. This SMSF pays no tax on investment income as it is all “exempt current pension” income. The fund currently receives a full refund of its franking credits every year. Under the ALP policy, the fund would cease to receive these refunds.

I’ve seen many SMSFs that have decided in their investment strategies to focus heavily on high dividend yielding Australian companies in defensive sectors in order to generate enough income to cover their pension liabilities and the fees, the long term strategy being that the dividend yield will cover pension payments until the members hit their late 70s. This defers the need to sell down assets to cover liabilities each year and their shares are left to grow with the market.

These funds may have weathered some volatile share price performance in the past 18 months, but this has been made tolerable through the strong dividend yield. The refund of the franking credits is key to the success of this investment strategy long term, and the loss of those will force these SMSF trustees to re-think their strategies ongoing.

Take for example, a $1M SMSF all in retirement phase pensions with 80% in Australian defensive shares – this fund might stand to lose around $15-$17K in “income” each year or nearly 2% in yield. These trustees are likely to be reconsidering their investment strategy, as under the ALP policy, the one they have is not going to serve them as well as it has in the past.

Even if the asset allocation were closer to a traditional ‘balanced” investor risk profile, with say 30% in Australian shares, there’s still around $6-8K pa in “income” the SMSF is no longer receiving and may bring forward the requirement to start selling assets down.

What are the Alternatives?

Change Investment Profile

The conventional wisdom is obviously that investment decisions should not be based on tax outcomes.  This is probably true but there is no denying that historically (and quite reasonably), the expectation of franking credit refunds has contributed significantly to the total future return expectations for high yielding Australian shares.

Trustees affected by the ALP proposals may look to adjust asset allocations away from a franked dividend focus to other investment classes such as property (direct or through real estate investment trusts), global shares, fixed income and unfranked dividend yielding Australian shares.

Make Concessional Contributions

Another option for some SMSF members is to make concessional contributions where the members are eligible (restrictions apply - members between 65 and 74 year of age must generally pass a work test in the year of contributing and members age 75 or over generally can’t make concessional contributions.)  Concessional contributions are tax deductible to the member and included in the fund’s taxable income, which can result in there being enough taxable income to use up the franking credits.

Add New Members

Alternatively, where the members/trustees have adult children, it might be appropriate for those children to join the SMSF and direct their employer, salary sacrifice and personal deductible contributions to it, thereby generating enough taxable income at fund level to use the franking credits. There’s pros and cons to this strategy though, so consider it wisely. Lyn Formica wrote about it here https://www.heffron.com.au/blog/article/adding-my-adult-children-as-members-of-my-smsf-what-are-the-pros-and-cons

In summary, and at risk of stating the obvious, the more taxable income a fund has, the more franking credits can be used up rather than lost.

Consider Alternative Funds

There has been much discussion as to whether smaller, single member SMSFs in retirement pension phase that invest only in shares, cash and managed funds (ie not direct property) may even consider rolling over all or part their remaining fund balance to a retail “wrap” type pension account or an industry fund. These large super funds generally have both accumulation and pension members, so generally have enough taxable income to use the franking credits.  Certainly this will be the right course for some funds.  Others will find that the other benefits of the SMSF such as control, estate planning flexibility, ability to change course quickly in response to legislative change or a change in circumstances and many others outweigh the tax savings.

Move Balances to Accumulation Phase

Much larger SMSFs with retirement phase pensions will see less of an impact on them due to the $1.6M transfer balance cap rules introduced from 1 July 2017. As members can only transfer $1.6M into a retirement phase pension, very large SMSFs these days are likely to also have accumulation accounts. These accounts of course are taxed on their investment income, and so the larger the fund, and the higher proportion of the fund that is in accumulation phase, the more franking credits that can be used up.  

Some SMSF pensioners whose minimum pension is more than their needs may even consider rolling some of their pension balance to accumulation phase (where permitted).  The fund’s tax position will remain the same (eg no refund of franking credits but no tax payable either) but the minimum annual amount to be withdrawn from the fund will have been reduced.

Note, these are just some of the alternatives to be considered.  The appropriate option for you will depend on your specific circumstances.

Summary

The proposal to abolish franking credit refunds has taken up a lot of space in financial media since it was first announced a year ago, and Mr Shorten has not budged on it.  Like anything, it’s good to plan and be prepared, but important not to take drastic action until we see the results of the upcoming election. It’s not unheard of for a political party to lose an “unlosable” election, and this policy is very divisive.  In addition, even if it wins the election, the ALP may need to make further concessions to their policy to win the support of the minor parties.

 

You’re welcome to share, re-post or replicate our content on your site or social channels, but please ensure that the content is always credited to Heffron SMSF Solutions - www.heffron.com.au

Watch pension payments before 30 June 2019

As we get closer to the end of the financial year, many SMSF members with pensions will be checking the amounts paid from their fund so far to make sure the minimum payment requirements will be met.  Others, who only take payments right at the end of the year, will need to double check the amount that needs to be paid from their fund and make sure it all happens before midnight, 30 June 2019.

Two very common questions at this time of year are:

  1. What happens if I do an electronic transfer from my SMSF’s bank account on 30 June but it doesn’t show up in my bank account until early July?
  2. Can I make my pension payment by taking some of the SMSF’s assets (eg listed shares) and transferring them to my name? Or do I have to take my pension payments in cash?

There’s a strange answer to the first question.

As a general rule, a pension is only considered to be “paid” by electronic funds transfer (EFT) when the money appears in the recipient’s bank account.  Given that 30 June is a Sunday this year, leaving it to the last minute will generally be too late.  Even transfers arranged on Friday 28 June might cause problems – it’s likely that the money won’t appear in the member’s bank account until at least Monday 1 July and possibly even later.  This might seem surprising since most banks will actually take it from the fund’s bank account immediately.  But the argument is that the pension is only really paid once the member has control of the money.

SMSF trustees that forget to make their pension payments until the weekend (29/30 June) do have one other option to make the payment on time - a cheque.  For a pension to be paid by cheque, the trustee simply needs to ensure that a cheque dated 30 June or earlier is in the hands of the member before midnight, there is enough money in the fund’s bank account to cover it and the cheque is presented promptly (say the following week) by the member. It’s a strange “back to the future” outcome (how many people actually use cheques these days?) but again, the argument is that once a member has a valid cheque in their hands, they have control of the money.

The second question is simpler.  Pension payments have to be made in cash.  SMSFs can certainly transfer assets such as shares to members and have that amount treated as a payment out of a pension account but it’s a different kind of payment – it’s a “commutation” of the pension.  Not all pensions can make these kinds of payments.  For example, someone who has not yet retired and is receiving a transition to retirement income stream (also known as a TRIS) can’t take a payment like this.  But someone who (say) has retired and is receiving a standard account-based pension can do so.

The trick here is that the commutation does not count towards the minimum pension payments required for the year.  So someone planning to transfer a large asset out of their fund would need to make sure that they also took their minimum pension payments (in cash). 

This is easy to overlook because the rules were different until 30 June 2017.  Back then, commutations did count towards the minimum rules.  That meant that it was possible to meet all the pension payment requirements by transferring assets out of the fund each year rather than paying cash.  The only catch was that there was some paperwork to put in place (flagging that the transfer was a commutation).  Not anymore.

Making pension payments at the right time and in the right way is vital.  Getting this wrong can have major consequences – not only will the fund be breaking the rules but it will often also lose the great tax concessions that come with paying pensions from superannuation funds (no tax on some or all of the fund’s investment income).  It certainly pays to get it right.

 

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Online TBAR lodgement & TBC Information now available to tax agents

Lodging transfer balance account reports (TBAR) and viewing transfer balance cap (TBC) information is now easier for tax agents but only where they are the tax agent for the individual member.

It has been a frustration for many tax agents that they have not been able to access online the TBC records for individual clients.  This frustration has now been solved with new online ATO services available, but only for those persons who are the tax agent for the individual member.  Unfortunately advisers for the client and accountants who act only as the tax agent for the self managed superannuation fund are still without access to this information, without the assistance of the client’s tax agent (or the client having a MyGov account).

Viewing Transfer Balance Cap Information

Tax agents can now view information about their individual client’s TBC, including:

  • transfer balance and available cap space
  • capped defined benefit balance
  • all transactions processed and posted to your client’s transfer balance account
  • information about an excess transfer balance determination
  • information about a commutation authority
  • any liability for excess transfer balance tax

To view TBC information in Online services for agents, select your client then “Super”, “Information” and “Transfer Balance Cap”.

Lodging an Electronic TBAR

For those accountants not using SMSF specific software, the new Online services also now offer the opportunity to lodge an electronic TBAR (eventually replacing the current spreadsheet option).

To lodge a TBAR in Online services for agents, select a client, then “Lodgement”, “Client forms” and “Transfer balance account report”.

 

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BUDGET: Miscellaneous Amendments/Changes already Legislated

In addition to the Government’s proposed changes to the contribution rules for older Australians and also exempt current pension income, they’ve proposed a couple of miscellaneous amendments.

Miscellaneous Amendments

Under current law, from 30 November 2019, rollovers to or from SMSFs will need to be made via SuperStream (ie via electronic means rather than paper-based).  The aim of this change was to reduce compliance costs for SMSFs and also improve the integrity of the superannuation system by increasing the ATO’s ability to verify SMSF data.

Whilst system changes are already in progress to facilitate this change, the Government has proposed deferring the commencement date from 30 November 2019 to 31 March 2021.

From this date, SuperStream will also be expanded to include requests for the release of monies from superannuation via release authorities (eg where an individual has exceeded a contribution cap).

Changes Already Legislated

As is often the case, in last night’s Federal Budget the Government took the opportunity to remind us of some of the changes which they have already legislated.  One of these, which has not received much air-play to date, is the change to default insurance and inactive member accounts.

When setting up an SMSF, it is a common strategy for individuals to roll over most of their accumulated balance from an industry, employer or other retail-type fund leaving a small amount behind so that they can keep their insurance cover going.  Likewise, opening a retail or industry super account just to obtain insurance cover is an often used strategy.

New laws recently legislated mean individuals in these situations should review the account which holds their insurance cover, otherwise that cover may be lost.

The Detail

From 1 July 2019, trustees of a MySuper or choice fund* are prohibited from providing insurance where:

  • the member’s account is inactive for a continuous period of 16 months or more, and
  • the member has not elected to obtain or maintain insurance in that fund.

In other words, from 1 July this year a member must “opt-in” to continue to hold insurance in an inactive super account, or make the account active. Failure to do so could mean the trustee will cancel the insurance cover.

* These rules apply to basically all superannuation accounts except SMSF, small APRA funds, defined benefit members, Australian Defence Force Super members, or members whose employer covers the full cost of the insurance premiums (over and above the employer’s super guarantee obligations).

What is an Inactive Super Account?

A member’s account is considered inactive simply if no contributions or rollovers have been received into it for a period of 16 months. Once a rollover or contribution is received, the 16-month period is reset.

This change affects insurance arrangements put in place both before or after 1 July 2019, and inactivity prior to this date counts towards the 16 months.  For example, a super account where no contributions or rollovers have been received since 1 March 2018 will be considered inactive on 1 July 2019.

What do Individuals need to do?

Where an individual holds a super account somewhere with insurance cover that they intend to remain in place, and the account is in danger of being considered “inactive”, they can either:

  • contribute or rollover an amount to the account to make it active (if they are eligible to do so), or
  • submit a valid election in writing to obtain or maintain the insurance cover.

Contributing or rolling over to the account will only make it active for up to 16 months, after which they would have to do either of the above again, whereas individuals only have to submit the opt-in election once, so it’s a more permanent solution.

Individuals who have insurance arrangements in their super accounts and who might be affected by these new rules can expect to hear from their super fund in the next few months.  They will be given the opportunity to elect (in writing) for their insurance to continue (if they choose to do so).

 

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BUDGET: Contribution Changes for Older Australians

The 2019-20 Federal Budget confirmed the changes to contribution rules announced in the Treasurer’s Press Release on 1 April.

Currently, once a person turns 65 they must meet a work test before any further voluntary contributions can be accepted by a super fund (unless the contribution is a downsizer contribution or a work test exempt contribution, both of which are covered later in this article). This test requires them to have completed 40 hours of gainful employment in a 30-day period. Voluntary employment does not meet the definition of “’gainful” employment, so volunteers or those who only work one day a week generally can’t contribute once they turn 65.

The Government has proposed to increase the key age here from 65 to 67 from 1 July 2020.

The measure also extends the ability for those aged 65 and 66 to access the bring forward arrangements for non-concessional contributions (NCCs).

Currently, certain individuals can make up to 3 years’ worth of NCCs in a single year (based on the current NCC cap of $100,000, this is $300,000 in a single year).  There are rules that limit this opportunity for anyone with a Total Superannuation Balance of $1.4m or more at the previous 30 June but assuming these are met, age is the only other key factor.  The final year in which an individual can generally trigger these bring forward rules is the year in which they turn 65.

Should the proposed change be introduced, this would be extended to the year in which the individual turns 67.  

Interestingly, and happily, no mention was made of changing the Conditions of Release to increase the current unrestricted access to super from age 65 to 67.  This means people in that age group can both contribute and draw down on their super without meeting any other tests.

There was also no mention of amending the downsizer contribution rules which are currently only available for those age 65 or over. Presumably, this means that a non-working 65 to 67 year old will be able to make voluntary contributions and a downsizer contribution (up to the relevant caps) all at the same time.

Nor was there any mention of winding back the work test exempt contributions that are currently legislated to commence from 1 July 2019.  These are the rules that allow individuals to contribute one extra year after they last met the work test providing they had a low balance (less than $300,000) at the previous 30 June (see our blog https://www.heffron.com.au/blog/article/proposed-work-test-exemption-for-recent-retirees-who-will-benefit for details of the new work test exempt contribution rules).

Case Study

John is 64 and will turn 65 in August 2019 which is when he plans to retire.  So far, he has built up very little superannuation and is well within the balance limits for someone wanting to make large non-concessional contributions. 

He was planning to contribute $100,000 NCC in June 2019, and another $300,000 in July 2019 before turning 65 – a total of $400,000. Under the current rules, he will be ineligible to make further NCCs as in the 2022/23 year he would be well over age 65 and not working and presumably not eligible to make work test exempt contributions (as his balance is likely to be greater than $300,000 at 30 June 2022).

With this announcement, however, he wonders if he should re-think this strategy.  If he triggers and fully utilises his bring forward in the current financial year by contributing $300,000 in June 2019, under this proposed measure he would be eligible to contribute $300,000 NCC again in July 2021 before he turns 67 – a total of $600,000 in a three-year period.

He would also be able to use the downsizer rules to add a further $300,000 from the age of 65, if he chooses to sell his home and meets all the requirements.

This proposal is a positive one, but the above example shows how hard it is to plan in this uncertain political climate.  If the measure doesn’t go through – and there’s a good chance it won’t - he will have missed out on the additional $100,000 he was planning on contributing in June 2019 and only get $300,000 in prior to age 65 and retirement.

Spouse Contributions

A further part of the proposal by the Treasurer is to increase the age for making spouse contributions from 69 to 74 from 1 July 2020, with those aged 65 and 66 no longer needing to meet a work test.  This could be a great opportunity to get further monies into super in anticipation of retirement or to equalise balances between a couple.

There is a tax offset available of up to $540 for the contributing taxpayer in respect of eligible contributions made on behalf of their spouse if the spouse’s earnings are less than $37,000 a year so an opportunity lies there too.

Take these measures as a positive, however, as always take care with acting on proposals without them becoming law.  In this case it may be prudent to wait to see if they go through before making major changes to financial plans.

Maximum age for making contributions

While the proposed measure has extended the period for which contributions can be made without a work test, as well as the rules for spouse contributions, there has been no change to the maximum age for contributions.

Generally, all contributions stop when a member reaches age 75 – or more correctly, the 28th day of the month following their 75th birthday.  This will remain and only contributions that are mandated (eg award contributions) can be made after that time.

 

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BUDGET: Changes to Exempt Current Pension Income (ECPI)

If the four short paragraphs about ECPI had been included in the 2016-17 Federal Budget, the Government could have saved actuaries and software providers hundreds of thousands of dollars in software development costs and saved the sanity of accountants and advisers!

Sadly they didn’t and their proposed changes will achieve the desired effect of reducing red tape a few years too late.

Nonetheless, we welcome the announcements as part of the solution to simplifying ECPI. 

Exempt current pension income, ECPI, is the name given to investment income that is exempt from tax because the fund is providing a retirement phase pension.  As a general rule, if all of the member accounts in the fund are retirement phase pensions, all of the fund’s investment income is ECPI.  If only a proportion of the accounts are retirement phase pensions, then only part of the fund’s investment income is ECPI.

The Government proposed two changes as part of the 2019-20 Federal Budget.  Both changes are due to take effect from 1 July 2020, ie the 2020/21 financial year.

Proposed Change 1

Under current law, some superannuation funds are entirely in pension phase all year (providing only retirement phase pensions).  Logically, they should be able to claim all investment income as ECPI.  Due to a quirk in the law, some of these funds still need an actuarial certificate to do so. The Government proposes to remove the requirement to obtain an actuarial certificate under these circumstances.

Proposed Change 2

Under current law, ECPI can be extremely complex for funds that move between different phases such as:

  • entirely providing retirement phase pensions for part of the year, or
  • providing a combination of retirement phase pensions and other accounts (eg accumulation accounts) for other parts of the year.

The complexity lies in the fact that some funds are currently required to claim their ECPI using two different methods for those different parts of the year:

  • the “segregated method” when the fund only has retirement phase pension accounts, and
  • the “proportionate method” at any other time.

The calculations are tricky, the results are confusing and it is generally a case of overengineering the tax rules.

Our understanding of the Government’s proposal is that they will remove the complexity by giving trustees a choice:

  • stick with the current system of using both methods when applicable, or
  • use the “proportionate method” all year.

The latter was common practice in the past until 2017-18.  Generally, the two choices provide much the same tax result but there can be a difference (discussed further below).

There are a number of points to note about Proposed Change 2.

First, under current law not all funds are actually allowed to use the segregated method to claim their ECPI.  What is unclear from the announcement is whether this second complication (some funds can segregate and some funds cannot) will also be removed.   We speculate it will not be changed – if it was removed, Proposed Change 1 above would not be required.

Those that cannot use the segregated method have never faced the complexity of having to use different methods for different parts of the year – they have always been required to use the proportionate method all year.  Presumably their position will therefore be unchanged.  

The proposed change will, however, be very useful for funds that are allowed to use the segregated method and have a period during the year when they are entirely providing retirement phase pensions. 

(Read our blog 'Segregating in SMSFs Beyond 1 July 2017' to understand which funds are currently allowed to claim their ECPI using the segregated method and which ones are not).

Second, the wording in the Budget papers is not particularly precise but we expect this choice will:

  • be made yearly – rather than once and locked in forever,
  • also apply for funds that, for example, have no retirement phase pensions for the first 6 months of the year and then move entirely to retirement phase pensions for the remainder of the year.  In other words, quite simple cases rather than only the complex situations outlined earlier.

We do not know whether the choice will need to be made in advance or whether it can be made at the end of the year.  There are practical challenges either way:

  • if the choice is made retrospectively, it may be possible to use it as a means of optimising the fund’s tax outcome (and neither the Government or the ATO likes anything that allows their tax revenue to be minimised), but
  • if the choice must be made in advance, it is easy to imagine situations where the trustee would find it difficult to predict that they needed to make a choice early enough to make one.

As a general rule, this change is all about simplifying compliance with the tax law.  Regardless of the choice they make, some funds will end up paying more or less the same amount of tax.  However, it is possible for differences to emerge.

This is perhaps best explained using an example.

Sally is the sole member of her SMSF and has been receiving a pension since she retired.  At 30 June 2020, her retirement phase pension was valued at $1m and she had no accumulation account.  On 1 April 2021, she made a $300,000 non-concessional contribution which remained in accumulation phase for the rest of the year.

Sally has no other superannuation.  Her fund is allowed to claim ECPI on the segregated method.

If no changes were made to the law, Sally’s fund would claim her ECPI as follows:

  • 1 July 2020 – 31 March 2021 : the segregated method.  All investment income earned during this time would be exempt from tax.  Capital gains and capital losses would be ignored.
  • 1 April 2021 – 30 June 2021 : the proportionate method.  The actuary for Sally’s fund would calculate the proportion of the fund’s income which is ECPI.  In this case, the relevant % would be around 77%.  In other words, 77% of all income earned in the last three months of the year would be exempt from tax and the remaining 23% would be taxable.

Under the proposed change, Sally could ask the fund’s actuary to calculate a % that applies to all income for the whole year.   In this case, the figure would be around 93%.

If Sally’s fund earned its income on a very regular basis (let’s say $10,000 per month), it would make very little difference which choice she made.

Using the current rules, the following income would be exempt from tax:

  • All of the first 9 months’ income ($10,000 x 9 = $90,000)
  • 77% of the last 3 months’ income ($10,000 x 3 x 77% = $23,100)

In total, $113,100 would be exempt from tax and the remaining $6,900 would be taxed.

Alternatively if she simply used the proportionate method all year, the tax exempt income would be 93% x 12 x $10,000 = $111,600.  This is very close to the amount of $113,100 above.

More substantial differences will emerge if Sally’s fund earns income unevenly.

Let’s say ALL of the fund’s income is earned in January 2021.  (This could happen, for example, if it came from a capital gain).

If Sally’s fund uses both methods (ie the current law) to calculate the ECPI, the fund will pay no tax because the income was earned at a time when the fund was using the segregated method.

If, on the other hand, Sally’s fund uses the proportionate method all year, tax will be paid on some of that $120,000 (93% of it will be exempt but 7% will not).

This change will certainly simplify compliance for some funds.  We welcome it on that basis but would continue to encourage the Government to remove the major complexity currently in place for ECPI – the fact that some funds are allowed to operate on a segregated basis and others are not.  Here’s hoping that’s exactly what is intended and it is simply unclear from the Budget Papers.

A final point: note that we expect both the changes to ECPI will only relate to funds that are providing account-based or market linked pensions.  Funds with defined benefit pensions have quite different actuarial certificate rules.

 

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BUDGET: Heffron Summary

On the superannuation front (and for SMSFs in particular), the 2019-20 Federal Budget was distinctly quiet.

There were positive changes to contribution rules which will help those looking to add to their superannuation beyond age 65.

Changes to the rules governing exempt current pension income will also go part of the way towards making it easier for superannuation funds providing pensions to comply with the tax rules.

And the Government took the opportunity to announce several other minor superannuation changes that are broadly sensible.

These low key superannuation changes are perhaps not surprising.  This Budget is an election platform for the Coalition and as a general rule, immediate cash payments or tax cuts are better vote winners than changes to the superannuation system.

In that vein it is not surprising that personal tax relief received careful attention and was emphasised by the Treasurer in his address.  In the short term, the proposed personal income tax cuts will be introduced by increasing an existing tax offset.  That allows it to be introduced as early as 1 July 2019 when individuals start lodging their 2018/19 tax returns.  A tax offset is a way of reducing an individual’s tax bill at the time they lodge their return.  It can be very specifically targeted to people at particular income levels (in this case, people earning between $18,200 and $126,000).  In contrast, simply changing the personal income tax rates for income between $18,200 and $126,000 would benefit everyone earning more than $18,200, including those earning more than $126,000.  A change in a tax offset that phases out completely at $126,000 only benefits those who earn less than $126,000.

Further changes to personal tax arrangements are proposed for the future, including changes to tax thresholds and ultimately individual rates.  If the Coalition is still in Government at the time,  2024/25 will see us with only three tax rates (19%, 30% and 45%). The middle rate of 30% would apply to income from $45,000 - $200,000 – capturing the vast majority of taxpayers (bear in mind that the minimum wage is currently around $37,000).   Depending on your perspective, this is either an incentive for effort or a virtual dismantling of the progressive taxation system.

The Government intends to try and legislate this in the coming week – ie before calling an election.

There was a lot of money splashed around on regulators and generally “doing the right thing” – the ATO, ASIC, APRA, a “reviewer of the regulators” (Financial Regulator Oversight Authority) –  as well as funding for the Government’s response to the Hayne Royal Commission.  It may be many years before we see the true fallout on the industry from the Royal Commission.  Perhaps in recognition that the Government needs to be managed to do the right thing as much as anyone else, there is a small investment (met from existing Treasury resources) into the feasibility of establishing a Superannuation Consumer Advocate.  The Advocate would provide input on behalf of consumers in policy discussions and would also help consumers navigate the superannuation system.

What didn’t make it into the Federal Budget is often every bit as interesting as what did.  In this Budget, for example:

  • we saw changes that align important superannuation contribution ages with the age pension age (67) but no change to the age at which individuals can access their superannuation (this remains 65 at the latest).  We certainly expect this to increase to 67 at some point and this Budget might have been the perfect time;
  • we have become accustomed to seeing contribution caps fall but none were changed this time around;
  • perhaps not surprisingly there were no changes to Limited Recourse Borrowing Arrangements for SMSFs (this won’t stop someone calling for yet another review though); and
  • sadly, there were no changes announced for legacy pensions (such as lifetime or life expectancy pensions).  Whilst these were briefly popular in SMSFs and from a limited number of annuity providers many years ago, they now often represent a major headache for the few thousand individuals who still have them.  The superannuation industry has begged Government, Treasury and the Australian Tax Office to find a solution here for many years and has proposed many and varied options.  It would seem that yet again, this has fallen on deaf ears.

All in all, a relatively quiet Budget for most people and most importantly, most of it is highly unlikely to see the light of day unless the Coalition is re-elected.


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6 Member Fund Concept Shelved

The Government has announced that they will not proceed with their plan to increase the maximum number of members of SMSFs and small APRA funds from four to six. 

Treasury Laws Amendment (2019 Measures No 1) Bill 2019 was due to be debated in the Senate last week.  However, the ALP had indicated they will not support the change and without the backing of the independents/minor parties, the Bill would not have succeeded.

Despite the Government remaining committed to making the change, they moved amendments to remove the 6 member concept from the Bill so the rest of the proposals (excise concessions for craft beer) could proceed.

Whilst we expect there were not large numbers of SMSFs intending to take advantage of the increased limit, this backdown will be a disappointment to those that were.

 

Article amended 8 April 2019 to reflect passage of legislation

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Don’t Jeopardise your Insurance Cover

If you hold insurance cover in a superannuation account separate to your SMSF, you might need to take action to ensure this cover continues.

When you set up your SMSF, did you follow a common strategy of rolling over most of your accumulated balance from an industry, employer or other retail-type fund, leaving a small amount behind so that you can keep your insurance cover going? Or likewise open a retail or industry super account just to obtain insurance cover?

New laws in place mean you probably should check on the account, otherwise you might lose that all important insurance cover.

The Detail

From 1 July 2019, trustees of a MySuper or choice fund* are prohibited from providing insurance where:

  • the member’s account is inactive for a continuous period of 16 months or more, and
  • the member has not elected to obtain or maintain insurance in that fund.

In other words, from 1 July this year a member must “opt-in” to continue to hold insurance in an inactive super account, or make the account active. Failure to do so could mean the Trustee will cancel your insurance cover.

* These rules apply to basically all superannuation accounts except SMSF and small APRA funds, defined benefit members, Australian Defence Force Super members or members whose employer covers the full cost of the insurance premiums (over and above the employer’s super guarantee obligations).

What is an Inactive Super Account?

A member’s account is considered inactive simply if no contributions or rollovers have been received into it for a period of 16 months. Once a rollover or contribution is received, the 16-month period is reset.

This change will affect insurance arrangements put in place both before or after 1 July 2019, and inactivity prior to this date will count towards the 16 months.  For example, a super account where no contributions or rollovers have been received since 1 March 2018 will be considered inactive on 1 July 2019.

Members who have insurance arrangements in their super accounts and who might be affected by these new rules can expect to hear from their super fund in the next few months and be given the opportunity to elect (in writing) for their insurance to continue. The fund will inform those members how they can opt-in if they choose to.

What do I need to do?

If you have a super account somewhere that holds insurance cover that you intend to remain in place, and is in danger of being considered “inactive”, you can either:

  • contribute or rollover an amount to it to make it active (if you are eligible to do so), or
  • submit a valid election in writing to obtain or maintain your insurance cover.

Contributing or rolling over to the account will only make it active for up to 16 months, after which you would have to do either of the above again. You only have to submit the opt-in election once, so it’s a more permanent solution.

As stated previously, expect to hear from your super fund about this.  However if you have changed address and the super fund hasn’t got your new address details, you should get in touch with them to update your contact details.

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Terminal medical conditions and access to super

When the unthinkable strikes, members can access their super tax free, but consider the strategies first.

When a person receives the devastating diagnosis that they have a terminal illness, their and their family’s world is turned upside down. When last week they were arguing with their spouse over who picks up the kids from gymnastics tomorrow night, suddenly those issues become irrelevant.  Life now is about doctors, treatments, and - importantly - making memories with their family.

Unfortunately, these illnesses can strike at any time, and it could very possibly be at a time when finances are stretched – mortgage payments are hurting and bills are going unpaid.

There is some potential relief from the financial stress in this situation in the form of a “condition of release” in the superannuation laws that allows those diagnosed with a terminal illness to access their super as a lump sum – tax free - regardless of their age.

As Trustee of your SMSF, you must ensure two conditions are met before releasing a member’s benefits under this provision:  

  1. two registered medical practitioners must certify that the member suffers from an illness, or has incurred an injury, that is likely to result in the member’s death with 24 months of the date of the certification, and
  2. at least one of those doctors must be a specialist practicing in the field of medicine relating to the member’s illness.

The certification lasts 24 months, and when it is supplied to you as Trustee of the Fund, the members’ benefits can be reclassified as “unrestricted non-preserved” and amounts paid out to the member are tax-free. The member does not have to withdraw their entire balance, it’s just that they can. Once benefits are classified “unrestricted non-preserved”, they stay that way.

If, after 24 months, the member still has a balance (and has not passed away), the benefits – and any additional benefits accrued in that period - are still unrestricted non-preserved, however tax may apply on withdrawals depending on their age. The member may supply a new certification to start the 24-month period again.

Strategic Considerations

Being able to access super benefits tax free on diagnosis of a terminal medical condition gives members greater options to “tidy up” their affairs prior to death.  However, it is important to not overlook strategy considerations including.

  1. For those members whose only beneficiaries of their super are their adult, non-dependant children, there can be tax advantages to withdrawing the money under this condition prior to passing away. Non-dependant beneficiaries are subject to tax on the taxable component of death benefit payments at 15% plus Medicare. Whereas payments under this condition are, as mentioned, tax free whilst the member is alive. Once the money is out of the super fund and paid to a member, it will form part of their estate on their death, and will be distributed in accordance with their Will.
  2. Trustees and members should be aware that once the medical certificates have been obtained, benefits accessed under this condition of release cannot be rolled over between super funds. They can be transferred to another super fund, however the payment from the original fund will be treated as a lump sum, and the amount paid into the new fund will be considered a personal contribution from the member and will count towards their concessional or non-concessional cap. SMSF Trustees beware: once a Trustee knows that a terminal medical condition exists in relation to a member, they cannot treat a transfer of that member’s benefit to another super fund as a rollover.
  3. Remember to consider any life insurance policies held in the super fund by the member and ensure that he or she doesn’t inadvertently cancel their cover by withdrawing their entire balance. Many death cover policies allow for a terminal illness claim.
  4. If Centrelink payments are a priority, and the member is under Age Pension age, consider leaving the money in super in accumulation phase, as it will be hidden from the Income and Assets test. Once the member withdraws it as a lump sum or commences a pension, it will start to be included in Centrelink’s means testing.   

 

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Retiring before preservation age

Those lucky enough to retire early – well before their preservation age – are often confused about when they can access their superannuation.

Imagine selling a small business at age 50, for example, and deciding never to work again.  While superannuation is not likely to be absolutely front of mind after that event, it still pays to understand the rules for the future.

Firstly, superannuation is not accessible immediately (ie at age 50) in any form unless there is some other circumstance that gives access (eg incapacity, terminal medical condition, compassionate grounds, financial hardship etc).  The earliest this individual’s superannuation will be accessible is their preservation age – 60 in this case.

Once they reach 60, they can clearly access their superannuation.  The key question is whether or not it will be available in any form (lump sum, account-based pension) or only a transition to retirement income stream.

This all comes down to their intentions for the future.

If they seriously never intend to work again, they meet one of the two retirement definitions.  This one is satisfied if all of the following are true:

  • the person has reached their preservation age (60 in this case),
  • an arrangement under which they were “gainfully employed” has come to an end, and
  • the trustee is satisfied that they never intend to work 10 or more hours per week in the future.

Importantly, there is no requirement (for this particular definition) that the employment arrangement ended after their 60th birthday or even recently.  The case of the small business owner selling up and retiring at 50 would be fine here, providing they genuinely don’t intend to work in the future.

Meeting the retirement definition means superannuation can be accessed in any form.  Any pension that starts will not be a transition to retirement income stream, it will be a full account-based pension from the start.

Note that they have to have been “gainfully employed” (which includes being self employed) in the past at some point.  Our small business owner will clearly satisfy this requirement as long as, say, they actually worked in the business and were remunerated for that work, and didn’t just hold shares in the company that owned it.

However, someone who has never been employed at all would not. They can’t meet the second condition above (an arrangement under which they were gainfully employed has ended).

Their only option at 60 (preservation age) would be to start a transition to retirement income stream.  If they want full access to their superannuation (eg to pay a lump sum) that would have to wait until they turn 65.

Still no SG “opt out” for employees with multiple employers

The Government’s proposal to enable individuals with multiple employers to elect to “opt out” of the superannuation guarantee (SG) system in respect of their wages from certain employers is not yet law.

Under current legislation, highly paid individuals with more than one job can find they exceed their $25,000 concessional contributions cap each and every year. The reason being that the compulsory 9.5% SG contribution for anyone earning a total of more than $263,157 gives rise to a cap breach.

Those individuals with only one job are currently protected from this problem because SG contributions are only compulsory up to a salary base of $54,030 per quarter or $216,120 per annum. However as that upper limit applies to each and every employment arrangement, those with multiple jobs currently have no way of avoiding the problem.

As part of the May 2018 Federal Budget, the Government had proposed (sensibly) to allow affected individuals to opt out of compulsory SG contributions under these circumstances and negotiate to receive additional wages instead.

Whilst this proposal was due to commence on 1 July 2018, Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018 is still awaiting progress in the Senate.  It would appear that the delay in the passage of this Bill is due to other measures in the Bill which the Australian Labor Party does not support, in particular the proposal to allow a once-off 12 month SG amnesty to correct historical SG non-compliance.

With Parliament not sitting again until 2 April and an election expected to be called shortly thereafter, it is not clear whether this proposal will be legislated in time for it to have application for the April to June 2019 quarter.

Having now waited almost 12 years for this problem to be fixed, let’s hope it becomes a reality sooner rather than later.

100% pension fund with contributions - do I need an actuarial certificate?

In the new world of calculating exempt current pension income, if your 100% pension fund receives a contribution, and a new pension is commenced with that amount immediately on receipt, do you need an actuarial certificate?

For the purpose of the following discussion, the term ‘pension’ is referring only to income streams in the retirement phase.

Fund not eligible to segregate

Where a fund is ineligible to segregate for tax purposes, for example due to a pensioner having a total superannuation balance (TSB) of greater than $1.6m at the previous 30 June, an actuarial certificate will always be required to claim any exempt current pension income (ECPI).

Any such certificate will cover the entire financial year, and the receipt of a contribution moved immediately into pension phase will have no impact on the exemption percentage.

Fund eligible to segregate

Where a fund is eligible to segregate for tax purposes (no member in receipt of a pension had a TSB =>$1.6m at the previous 30 June), it must do so.  For this type of fund, the receipt of a contribution will cause it to move from totally supporting pension accounts to supporting both pension and accumulation accounts, albeit only for part of a day.

That means, under the current legislation, if there was income generated on the day of the contribution, you would expect that an actuarial certificate should be obtained to exempt some of this income.  However, whilst this may be the technically correct answer, the SMSF specific software programs do not allocate income or losses on an hourly basis and they do not cater for a part-day segregated period.  Thus, the systems will treat the fund as being in pension phase for the entire year and no actuarial certificate is required.

Notwithstanding the above, if there was income earned on the day of the contribution, to avoid any doubt, we would recommend that the contribution is held in a sub-account, separate from all other assets during its period in accumulation phase.

In contrast, if no income is earned on the day of the contribution, both the practical and technical approaches would result in the same outcome.  There is no need to obtain an actuarial certificate as there is no income to apply the certificate to.

Why do pension payments now need to be paid in cash?  I’m sure my clients used to be able to take in-specie pension payments.

Well, in fact pension payments have always needed to be paid in cash.  Only lump sums can be taken in-specie (ie in the form of assets rather than cash).  Whilst it may have appeared in the past as though your clients were taking in-specie pension payments, the payments would have in fact been in-specie lump sums.  Let me explain.

The term “lump sum” is specifically defined in the superannuation legislation as “including an asset” [SIS Reg 6.01(2)].  This means lump sums can be paid in-specie.  However, there is no similar definition stating that the term “pension payment” includes an asset.  As a result, the Regulators take the view that a pension payment cannot be paid in-specie (ie only cash pension payments are permitted).

Anyone with an account-based pension (or a TRIS) that includes some unpreserved money can take a lump sum commutation from their pension, and the lump sum can be an in-specie payment.  Whilst this lump sum payment may feel like a pension payment, it’s actually a lump sum commutation and must be documented that way.  This is simply because only cash payments can be treated as pension payments.  This rule has not changed.

The superannuation legislation also requires that a minimum amount is paid each year from a pension account (eg 4% of the individual’s 1 July balance for those under age 65) [SIS Reg 1.06(9A)(a)].  This requirement is commonly referred to as the “minimum payment rules”.

Prior to 1 July 2017, almost all payments from a pension account could count towards satisfying the minimum payment rules, including both cash payments and lump sum commutations (including in-specie lump sums).

However, the rules about “what counts towards the minimum” changed effective 1 July 2017 and lump sum commutations no longer count towards satisfying the minimum payment rules.  That is, only pension payments can now satisfy the minimum payment rules and pension payments can only be taken as cash payments.  

In a nutshell, this means in-specie lump sum commutations from pension accounts are still permitted (providing the member has unpreserved money and the terms of the pension allow a lump sum commutation) but, to satisfy the pension rules, since 1 July 2017 a cash payment of the minimum required amount is also needed.

This is just one of the many concepts we’ll be exploring in our upcoming Pensions Masterclasses.  Held throughout the country from 11 to 22 March 2019, our Pensions Masterclasses will show you “why” the rules work in a particular way, helping you to successfully put in place strategies for your clients.  Click here for further details and to register.

A superannuation default for life

Both the Productivity Commission and the Hayne Report identified the long running issue of multiple superannuation accounts as an issue.  Almost everyone has a story about discovering that they or a friend had multiple superannuation accounts as a result of having multiple jobs throughout their lives.

Hayne has supported the Productivity Commission’s recommendation that an individual should have a single “default” superannuation account that effectively follows them from job to job.  Should they start a new job and not nominate another superannuation account, their superannuation would be paid into that default rather than an account nominated by their new employer as the default for all employees.

This would not prevent people from exercising their right to choose a different account – or even from having superannuation from different employers paid into different superannuation funds.  It is simply changing the mechanics of how a fund is chosen when the individual makes no choice.

Some will support an alternative – continue to allow employers to choose the default fund but provide a means of compulsory “aggregation” when individuals end up with multiple accounts.

Hayne’s solution stops the problem in the beginning rather than waiting until it happens and then tidying up the mess.

It will be interesting to see how that very first default account is chosen.

See more on our Royal Commission commentary

The real challenges for trustees of large superannuation funds

There was presumably a collective sigh of relief from our largest financial institutions when Hayne decided not to recommend a ban on superannuation funds that make a profit (often called “retail” funds and offered by financial institutions as distinct from “industry funds” which were historically set up and backed by trade unions and are designed to return profits to members).

The Final Report does, however, spend considerable time highlighting the challenges some trustees face when it comes to acting in the best interests of members (a legal requirement) in the face of competing financial interests.

But that’s not what I find most interesting.

What is even more fascinating is this : why do we perpetuate the myth that it is ever possible for the trustee of a large fund to genuinely act in its members’ best interests?

People are different.  They have different needs and therefore different “best interests”.  Surely it follows, then, that acting in my best interests might not be acting in yours.  How does this play out if we are both members of the same superannuation fund?  How do superannuation funds with thousands or in some cases more than one million members balance their various interests in making any decision?

Let’s say our superannuation fund has thousands of members.  The trustee is considering adding a new investment option that a number of members would value and use.  However, other members are not interested in this new option and resent the fact that the fund is wasting money introducing it.  Whose “best interests” are being served if it is introduced?

The same dilemma faces both industry and retail funds – in fact it faces any fund where there are a great many members to consider and their interests diverge.  Which they will. People are different.

In practice, SMSFs are the only superannuation funds that genuinely have a hope of ensuring they routinely act in the members’ best interests.  This is not because SMSF trustees are inherently more noble than trustees of large superannuation funds, it’s because the job is simpler when there are very few members and their interests are aligned.

See more on our Royal Commission commentary

Is this a missed opportunity?

While the hearings sent shockwaves through Australia’s major financial institutions, I would describe the final report as being light on major structural reforms when it comes to advice and restoring trust for the thousands of individuals saving for retirement.

Kenneth Hayne devoted quite a few pages in his report to exploring the issues surrounding so called “vertical integration”.  This is where a single organisation offers financial structures and products such as bank accounts, platforms and managed funds as well as licencing or employing financial advisers.

The opportunity was there to recommend that “product” and “advice” to be structurally separated in some way.

He could have proposed that product providers (such as banks) simply be prevented from owning advice businesses or licensees.  Alternatively, he could have recommended that there was a clear demarcation between those who sold products produced by their employers or licensee (who are not called advisers) versus those who are genuinely advising without any link to a particular product (the UK system operates something like this).

In the end, the Final Report did not recommend that “product” and “advice” were separated.  The only change is that those who are not classified as “independent” will have to explicitly remind their client of that fact.  But this is a blunt instrument.

While Hayne acknowledged that changes here were likely to reduce conflicts, he felt that the resulting disruption would outweigh the benefits.

I’m not convinced.

This doesn’t sit comfortably with some of the explosive revelations in the hearings themselves.  There are some conflicts that must surely be impossible to manage and disclosure will never be enough.

See more on our Royal Commission commentary

Independence matters

The Report made a number of recommendations about financial advice that will be well covered by others (for example, new annual renewal requirements for ongoing service fees, bans on grandfathered commissions, a review of other commissions for insurance, new disciplinary approaches for financial advisers, restrictions on the payment of advice fees from MySuper accounts etc).

But there were also some interesting comments and recommendations around “independence”.

Hayne recommended (Recommendation 2.2) that any adviser unable to describe themselves as “independent” should be required to explain “simply and concisely why the adviser is not independent, impartial and unbiased”.

Hayne has not recommended any change to the definition of "independent" in the Corporations Act 2001.  This means advisers who receive commissions that are not fully rebated to the client, volume bonuses (or similar) or are (say) licenced or owned by a product issuer are not considered independent.  Advisers are still free to charge asset based fees (often described as commission by another name) and refer to themselves as independent.

What Hayne is doing, however, is elevating the importance of independence (regardless of flaws in the definition) by:

  • recognising that simply disclosing potential conflicts and inviting clients to read between the lines is not enough, and
  • actually requiring advisers who are not independent to disclose how this is so.

Of course, independence alone does not guarantee good advice.  But I do see something positive about an environment that raises the profile of a very obvious source of potential conflicts of interest.

True independence can only happen when the client (not an intermediary on their behalf) is making an informed and conscious decision to pay for advice.  They know what they are paying, who they are paying, what they get for it and they choose to pay.

The irony of all of this is the classic “be careful what you wish for”.  If removing conflict means the product provider no longer subsidises the cost of advice, it may well be far more expensive than the consumer realises.  Truly good financial advice is incredibly valuable.  Let’s hope clients work that out.

See more on our Royal Commission commentary

What are the implications of the Royal Commission for SMSFs?

The first thing I did when I opened the final report from the Hayne Royal Commission into Banking Misconduct and Superannuation was to search for “SMSF”.  Other than the definitions, it appeared twice – once to explain that SMSFs are administered by the ATO and the second time in the context of explaining choice in superannuation.

So is it surprising that none of the 76 recommendations specifically relate to SMSFs? And that none of the commentary that was so unflattering about our largest financial institutions, their management and their culture touched on SMSFs?

In a nutshell probably not.  For a start, the terms of reference largely related to the behaviour and regulation of financial services entities, not the superannuation system itself.  Perhaps even more relevant, though, SMSFs are in fact almost the thinking person’s response to all the terrible things that were revealed in the Royal Commission hearings.  The great thing about an SMSF is that it empowers individuals to take charge of their own retirement savings journey and make informed choices about the advisers, products and services they use.

Of course, SMSF trustees are not immune from poor advice and many SMSFs use products provided by the financial institutions criticised in the Royal Commission.  Some of the recommendations therefore do touch SMSFs and are worthy of further discussion.

But it was telling that – like the Productivity Commission’s recently completed review into superannuation – the Royal Commission found no need to raise specific concerns about SMSFs.  This might come as a surprise to those routinely concerned that limited recourse borrowing will cause the end of the world as we know it.

See more on our Royal Commission commentary

No lower limit: a good start for SMSFs in 2019

Before the Productivity Commission publicly released their final report into superannuation review this month, there was inevitably much discussion about whether or not a minimum balance for SMSFs would be recommended.

The draft report was interpreted by some as positioning the Productivity Commission to set the benchmark at $1m as it made the claim that while larger SMSF funds perform broadly in line with APRA funds, “smaller ones (with less than $1 million in assets) perform significantly worse than institutional funds, mainly due to the materially higher average costs they incur due to being small. It is not clear how many of these will perform better in future as they grow in size.” (page 14, Draft Report).

The data and methodology used to make this claim was widely discredited and the final report softened the commentary to refer to SMSFs of under $500,000.  I suspect even that figure could do with some scrutiny.

Importantly, however, the report did not recommend a minimum fund size.

Instead it made recommendations about SMSF advice.  Specifically (Recommendation 12 : Stronger Safeguards on SMSF Advice), the report recommended that anyone advising a client to set up an SMSF should require specialist training and they should provide a document written by ASIC about “red flags” (things to consider or issues to be aware of that might indicate an SMSF is not appropriate).

The decision not to impose a minimum fund size makes perfect sense.  In every aspect of financial advice our legislation, regulators and even the press emphasise the importance of “knowing your client” and providing advice that is specifically suitable for them.  There is widespread acceptance that even people who superficially look the same (eg same wealth or income) could be very different when it comes to their needs for the future, risk appetite and objectives.  For that reason, advisers are regularly criticized if there is even a hint that they are treating all their clients as if they are exactly the same.

How does a legislated minimum SMSF balance fit in this environment?  Is tailoring advice to suit the particular needs of a client important or not?  If clients are different then a minimum balance makes no sense.  An SMSF might be exactly the right choice for one person with $100,000 and totally wrong for someone else with $1 million.

What about the recommendations on specialist expertise for SMSF advice and appropriate warnings on the downsides?  To be honest decent advisers are already doing something like this.  Whenever a good adviser recommends a course of action they also highlight reasonable alternatives if there are any and flag the relevant positives, negatives and implications of both.  This makes perfect sense – their role is to equip the client to make a sensible decision that leans on all the expertise and experience of the adviser. 

So I wonder why SMSFs need to be singled out here?  Should there also be a requirement, for example, to highlight the red flags that come with choosing a public offer fund?  Perhaps advisers should be required to quote the average time taken to pay death benefits for the fund they recommend, or the number of times the fund has made unit pricing errors?  Perhaps ASIC could create a red flag document that talks about the lack of control you’ll have in a large fund, the fact that product design changes to adopt new strategies are often slow (and frequently only happen after the SMSFs have led the way) and the extra fees they need to charge to build or maintain their operational risk reserves.  Finally, perhaps advisers should be required to specifically quantify the fees relative to an SMSF and show that having a large balance in a fund that charges most of its fees on a percentage of assets basis can be terrifyingly expensive.  That would help the member make an informed choice about whether they want to manage their own super via an SMSF or pay a large fund to do it for them.

Like every other commentator I will happily say that an SMSF is not for everyone.  Nor is an investment property, a Ferrari or running a small business.  But SMSFS ARE the perfect answer for a great many people.  I hope to see the day when we stop treating these people like they have been hoodwinked into something slightly stupid rather than making informed and carefully considered decisions about how they take personal responsibility for their retirement.  Instead, let’s congratulate them for that and help them make the best possible fist of doing it.

This article was written for The Australian and featured January 29

The Audit Report for my SMSF has been qualified.  What does that mean?  Should I be worried?

All SMSFs trustees are required to appoint an approved auditor to audit the operations of their fund each year.  This annual audit must include both a financial audit and compliance audit.

The auditor is required to report their findings to the trustees in the form of an audit report.  The audit report consists of two parts, Part A and Part B.  The consequences of receiving a qualified audit report are quite different, depending on whether it is a Part A or Part B qualification.

Part A

Part A of the audit report covers the financial audit and requires the auditor to form an opinion whether, in all material respects, the fund’s financial statements present fairly the financial position of the fund and the results of its operations for the year.

In conducting the financial audit, the auditor will seek to obtain sufficient and appropriate evidence that the assets and liabilities of the fund:

  • exist and are clearly owned by the fund (or are obligations of the fund in the case of liabilities),
  • are appropriately valued in the financial statements according to relevant accounting standards and Australian Taxation Office (ATO) requirements,
  • are appropriately classified in the financial statements according to relevant accounting standards, and
  • no material assets or liabilities have been excluded.

Where an auditor does not feel that the fund’s financial statements fairly represent the financial position of the fund (in all material respects), he/she will issue a Part A audit qualification.  Part A qualifications are often issued in situations where the auditor is unable to accurately determine:

  • the existence of a fund asset without physically inspecting the asset (eg gold and silver bullion), and/or
  • the value and recoverability of a fund asset without formally valuing the asset or auditing the entity in which the fund has invested (eg shares in unlisted companies, units in private unit trusts, unsecured loans).

In a number of recent court decisions auditors have been found liable for investment losses suffered by SMSF trustees because the non-recoverability of those investments had not been brought to the attention of the trustees.  As a result of these decisions, we expect it will be more common for auditors to qualify Part A of their audit report where the fund’s assets extend beyond the typical cash at bank, term deposits, listed shares, managed funds and real property, in the hope of protecting themselves from future litigation.

If you receive a Part A qualification for your fund, there is no need to panic.  It is not reportable to the ATO and generally no immediate action is required.  However, it is important that you:

  • make sure you understand the reason for the qualification, and
  • make your own assessment of the continued appropriateness of the fund’s investments.

 

Part B

Part B of the audit report covers the compliance audit and requires the auditor to form an opinion whether, in all material respects, the trustee has complied with particular provisions of the Superannuation Industry (Supervision) Act and Regulations.  Where an auditor believes the trustees have materially breached one of these reportable provisions, he/she will issue a Part B audit qualification. 

The existence of a Part B audit qualification must be reported to the ATO on the fund’s SMSF Annual Return and the auditor may also have lodged an Auditor Contravention Report with the ATO.

Failing to comply with the Superannuation Industry (Supervision) Act and Regulations can result in the fund being found non-complying and losing its concessional tax treatment.  Trustees can also be fined or even imprisoned.  However, the Commissioner is able to exercise its discretion and overlook breaches where trustees have inadvertently broken the rules, the breaches have been rectified and steps have been put in place to make sure they do not happen again.

For this reason, if you receive a Part B qualification for your fund, it is important that you:

  • make sure you understand the reason for the qualification (eg what provision did you breach),
  • if not already remedied, immediately take action to remedy that breach, and

make sure you understand the rules so that breaches of this nature do not reoccur in the future.

Does your SMSF own a residential investment property?  Do you know what deductions are able to be claimed by the fund in connection with that property?

SMSFs can claim deductions for certain expenditure incurred by the fund provided the residential investment property is rented or available for rent.  The types of expenditure which can and can’t be claimed and your record keeping requirements are summarised below.

Expenditure which can generally be claimed

The sorts of expenditure for which a deduction can generally be claimed includes:

  • advertising for tenants
  • body corporate fees
  • cleaning
  • council rates
  • decline in the value of any depreciating assets held in connection with the property (eg furniture & fittings)
  • electricity and gas
  • gardening and lawn mowing
  • insurance (building, contents, public liability)
  • land tax
  • lease document expenses (preparation, registration, stamp duty)
  • pest control
  • property agent fees and commissions
  • repairs and maintenance
  • water charges

However, this list is subject to the following qualifications:

  • Where a property is untenanted for a period, deductions are only available where the property was genuinely and publicly advertised for rent and the condition of the property meant it was suitable for rent. 
  • SMSFs are only able to claim deductions for costs which are actually incurred by the fund (ie not those reimbursed by the tenant).
  • Where a property is only used partially for producing assessable income (eg a portion of the fund’s income is exempt from tax because the fund is paying retirement phase pensions), only a portion of these costs are deductible.
  • Since 1 July 2017, the decline in value of second hand depreciable assets acquired since 9 May 2017 is not deductible.  This means existing plant & equipment acquired as part of a property purchase post 9 May 2017 is generally not depreciable and SMSF trustees are generally no longer able to use a quantity surveyors’ report to increase depreciation deductions.

Expenditure which generally can’t be claimed

Expenditure for which you generally can’t claim a deduction includes:

  • acquisition and disposal costs for the property
  • costs to attend seminars about helping you find a rental property to invest in
  • travel expenses to inspect a property before you buy it
  • since 1 July 2017, travel expenses relating to inspecting, maintaining or collecting rent on the property (these costs are also not included in the cost base of the property)
  • as noted above, since 1 July 2017, the decline in value of second hand depreciable assets acquired since 9 May 2017 and held in connection with the property

Record keeping requirements

To substantiate the fund’s tax calculations, as trustee, you should keep records of both the income and expenses relating to the rental property.  In relation to expenses, your records should include:

  • the name of the supplier
  • the amount of the expense
  • the nature of the goods or services, and
  • the date the expense was incurred (or a fund bank statement covering that period)

These records should be kept for five years from the end of the year to which the expense relates.

Parliament has now retired for the 2018 year.  Did they leave any unfinished “superannuation business”?

In the final week of Parliament, there were a number of superannuation related measures still to be passed into law.  We provide a status update below on each of these measures together with the Government’s other May 2018 Federal Budget superannuation related proposals.

Reversionary Transition to Retirement Income Streams (TRISs)

Legislation which amends the Income Tax Assessment Act (with effect from 1 July 2017) so that a TRIS which automatically reverts to a reversionary pensioner is also automatically a retirement phase pension has now passed the Senate [Treasury Laws Amendment (2018 Measures No. 4) Bill 2018].  Unfortunately the Senate proposed a number of changes  to other measures in the Bill (non-superannuation related) so it now returns to the House of Representatives for approval.  We expect Royal Assent will be given in the new year.

Superannuation Guarantee (SG) integrity measures

Legislation aimed at strengthening employers’ compliance with their SG obligations has also passed the Senate and as above, has now returned to the House of Representatives [Treasury Laws Amendment (2018 Measures No. 4) Bill 2018].  Among other things, this legislation:

  • allows the Commissioner to issue employers with education directions or directions to pay an SG charge, and
  • strengthens the director penalty provisions.

SG & one-off 12 month amnesty

Legislation to encourage employers to voluntarily disclose historical SG non-compliance and pay an employee’s full entitlements passed the House of Representatives in June 2018 and is awaiting progress in the Senate [Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018].

Salary sacrifice contributions & employer SG obligations

Legislation to ensure that amounts that an employee salary sacrifices to superannuation do not reduce an employer’s SG obligations and SG entitlements are calculated on a pre-salary sacrifice base is still awaiting progress in the Senate having passed the House of Representatives in November 2017 [Treasury Laws Amendment (Improving Accountability and Member Outcomes in Superannuation Measures No.2) Bill 2017].

SG “Opt Out” for employees with multiple employers

Legislation to enable individuals with multiple employers to elect to “opt out” of the SG system in respect of their wages from certain employers from 1 July 2018 has passed the House of representatives but is still awaiting progress in the Senate [Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018].

Non-arm’s length expenditure

Legislation  to amend the non-arm’s length income (NALI) provisions to ensure expenditure is also taken into account has passed the House of Representatives but is awaiting progress in the Senate [Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018].

Limited Recourse Borrowing Arrangements (LRBAs) and Total Super Balance

Legislation that aims to increase the amount of an individual’s Total Super Balance by “adding back” a proportion of any outstanding LRBA loan balance has passed the House of Representatives but is awaiting progress in the Senate [Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018].

If enacted, this change would apply to any individual where the LRBA was entered into on or after 1 July 2018 and:

  • whose superannuation interests are supported by an asset to which the LRBA relates if that individual has satisfied a “full” condition of release (ie a condition of release with a nil cashing restriction such as reaching age 65, retirement, permanent incapacity, or terminal medical condition), or
  • where the lender is an “associate” of the SMSF.

Work Test Exemption for Recent Retirees

The Superannuation Industry (Supervision) Regulations have now been amended to give effect to the Government’s May 2018 Federal Budget proposal to allow voluntary contributions (called “work test exempt contributions”) to be accepted from 1 July 2019 where [Treasury Laws Amendment (Work Test Exemption) Regulations 2018]:

  • the individual is generally aged 65 to 74 (or 65 to 69 for spouse contributions),
  • the work test wasn’t met in the year the contribution was made, but
  • the work test was met in the immediately preceding financial year,
  • the member had a Total Super Balance of less than $300,000 on 30 June of the immediately preceding financial year, and
  • no contribution has ever been accepted using this work test exemption in any previous financial year.

In a welcome move, the Government decided to not proceed with its proposed changes to the bring forward rules meaning a person turning 65 in a financial year will be able to use a “work test exempt contribution” to trigger bring forward mode. 

Increase in SMSF Membership from Four to Six

We are still awaiting the release of draft legislation on this proposal, which is due to commence 1 July 2019.

Three-Yearly SMSF Audits

We are also still awaiting the release of draft legislation on this proposal, which is due to commence 1 July 2019.

Parliament is scheduled to return in mid-February 2019.  We look forward to providing you with further updates on the progress of these measures in our next webinar to be held on 28 February 2019.  Costs and details on how to register can be found here https://www.heffron.com.au/heffron/training/webinars.

Adding my adult children as members of my SMSF – what are the pros and cons?

As part of the 2018/19 Federal Budget announcements, the Government confirmed that they intend to legislate to increase the maximum number of members that can belong to a single SMSF from four to six. This change is to apply from 1 July 2019 but has not yet been legislated.*

This announcement has prompted many to think about whether it can be beneficial to add adult children as members of their parent’s SMSF or is this a strategy to be avoided.

What are the Advantages?

Having your adult children as a member of your SMSF can offer a number of advantages including:

  • potential savings in overall cost (depending on the investments, transactions undertaken in the SMSF etc),
  • allowing the SMSF to diversify its investments,
  • allowing for the intergenerational transfer of fund assets.  For example, some parents who now have a mix of both retirement phase pension and accumulation balances are choosing to undertake a modified form of withdrawal and recontribution strategy whereby they withdraw money from their accumulation account, loan the monies to their children and their children then make concessional and non-concessional contributions to the SMSF. Depending on the time available and the quantum of the dollars involved, the need to sell fund assets on your death may be eliminated,
  • helping meet any liquidity issues of the SMSF.  The cashflow generated from your children’s contributions or rollovers into the SMSF could be used to meet your minimum pension requirements, finance limited recourse borrowing arrangements etc, and
  • acting as a way of mitigating some of the impact of the Australian Labor Party’s plans to limit refunds of excess franking credits for some taxpayers.  Having the children direct their concessional contributions to the SMSF would enable the franking credits to be used, thereby minimising or eliminating any excess franking credits. Our modelling suggests that concessional contributions have a much larger impact on excess franking credits than assessable investment income generated from accumulation balances. 

What are the Disadvantages?

There are potentially a number of perils in adding additional members such as adult children to your SMSF including:

  • your children will be privy to information about your SMSF entitlements and any arrangements you have put in place (eg reversionary pensions, binding death benefit nominations),
  • you risk being “out-voted” by your children in the running of the fund unless you introduce adequate controls,
  • trustee decisions must be made in the best interests of all beneficiaries not just the beneficiaries with the majority balances,
  • your adult children are likely to have different risk profiles to you, perhaps requiring different investment strategies.  While you can run separate investment portfolios and allocate earnings to the specific account balance(s) supported by a particular portfolio, this brings additional administrative complexities.  And, as a result of changes made with effect from 1 July 2017, it may be impossible to reflect these different investment strategies when it comes to calculating tax on the fund’s investment income, and
  • there would be a greater need to develop a workable dispute resolution mechanism for the fund.

There is no definitely right or wrong choice here – every family is different and every child within a family is different.  However, given the number of cases where the inclusion of one or more adult children as members or trustees of an SMSF has caused untold angst for the remaining members/beneficiaries, it is not a decision to be made lightly.

*This proposed change was not legislated before the Federal Election was called and is therefore not law.

A new opportunity to top up super for those over 65 – downsizer contributions

From 1 July 2017 it became much harder to build up more superannuation thanks to a tightening of the limits on contributions.  The maximum “concessional contributions” (employer, salary sacrifice contributions or contributions made by someone who claims a tax deduction for them) reduced to $25,000 pa.  At the same time caps on “non-concessional contributions” (contributions made from someone’s own money for which they do not claim a tax deduction) reduced from $180,000 pa to $100,000 pa and even $nil for anyone with more than $1.6m in superannuation.

Quirkily, at the same time, legislation was underway to introduce a brand new type of contribution that provides far more freedom for older Australians to make contributions.  These new contributions are known as “downsizer contributions” and they started from 1 July 2018.

“Downsizer contributions” are really just like non-concessional contributions once they arrive in the superannuation fund.  For example, the fund doesn’t have to pay any tax on them and when they are eventually paid out either during the person’s lifetime or after they die, there is no tax to pay.  If they are used to start a pension they will count towards the new $1.6m limit on pensions. 

But they come with completely different eligibility rules and limits.

For a start, downsizer contributions can only be made by someone who is over 65. This is unusual for superannuation.  Most other rules are designed to stop people contributing after 65 unless they are still working and it’s virtually impossible to make contributions after 75.  Downsizer contributions are exactly the opposite, they only come into play after 65 and there are no work requirements or maximum ages.

They are only available to someone who has just sold an eligible “dwelling” after 1 July 2018 that has been owned by the person making the contribution or their spouse for at least 10 years.  There are a few rules about the nature of the dwelling but it essentially includes any family home located in Australia.  It can even include properties such as farms where the family home is only part of the overall property.  A good guide is: if someone sells a property and does not have to pay capital gains tax on at least some of that sale because it was their main residence, it’s worth checking if it triggers eligibility for the downsizer contributions.

The maximum amount of the downsizer contribution is $300,000 per person, so $600,000 combined for a couple regardless of how much they already have in their superannuation fund. But there’s an extra limit – the total amount contributed cannot exceed the sale price of the property.  So if a property is sold for $400,000, a couple could contribute $200,0000 each or $300,000 for one person and $100,000 for the other or some other combination.  They could not use their full limit of $300,000 each ($600,000 combined).

Only one property can trigger a downsizer contribution over a person’s lifetime.  But it can happen any time after 65 – even someone who is 90 and is selling their home to move into an aged care home could make one.

So why are they such a big deal?

One reason is that downsizer contributions can be made by people who already have very large superannuation accounts.  In the future it will be common for these people to find that they cannot make non-concessional contributions for many years before they turn 65 (once they cross the magic $1.6m threshold) but when they sell their house at (say) 80 they can make a downsizer contribution.  It is therefore a belated chance to add to superannuation.

While they are called “downsizer contributions” (implying that there is an expectation of selling a large house and buying something smaller) there is actually no requirement to be downsizing or even to be buying another home at all.   The rules are simply an opportunity for those over 65 to make superannuation contributions that is triggered by selling their home.

There is also no requirement that the contribution actually comes from the proceeds of the sale.  Some people might have no intention of adding more money to their superannuation fund but they are concerned that the super they already have would all be taxed very harshly if inherited by their adult, financially independent children (up to 15% plus medicare).  The new rules give people in this position the ability to withdraw some existing (taxable) superannuation and then put it back into the fund as a (tax free) downsizer contribution when they sell their home.

And there are some quirks about eligibility.  Just some aspects to think about:

  • While the home must have been owned for 10 or more years, there’s no requirement that the couple have been together for all of that time – a late-in-life marriage could still allow downsizer contributions for both members of the couple if one of them sells their home,
  • Even where the home is owned entirely by one member of a couple, both can potentially make a downsizer contribution,
  • Only someone over 65 can make a downsizer contribution.  But if one member of the couple is under 65, that simply means only one of them can make one – it doesn’t rule them both out entirely.

One potential shortcoming is the impact on age pension entitlements - people making a downsizer contribution will potentially be moving money out of an exempt asset (their family home), into an environment where it will affect their age pension (superannuation).

For a new rule that’s not being talked about much, downsizer contributions have a lot to offer and a great many over 65s selling their homes should give them some serious consideration.

Work Test Exemption for Recent Retirees – Who Will Benefit?

In the May 2018 Federal Budget, the Government announced plans to extend the ability for recent retires to make contributions to superannuation from 1 July 2019.  This change has now been legislated.

In a nutshell, the rules in the current year only allow superannuation contributions for someone over 65 if:

  • the contributions are legally compulsory (eg required by an award or the Superannuation Guarantee rules), or
  • the member has met a “work test”.  (The work test is, broadly speaking, completing 40 hours of paid work over no more than 30 consecutive days at any time in the financial year and before the contribution is made).

What’s the change?

From 1 July 2019 individuals will have one extra financial year in which contributions can be made after the year in which they last meet the work test.

The one condition they must meet is that their Total Superannuation Balance (ie the measure of all of the money they have in superannuation across all their funds) must be less than $300,000 at the relevant time.

More specifically, the process will be:

  • identify the last year in which the individual met the work test (let’s say an individual retired, having recently turned 67, in May 2020), and
  • confirm that their Total Superannuation Balance was under $300,000 at the end of that year (30 June 2020 in this case), and if so
  • member and employer contributions will be allowed in the 2020/21 year even though the individual will be turning 68 and will not have worked at all during that year.

The exemption applies for the first time in 2019/20.  Note that this is the first year in which contributions will be possible under the new rules – those using it in that first year would need to meet the work test in 2018/19.

What is and isn’t allowed?

Those who cease work entirely well before age 65 will effectively receive no benefit from this change.  It is not a blanket exemption for one year after the last year in which contributions were possible.

It doesn’t allow contributions at times when they are not allowed regardless of whether the person has met the work test – eg voluntary contributions are illegal after 75 (or more technically, the 28th day of the month following their 75th birthday) and this remains the case.

The exemption is also only available in one financial year.  This means that it isn’t possible for someone to use the exemption in one year, then meet the work test in the next and use the exemption again the year after.

How does the exemption interact with the bring forward rules?

The “bring forward rules” are the special rules that allow people to contribute up to two or three years’ personal contributions in a single year (effectively “bringing forward” one or more subsequent years’ contribution limits).

Currently, the year in which an individual turns 65 is the last year in which they can initiate a bring forward period and this will not change as part of the exemption.

Conclusion

The feature that limits the value of this opportunity is the $300,000 cap on members’ Total Superannuation Balances.  However, it does present some new opportunities for those with small balances.

Article amended 10 December 2018 to reflect release of amending legislation

My client has been offered shares in his employer’s company as part of an employee share scheme. 

Under the scheme, the employee is able to take up the entitlement themselves or nominate an associate to take up the share entitlement.  If his SMSF were to take up the shares, what would be the consequences from a superannuation perspective?

An employee share scheme is a scheme under which shares or options in a company are provided to an employee or their associate in relation to the employee's employment.  We are often asked the question whether an employee could nominate their SMSF as the entity to acquire the shares/options under the employee share scheme.

Where an employee is granted rights to receive shares or options and the employee surrenders those rights to their SMSF, or exercises those rights but nominates their SMSF to receive the shares or options, the ATO generally considers the following transactions to have occurred:

Acquisition of Asset from Related Party

In the ATO’s view, shares or options transferred to an SMSF under an employee share scheme are generally considered to have been acquired from the employee (who would be a related party of the fund), even if the shares or options are transferred directly from the employer to the SMSF. 

If the shares or options are acquired from the employee, from the perspective of the Superannuation Industry (Supervision) Act (SIS), the SMSF will be in breach of section 66 unless the shares or options are listed securities at the time of acquisition by the fund (or the employer is a related party of the fund and the acquisition wouldn’t cause the fund’s in-house asset ratio to exceed 5%).

Determining whether or not the shares/options are in fact acquired from the employee or the employer will require a review of all of the facts & circumstances of the offer.  If trustees or their advisers are in any doubt, we recommend they request SMSF Specific Advice from the ATO.

Personal Contribution

If the SMSF acquires the shares or options, the employee will have made a personal contribution to their SMSF equal to the market value of the shares or options less any consideration actually paid by the fund.

For example, where the SMSF pays, say, $10,000 for the shares or options but they have a market value of $50,000, the employee is considered to have made a $40,000 personal contribution to their SMSF, and the cost base of the shares or options for capital gains tax purposes in the fund will be $50,000.

The trustee of the fund will need to ensure the employee is eligible to make contributions to superannuation (eg under age 65, aged between 65 & 74 and satisfies the “work test”).  This contribution would then generally be counted against the employee’s non-concessional contribution cap (which, depending on the employee’s circumstances, could be $nil).

In summary, where the shares/options are listed securities, the acquisition by the fund will not cause any SIS compliance concerns provided the employee is eligible to make contributions to superannuation.  However, the employee may need to consider the impact on their non-concessional contribution cap.

However, where the shares/options are not listed securities, SMSF trustees should exercise considerable caution before allowing the fund to be nominated to take up the entitlement.

Is segregation really just about pension accounts or can accumulation accounts be segregated too?

When we use the term “segregation” or refer to an asset as being “segregated” in a superannuation fund, we are generally referring to a tax concept which relates to funds providing retirement phase pensions.

In a nutshell, if a fund has assets that are purely supporting one or more pension accounts and those assets are classified as “segregated” for tax purposes, the fund claims a tax exemption for all investment income earned on those assets (known as exempt current pension income or ECPI).  Providing the fund doesn’t provide any defined benefit pensions, it doesn’t even need an actuarial certificate to claim this tax exemption.  Other funds with pensions – where the assets supporting those pensions are not classified as segregated – claim their tax exemption using a different method often referred to as the “actuarial certificate method”.

But the Income Tax Assessment Act 1997 also allows trustees to set aside assets exclusively for precisely the opposite purpose – ie to support accumulation (non pension) benefits.  Providing the fund is allowed to have segregated assets (see below), assets set aside in this way can be treated as “segregated non-current assets”.

Not surprisingly, earnings on segregated non-current assets are subject to the usual tax rate of 15%.  So why would anyone bother – why would a fund choose to isolate some of its assets for the sole purpose of supporting an accumulation account?

Before answering this question, it is important to briefly re-cap which funds are allowed to treat their assets as segregated for tax purposes.

Re-cap – which funds can segregate?

In any given year, an SMSF is allowed to have segregated assets if, at the end of the previous year, no fund member had both:

  • A total superannuation balance of more than $1.6m, and
  • A retirement phase pension (in this fund or any other).

If a fund is allowed to segregate, the trustee is allowed to have either segregated pension assets or segregated accumulation assets or both.

And when might segregating accumulation assets prove attractive?

This is perhaps best explained using an example.

Consider a fund with two members, both of whom have $1m accumulation balances at the beginning of the year.  On 1 January, one of the members starts a retirement phase pension while the other remains in accumulation phase.

In the normal course of events, this fund would obtain an actuarial certificate for the whole year.  It is likely that this certificate would show a percentage of approximately 25%.  In other words, 25% of all of the investment income received throughout the whole year would be exempt from tax.  This would apply to:

  • income before any pensions started (when the fund was actually 100% in accumulation phase),
  • as well as all income after the pension started (when the fund was actually 50% in pension phase).

If the fund is making roughly the same amount of investment income every month, this will give a result that feels about right.

Where things get complicated is if (say) the fund sells a major property asset in June.  Because it occurred at a time when the fund had around 50% of its assets supporting pension accounts, the trustee could be forgiven for assuming that 50% of the capital gains (after discounts) will be exempt from tax.

This is where the ability to segregate an asset to support an accumulation account can be vital.

What if all the fund’s assets were treated as segregated accumulation assets until 1 January?

Since the fund is allowed to segregate its assets for tax purposes, the trustee can choose to elect (up front) that all its assets are segregated accumulation assets at 1 July until the pension starts on 1 January.

This helps because it means that:

  • the account balances for the first half of the year are completely ignored in working out the actuarial percentage,
  • the percentage is therefore higher – in this case, it is likely to be around 50%,
  • the percentage is applied to all income after 1 January (all income before that time would be fully taxable).

In this case, it means that 50% of the capital gain (after discounts) would be exempt from tax rather than only 25%.

How are assets segregated for accumulation accounts?

The process is essentially the same as choosing to segregate specific assets for pension accounts (ie the trustee resolves to do so, records the assets that should be treated as segregated assets and ensures that they are kept separate from other assets).

There is one important difference in that funds segregating assets for accumulation accounts must obtain an actuarial certificate.  This is different to the situation for funds that are segregating assets for pension accounts – as mentioned earlier, this can be done without an actuarial certificate as long as the fund has no defined benefit pensions.

Conclusion

Since segregating assets is almost always talked about in the context of pensions, it is easy to overlook the fact that funds can also segregate assets to support accumulation accounts.  The concept can, however, be just as valuable.

Data is an asset - right?

The title to this blog is a common refrain these days and most of us don’t blink an eyelid when someone says data is an asset.

However, if it really is an asset why don’t more of us treat it like one?

How we treat assets

  • We try and acquire data at low prices
  • We protect them from damage and theft
  • We repair and maintain them – well maintained data will increase in value
  • We use them to generate revenue – if we keep our asset in good condition it usually generates stronger revenues
  • We don’t give them away for free

In my experience, if we truly believe data is an asset, many of us don’t treat data as well as we should.

This is a big subject and I will only scratch the surface in this blog. However, I want to stimulate the reader into asking themselves questions about their data assets and hopefully inspire action that extracts more value from those assets.

Protection & theft

This principle is quite well understood from a data point of view, but the data protection focus has been driven as much by legislation (for example, the Privacy Act) as commercial priorities. If the community hadn’t had this legislative burden imposed, I wonder how long it would have taken to reach our current level of data protection competence.

At any rate, it is generally understood that personal data must be protected in order to ensure client privacy and cyber-crime insurance is also becoming more common. Not backing up your data and storing that back up in a safe place (usually outsourced to the cloud and therefore off site) is now the exclusive domain of the fool.

Nevertheless, it still surprises me how much information is readily shared via email instead of using more secure electronic methods or how frequently applications like Dropbox (where data sovereignty might be an issue) is used for personal information. It would appear there is still plenty to learn in this space.

Given the ubiquity of cloud-based software solutions it is also vital that you understand how your suppliers protect your data. Make sure the contracts you have with these suppliers protects your data in a way that is necessary and satisfactory to you.

Maintenance

No asset will deliver on its potential if it isn’t well maintained. Data is no different to any other asset in this respect.

If we are to extract value from our data asset it must be accurate, relevant, easy to use and analyse.  This is the work of data asset management and requires focus and process. It’s important that we define whose job it is to do each part of this work. 

Without doing the maintenance work, we will struggle to generate a return from our asset. Given the size and importance of this topic, I will be dealing with it in more detail in my next blog.

Generate a return

Almost all data is valuable but how can we turn the asset into dollars.

Quality data generates its returns in four main ways:

  • Improved efficiency
  • Improved accuracy and quality
  • Improved scalability
  • Better decisions

Data has rich information locked up in it that has the potential to help us understand almost everything about our business more accurately and in real time. If extracted and analysed well it can transform the quality and scalability of our decision making and add huge value to the organisation.

Each component of this process (collection, storage, extraction, analysis, insights) can be scaled and improved using data management techniques but only a few organisations will have the resources and therefore capability to do it all at once. Digital natives (even if they are small) often have the jump on traditional business because their processes and systems have been built from the ground up to do this work.

However, as with most things data, data analytics and even the application of artificial intelligence (AI) to the results of that analysis is becoming cheaper and easier to use for smaller organisations. There are now several software packages available at modest cost, for example Tableau, ClearStory Data or even just good old Google Analytics

Those organisations that master the ability to collect, analyse and act on their data earlier than their competitors will undoubtedly have a key competitive advantage in their market places.

Gifting

We don’t generally give away our assets for nothing, yet many organisations do this all the time when they provide data to a third-party for free. 

On other occasions, you may be able to negotiate a better deal if the supplier realises you understand the value of your data asset.

If you are using a third-party provider and your data will be stored in their systems on a server out of your control, make sure you understand what that data can be used for and who (if anyone) is going to generate a return from that asset. Sometimes, the functionality of the provider plus the price you are paying for that functionality maybe be enough to offset the fact you are giving an asset away for nothing but make sure you do that with your eyes open.

Acquisition

If data has so much value, then we should be collecting as much of it as we can, ensuring its accuracy and storing it in a way that is easy to use, especially if we can do so at low cost.  Many of your third-party software providers are doing this with your data already. 

Data can come from two sources:

  • Your own data
  • Third-party data

At the very least we should be collecting all our own data in a way that enables us to extract value from it. It’s the data management processes that ensure the data is in a condition to add that value.  As alluded to above, given the importance of the data management process, I will be writing about that in my next blog.

Once again though, the means of doing this are getting cheaper as running your own scalable data base and controlling your own Application Programming Interfaces (APIs) becomes more common in the Small to Medium Enterprise  space.  

I don’t think it will be long before those capabilities become an essential component for any organisation with growth and sustainability ambitions.

Government moves to fix Transfer Balance Cap anomalies

In recent days the Government announced a handful of proposed technical changes to the taxation law to address a number of minor but important issues affecting some retirees.  We cover two of these proposed changes below.

Valuation of Defined Benefit Pensions

Since 1 July 2017, whenever an individual commences a retirement phase pension the “value” of that pension is counted towards their $1.6m Transfer Balance Cap.  For account based pensions, the “value” for this purpose is simply the starting value of the pension.

However, for some defined benefit pensions (eg lifetime, life expectancy pensions), the legislation provides a formula instead.  One of the components in this formula is the pension’s annual entitlement which, in simple terms, is worked out by annualising the first payment the individual receives from the income stream.

For some schemes, particularly say public sector schemes, the pension payments to  a reversionary pensioner may temporarily be paid at a higher rate for a period of time, after which there is a permanent reduction in the payments.  For example, the payments made to a surviving spouse for 4 weeks after the original pensioner’s death are equal to what the original pensioner was receiving and then payments reduce to say 70% of the original amount.

Under current law, the amount counted towards the surviving spouse’s Transfer Balance Cap will be based on the first (ie higher) payment the spouse receives.  This is the case even though shortly thereafter there will be a permanent reduction in the payments received.

The Government has proposed amending the rules for valuing these pensions so individuals are not disadvantaged when permanent reductions in the payments occur.

 

Stopping & Restarting Market Linked Pensions Post 1 July 2017

As mentioned in Meg Heffron’s June blog article (https://www.heffron.com.au/blog/article/market-linked-pension-update), up until recently there had been uncertainty around the Transfer Balance Cap treatment of the commutation of market linked pensions (eg where the proceeds are rolled over and used to commence a new market linked pension in another fund or even in the same fund).  In short, an unintended consequence of the 1 July 2017 changes meant that stopping and restarting the pension in this way could have caused the individual to exceed their cap.  This is because the commutation of the pension arguably didn’t result in a reduction in the amount counted against their transfer balance account but the commencement of the new pension was still counted.

The ATO addressed this in August by announcing that they would essentially administer the law as was originally intended [CRT Alert 066/2018] by agreeing to not take compliance action if the stop & restart of the pension is not reported at all or those events are reported but the values used are modified appropriately. 

The Government has now announced that they are committed to finding a more permanent legislative solution to this problem by amending the way in which the commutation of these pensions are valued for the purposes of the Transfer Balance Cap. 

Whilst irrelevant for many retirees, these changes will be welcome news for those who were inadvertently impacted by the drafting of the original reforms.

If my client receives a lump sum from superannuation, will the lump sum be included in their “income” for Division 293 purposes?

Potentially, but this will depend on why your client is receiving the lump sum, their age, the amount paid and the components of the lump sum. 

Individuals subject to Division 293 tax are levied with an effective tax rate of 30% on their concessional superannuation contributions, rather than the usual 15% rate. This additional 15% tax is colloquially known as “Div 293 tax”.

Div 293 tax is applied to certain concessional contributions where an individual’s combined “income” and “low tax contributions” for a year exceed $250,000 ($300,000 for financial years prior to 1 July 2017).

“Income” for this purpose is primarily based on your client’s taxable income with a few modifications. 

So which lump sums are included in “income” for Division 293 purposes?

Your client’s lump sum will be included for Div 293 purposes if your client is receiving the lump sum because they are drawing down on their own superannuation benefits and:

  • they are at least age 60 – in which case the amount which is included is the amount (if any) of their untaxed element
  • they are at least their preservation age but not yet 60 – in which case the amount which is included is the amount (if any) of the taxed element which exceeds the low rate cap ($205,000 in the 2018/19 year) plus the amount of any untaxed element
  • they are under their preservation age – in which case all of the taxed and untaxed elements are included
  • they have received the payment in breach of the payment rules (eg because they weren’t yet eligible to draw on their benefits in lump sum form) - in which case all of the payment is included including any tax free component

Your client’s lump sum will also be included for Div 293 purposes if the lump sum they receive is a death benefit paid directly from a superannuation fund and they are a non-dependant beneficiary – in which case all of the taxed and untaxed elements are included.

Interestingly, if your client had received the death benefit via the deceased’s estate, then it would not have been included in their taxable income (the estate will be liable for any tax) and therefore not included for Div 293 purposes. 

Quarterly TBAR reporting – does every fund need to lodge?  What if I can’t lodge on time?

With the 1 July 2017 introduction of the $1.6m Transfer Balance Cap came a new obligation on superannuation fund trustees to report certain member “events” to the ATO. These events are reported using a “Transfer Balance Account Report” or TBAR.  For TBAR purposes, SMSFs are either annual or quarterly reporters with the first TBARs under the quarterly system due on 28 October 2018.

Does this mean every SMSF who is a quarterly reporter needs to lodge a TBAR before 28 October 2018?

Put simply, no.

TBAR reporting is an events based system.  A TBAR only needs to be lodged where an “event” has taken place.  In addition to reporting the 30 June 2017 value of retirement phase pensions in place just before 1 July 2017, reportable events include:

  • the commencement of a retirement phase pension on/after 1 July 2017,
  • the reclassification of a transition to retirement income stream (TRIS) as a retirement phase TRIS on/after 1 July 2017,
  • a lump sum commutation (full or partial) from a retirement phase pension on/after 1 July 2017, and
  • the reversion of a retirement phase pension on/after 1 July 2017.

There is no need to lodge a TBAR to report pension payments, lump sums from accumulation accounts, etc.  In addition, there is no need to lodge a “nil” TBAR for funds which have not had any reportable events in the relevant period.

For many funds, it is quite possible that post 1 July 2017 no further TBARs will need to be lodged until say:

  • a member dies and his or her pension is transferred to the surviving spouse, or
  • the trustee decides to wind up the fund and transfer the remaining member balances to a public fund.

Of course, those quarterly reporters who have had a reportable event in the relevant period need to take appropriate action to identify these events, collect the necessary information and lodge a TBAR for the affected members.  This can be a time consuming process for those accountants not processing their funds’ transactions regularly, but it won’t be an issue for every SMSF.

What if you won’t be able to meet the 28 October 2018 due date?

A TBAR is an approved form and trustees can be penalised $210 for each period of 28 days that the form is late up to a maximum of $1,050.  However the ATO have indicated that they are currently taking an “educative and supportive approach” where TBARs are lodged late.  Specifically they have stated “Where agents will not meet the 28 October deadline, but are working towards lodging a TBAR due on 28 October 2018 as soon as possible, there is no need to contact us to seek a formal extension of time.  Whether or not an extension of time is granted, any late lodgement of a TBAR may result in the member’s transfer balance account being adversely affected, the member being adversely affected and possible reverse workflow for the trustee. We therefore strongly recommend agents discuss with members potential consequences of late lodgement.”

SaaSy for some

My previous blog on data flagged that the digital revolution enables great masses of data to be generated, collected, stored and analysed relatively quickly and cheaply.

At the start of this process of digitization, data was stored on-site on tapes, discs and then hard drives sitting inside specialised computers called servers. In the dim and distant past (1994) I remember buying a new server for my employer with (wait for it) 1 whole gigabyte of storage.  At the time this seemed excessive and I never expected the space to be used. However, twenty-four years later, our family of four have hand held devices with around 12,800% more storage space than that – most of it already used.

The use of on-site digital data storage proved to be transient phase.  The creation of very fast, reliable internet connections enabled data to be cheaply stored off-site in “the cloud” by specialist, scaled providers without impacting the almost instant availability of the data to the user.

In addition, the fast, reliable internet enables software suppliers, who used to deliver their software to customers on discs so that customers could load the code onto their own desktops or local servers, to store the code on their own servers in the cloud. The fast internet enabled customers to easily access that software on-line and providers could update their software without the cost of mailing out thousands of new release discs to customers.  This business model became known as Software as a Service (SaaS).

There are clear benefits to both customers and suppliers in using this model. But there is a side effect – it has created ambiguity around the question of data ownership. When the data was stored locally on the user’s equipment there was little doubt about data ownership or the ability of the data owner to exclusively access and analyse their own data. In the SaaS model, data is stored on the supplier’s equipment (or equipment rented by the supplier) and data ownership, access and the ability to analyse that data becomes subject to the law and the contract between supplier and customer.

We already know that data has great value (just look at Facebook) so when a business uses a SaaS provider it is potentially giving them away a business asset for free whilst paying that provider for the privilege.

Leveraging digital data commercially is often described as a “data play”. They are easier to pull off when one party understands the value of data and the other party does not. Acquiring a valuable asset for free is an excellent trade and the ability to arbitrage the knowledge gap around the value of data has already created more wealth than any other transaction type in history.

Resolving the Kitchen Bench Dilemma - why Heffron uses electronic signatures

Like any business that wants to thrive and remain relevant to its clients, Heffron is always looking for ways to improve how we do our work.

Naturally we look for ways to get more efficient (clients love things to be done more quickly or at a lower cost) but we also have to calibrate that against the fact that most changes we make affect two very different client groups – the trustees of the SMSFs we look after and the advisers who referred them to us and who manage the delivery of our service to their client. 

That can be tricky – what’s great for the adviser may not be great for the trustee, and vice versa.

So we started using an electronic signing platform (Docusign) with some trepidation.

One of the main reasons we started down this path was to remove the long delays that inevitably occur when a large pack of documents is posted and needs to be returned.  We have the uncertainties and vagaries of Australia Post (and the documents never arrive with the client anything close to the pristine state in which they left our office) but perhaps the most significant delay is what a friend of mine once described as the “kitchen bench effect”.

The Kitchen Bench Effect

We’ve all done this.  A document arrives at home or at our office. It’s not simple to deal with it immediately – we need to read it, sign in a million places, often have our partner sign too (and they don’t conveniently work with us so we can’t do it at work) and then post back somewhere (and realistically, when was the last time any of us entered a post office?).  So naturally it stays on the kitchen bench.  Often unopened.  For weeks. 

This was a major challenge in our business.  It is not uncommon to reach April / May, a key deadline for businesses like ours, and still have 300-400 tax returns sitting on our clients’ kitchen benches all around Australia.  Many will have been sent months earlier but still haven’t been returned. That is challenging and time consuming for us and our advisers (who don’t have a lot of control over their clients’ kitchen benches either) but even for the trustees – all of a sudden something they have been ignoring for weeks has become urgent.

Moving to electronic signatures

We took a random sample of the SMSF returns we sent out recently – those sent by Docusign are typically returned in 3 days.  Those sent via paper are typically returned in 21 days.  (And remember this is looking at the “typical” case (or median) rather than the extremes – some of the paper packs still set up home on the kitchen bench for many months!)

So moving to electronic signing definitely achieved what we wanted – but is it a positive experience for clients?

For some clients it is an immediate win – those where the trustees don’t all live together or where the financials arrive at a time when someone is away are over the moon.  Equally those who know they have a kitchen bench problem are delighted that all they need to do is review and discuss the package with their fellow trustees and then the actual sign / return process is no more than a few clicks.  Every signatory receives a copy of the signed documents at the end (no need to separately copy and post or email) and we are able to upload them to our portal virtually immediately once they are returned.

It also means clients are very aware of where they need to sign and whose signature is required.  While our paper packages have often jokingly been referred to in-house as “death by Sign Here stickers”, it’s amazing how easy it is to miss one, sign in the wrong place, forget to add a date when there’s a lot to do.  Many clients comment how much easier it is to just be prompted electronically.

The security benefits are clear too.  We can be confident that our clients’ financial data goes directly to them rather than potentially sitting in a letterbox for days or weeks, getting lost in the mail or being delivered to their neighbour by accident.  We can tell them where and when the documents are signed and even the IP address of the computer on which it happens.

Quite apart from the personal wins, many clients love the fact that Heffron and their advisers are taking this small step towards a paperless, greener future.  And when you think about it, the impact of simply not printing a large document pack is huge - no paper, less toner, no transport, no special envelopes (which we needed to do our best to combat the battering documents inevitably receive when transported through the mail).

Were there any concerns?

In some cases it wasn’t initially obvious that electronic signing would be great. 

An early concern we bumped into was that advisers and clients like to work through these documents together face to face.  The same applied for some of our trustees whose children belonged to the fund – they liked the idea of a family meeting where they really talked about their superannuation fund together.  The act of signing the paper was an integral part of the whole process.

We found other cases where advisers and clients didn’t necessarily meet face to face to execute the documents but they did want the adviser to review the work before it was passed on to the trustees.  Others simply wanted to ensure that the adviser received a copy of the signed package.

Fortunately, we realised we could accommodate numerous signing approaches that meet this need, for example:

  • Even before anyone starts signing the document, it is possible to create a PDF of the full copy and print it to share with others.  Advisers and trustees can then review together on either paper or their own devices before completing the electronic signing,
  • We can set up the process so that the document is only forwarded to the client for e-signing once the adviser has reviewed and approved it or the adviser can simply receive a copy at the end.  Just like sending out paper copies, we have tailored this to suit the adviser and their client – different people make different choices, and
  • We can even identify at a glance whether anyone in the process needs to be reminded that they need to do something.  (Any of us with very full email in-boxes know that there is a kitchen bench equivalent for emails too!)

Whatever the preferred method, the act of actually signing AND returning still only takes a few clicks. Sometimes this is done on the spot where clients have access to their emails on a mobile device or others after they return home.

And in the end?

The most interesting aspect of this change is how many advisers initially rejected the idea of electronic signatures out of concern for their clients, only to discover that the trustees are far less concerned by it than they are.  Even in the 12 months we have been using the system, it has become far more common than previously for all of us to sign contracts electronically – whether it’s buying a new phone, taking virtually any form of delivery or renting a car, we just don’t expect to see so much paper any more.  Electronic signing in its many different forms is everywhere.

Not surprisingly the benefits of:

  • speed and certainty of delivery both to and from the trustees
  • ease of signing – particularly when accommodating trustees and advisers at multiple addresses
  • security, and
  • far less paper

are being understood and appreciated by all of us.

Contribution Caps for 2018/19 Financial Year

With a new financial year upon us, you may be thinking about what contribution caps apply for the 2018/19 financial year.

Concessional Contributions

The concessional contribution cap remains at $25,000 for the 2018/19 financial year. 

The concessional contribution cap captures both employer contributions (including superannuation guarantee and salary sacrifice contributions) and personal contributions where a tax deduction is being claimed.

Non-concessional Contributions

The non-concessional contributions cap for the 2018/19 financial year remains at $100,000 for individuals who had a total superannuation balance of less than $1.6m at 30 June 2018.  Individuals who had a total superannuation balance of $1.6m or more at 30 June 2018 are unable to make any non-concessional contributions in the 2018/19 financial year without exceeding their cap (ie their cap is $nil).

The non-concessional cap captures personal contributions where a tax deduction is not claimed or contributions made for a spouse.

Broadly speaking, total superannuation balance is all of the money an individual has in superannuation across all superannuation funds to which they belong.  Importantly, it is not just the amount in the SMSF.

As you may be aware, in certain situations, it is possible to “bring forward” the non-concessional contributions cap from a future year and use it in the current year.  The bring forward amount and periods are shown in the table below.

Total Superannuation Balance on 30 June 2018

Bring Forward Amount if triggered in 2018/19

Bring Forward Period if triggered  in 2018/19

 Less than $1.4m

 $300,000

 3 years

 ≥ $1.4m but less than $1.5m

 $200,000

 2 years

 ≥ $1.5m but less than $1.6m

 $100,000

 n/a

 $1.6m or more

 $nil

 n/a

 

Downsizer Contributions

From 1 July 2018, some individuals are eligible to make a new type of contribution called a “downsizer contribution”. 

Generally speaking, an individual is eligible to make a downsizer contribution if they are over age 65 when the contribution is made, they sell their home on or after 1 July 2018, and they owned the home for at least the last 10 years.

Importantly:

  • there is no maximum age limit (rather the contributor must simply be aged 65 or over),
  • there is no requirement to satisfy a work test, and
  • unlike non-concessional contributions, downsizer contributions can be made regardless of the size of the individual’s total superannuation balance.

Downsizer contributions are limited to the lesser of:

  • $300,000 per person (eg $600,000 combined if both members of a couple are eligible), or
  • the capital proceeds from the disposal of the dwelling.

If you are unsure if you are eligible to make contributions to superannuation or use bring forward mode, or would like further information on downsizer contributions, please give us a call to discuss.

Event Based Reporting

With the 1 July 2017 introduction of the $1.6m Transfer Balance Cap (or “pension cap” as some people call it) came a new obligation on superannuation fund trustees to report certain member “events” to the ATO.  These events are reported using a “Transfer Balance Account Report” or TBAR. 

The TBAR is a way of reporting a number of things but mainly it is concerned with funds telling the ATO when:

  • a new pension starts for someone who is retired or age 65 or over (or otherwise able to access their superannuation benefits without restriction),
  • a transition to retirement pension becomes a retirement phase pension (because the recipient retires or reaches age 65 etc),
  • some or all of an existing retirement phase pension stops (called a commutation), and
  • some other special events that affect the Transfer Balance Cap,

and the amount involved.

For many SMSF members, the first TBAR lodged for them was to report the balance of any pensions already in place on 30 June 2017. 

Will SMSFs need to lodge TBARs on an on-going basis?

For most SMSFs, no.  For many funds, it is quite possible that no further TBARs will need to be lodged until say:

  • a member dies and his or her pension is transferred to the surviving spouse, or
  • the trustee decides to wind up the fund and transfer the remaining member balances to a public fund.

This is because there is no need to lodge a TBAR to report for:

  • pension payments, or
  • payments from a member account that is not a retirement phase pension (eg a withdrawal from an accumulation account – money that has not been converted to a pension).

More regular TBARs will be required by some SMSF members.  For example:

  • those who had not yet started to draw a pension from their fund at 30 June 2017 but do so at a later stage,
  • those who “stop & restart” or “re-set” their pension each year to combine it with new contributions made in the previous year (not possible for those members who have already fully utilised their $1.6m Transfer Balance Cap),
  • those who are drawing a transition to retirement pension and reach age 65 or retire etc after 30 June 2017, and
  • those who take payments known as partial commutations (where part of the pension is withdrawn as a lump sum rather than a pension payment).  This might be common in the future as a partial commutation reduces the amount counted towards an individual’s Transfer Balance Cap.  Many people who will potentially inherit a superannuation pension from their spouse in the future will take partial commutations rather than larger pension payments to make sure they have as much of their cap available in the future.

In summary, whilst a great many SMSFs had to initially lodge TBARs (because members had pensions in place at the end of 30 June 2017), TBARs won’t be a major issue for most funds in most years in the future.

Re-think Treatment of Amounts in Excess of Minimum

Prior to 1 July 2017, as a general rule, where an individual was age 60 or over and wanted to draw monies from their pension account in excess of their minimum pension requirements, the excess was simply treated as an additional pension payment.  This is because, whilst the payment was tax free regardless of whether the amount was treated as a pension payment or a lump sum commutation, pension payments didn’t necessitate any additional paperwork whereas lump sum commutations did.

However, since 1 July 2017, individuals aged 60 or over who need/want to take more than the minimum amount from superannuation are often inclined to:

  • firstly, take monies from their accumulation account (if any eg the excess above the $1.6m which they “rolled back” to accumulation on 30 June 2017), and
  • once the accumulation account has been exhausted, treat subsequent payments over the minimum pension as a partial lump sum commutation from their retirement phase pension.

This approach firstly maximises the portion of the fund generating tax free income by leaving as much as possible in the pension account.  Secondly, partial lump sum commutations create “cap space” by reversing some of the amount that has used up their $1.6m Transfer Balance Cap.  This will help an individual leave more in superannuation should they inherit a spouse’s superannuation in the future.

However, the ATO expects SMSF trustees to be able to identify whether a payment is a pension payment, a lump sum from accumulation or a lump sum commutation from pension the moment the payment is taken.  We have developed documentation which can be put in place at the start of each financial year which dictates how each payment from the fund is to be treated in that financial year.  If you are drawing more than the minimum from your retirement phase pension, and have an accumulation account or think it would be worthwhile treating some of the payments as a partial lump sum commutation, please let us know so we can prepare the necessary paperwork for you.

Three Yearly Audit Proposal

In the May 2018 Federal Budget, the Government proposed that SMSFs with three years of clean audit reports and returns lodged in a timely manner would be eligible to move to a three-yearly audit cycle rather than being audited every year. 

Not unexpectedly, this announcement led to a number of questions by SMSF trustees and their auditors.  Thankfully, the Government has now released a discussion paper on this proposed change which gives us a bit more of an idea of how it may work.

We’ve summarised the main points below:

  • Not every SMSF will be eligible for a three-yearly audit. 
  • Eligibility requirements are still to be finalised but are proposed to be determined by whether the fund’s auditor has reported to the ATO any contraventions of the superannuation law in the last three years and whether the fund has lodged its SMSF Annual Returns on time.
  • Where a fund is eligible for a three-yearly audit, the auditor will still be required to audit each of the three years in that period.  For this reason, we do not expect there will be any significant reduction in overall audit costs (although funds may only actually pay their audit fee once every 3 years). 
  • It is proposed that eligible SMSF trustees will be able to choose whether or not to move to the three-yearly audit cycle.  Some trustees may choose to remain being audited annually simply as a means of keeping on top of their record-keeping.  Locating a missing bank statement can be troublesome enough say 12 months after the event, let alone potentially 4 or more years later.
  • In addition, if an eligible fund experiences a “key event”, eligibility would cease (at least temporarily) and an audit would be required before the SMSF Annual Return for that year was lodged.  This audit would need to cover all financial years since the SMSF’s last audit. 

           A “key event” is proposed to include events like:

           - the commencement of a pension for the first time,

           - the death of a member,

           - the addition or removal of a member,

           - the commencement or continuation of a limited recourse borrowing arrangement,

           - the purchase of an asset from a related party, or

           - investments, loans or leases with related parties.

           But the year after the key event, provided the auditor doesn’t report any contraventions to the ATO, it is proposed the fund would be eligible to return to a three-yearly audit.

  • Whilst it is proposed that this change will commence for audits for the 2019/20 financial year and onwards, transitional arrangements may mean funds become eligible on a staggered basis to assist auditors in adjusting to the new arrangements.

We expect there is still a lot of consulting and negotiating to be done before we see this proposal legislated.  However, as you can see, there may be far less cost savings for SMSF trustees than the initial announcement suggested and some trustees will choose to remain on an annual audit cycle.

How can I check my client’s Total Superannuation Balance?  And what about the amounts which have been counted towards my client’s Transfer Balance Cap?

The methods available for obtaining Total Superannuation Balance and Transfer Balance Cap information depend upon whether or not you are the individual’s tax agent. 

Tax Agent for Individual

The tax agent for the individual can access Total Superannuation Balance information via the Tax Agent Portal by:

  • sending a Mail message using:
    • the mail topic “Superannuation”, and
    • the subject “NCC balance”,
  • in the mail message, you can request both the Total Superannuation Balance and non-concessional contribution bring forward information (if desired) for either:
    • all linked clients, or
    • specific clients.

You will need to include the relevant tax file numbers (TFNs).   A spreadsheet of TFNs should be included if the request is for more than 10 clients.

Transfer Balance Cap information is not currently available on the Tax Agent Portal.  Tax agents can only access this information by ringing 13 10 20.

 

Tax Agent for Fund/Adviser for Individual

Unfortunately Total Superannuation Balance and Transfer Balance Cap information is not currently available to persons who are not the individual’s tax agent.

If you are not the individual’s tax agent, you could try asking the client to view the information via their myGov account (see below) or ask the client’s tax agent to request the information from the ATO (as above) and then forward the information to you.

 

Clients

Clients can view and download a print-out of their Total Superannuation Balance and Transfer Balance Cap information via their myGov account (where they have one). 

In relation to the Transfer Balance Cap information, we recommend asking clients to provide you with the debit and credit information as well as the balance amount.

In relation to the Total Superannuation Balance information, clients are able to view their total as well as the various superannuation balances making up the total.

 

My client is well within his/her Transfer Balance Cap and their Total Superannuation Balance is below the relevant thresholds, so why would I need to check?

We’ve seen many instances of tax agents and advisers (and even clients) discovering superannuation balances they didn’t know the client had.  In other cases, amounts have been inadvertently reported twice for Transfer Balance Cap purposes and commutations not reported at all.

Where these errors result in the client exceeding their Transfer Balance Cap, the first you may know of the problem will be when an excess transfer balance determination is received.  If the problem is simply due to reporting errors, it can easily be fixed but your client (and you) may get a fright which could have been prevented.  For some clients, these sorts of reporting errors may not even come to light until many years down the track (eg when they inherit a superannuation pension from their spouse).

With the Total Superannuation Balance now being used as an eligibility threshold for so many tax concessions (eg non-concessional contributions cap, utilising unused concessional contributions, method for claiming exempt current pension income), we expect to see many more instances of excess contributions, mistakes in tax calculations etc going forward. 

It’s one of those areas where a little bit of time spent now reviewing client records may save a lot of heartache later on.

Remember of course, the data provided (whether via the ATO or a myGov account) will be based on the information reported to the ATO by your client’s various superannuation funds and it may not always be up to date. 

Market Linked Pensions - PAYGS & untaxed offset

Must the fund issue a PAYG summary?  Does the individual need to report the payments in their personal tax return?  Are they still eligible for the untaxed element tax offset?

Fund PAYG Summary requirements

Where an MLP meets the definition of a Capped Defined Benefit Income Stream (CDBIS), the paying fund is required to issue a PAYG Summary. 

An MLP will be a CDBIS if it commenced prior to 1 July 2017 and the recipient is:

  • over age 60, or
  • the beneficiary of a death benefit MLP where the deceased was over age 60.

A PAYG summary must be issued, even if the withholding amount is NIL.  Why?

The introduction of the Transfer Balance Cap limited the amount that could be transferred to retirement phase, and individuals with more than the allowed amount were required to return the excess to accumulation.

However, MLPs and similar income streams, are prohibited from being returned to accumulation.  To create a broadly similar limited tax concession for these types of pensions, a $100,000 pa defined benefit income cap was introduced.  This cap is applied at the individual level.

As the trustee of a superannuation fund has no way of knowing what other CDBIS payments an individual may be receiving, they are required to issue a PAYG summary and the individual is then responsible for determining what to report in their personal tax return.

 

Individual return & CDBIS payments – to include or not?

Below age 60 for entire year

For individuals aged under 60 receiving their own pensions or in receipt of death benefit pensions where the deceased was under age 60 at the time of passing, there have been no reporting changes.  Total taxable, untaxed and tax withheld figures for all pensions should be reported at Item 7.

 

Aged over 60 for entire year and pension held for whole year

Individuals aged over 60 for the entire year will generally only receive a PAYG summary for a pension if that pension:

  • meets the definition of a CDBIS, or
  • has an untaxed element.

Simply receiving a payment summary for a CDBIS does not mean an amount always needs to be included in the individual’s income tax return.  An amount only needs to be included if:

  • the sum of all of the individual’s CDBIS amounts (both tax free & taxed elements) exceeds $100,000.  The amount to include is then 50% of the excess above $100,000 (label 7M), or
  • the individual has an untaxed element (label 7Z).

 

Receiving own MLP & turned 60 during the year OR aged below 60 and in receipt of death benefit MLP where deceased was over age 60 at death

Individuals in this category may have a reduced defined benefit income cap to reflect that some of the payments they received were not concessionally taxed.  This is discussed in detail in Law Companion Ruling 2016/10 and the 2018 Individual Tax Return Instructions (QC 54214).

Very simply, the $100,000 cap is prorated to only capture the period of tax concession.  Similarly, the reportable amount will be half the amount that exceeds the reduced income cap received during the period of the tax concession.  For example, if you turn 60 during the year, it only includes the payments received after reaching age 60.

 

What about the untaxed element tax offset?   It’s not showing on the PAYG summary anymore – can it still be claimed?

Similar to the PAYG summary requirement, as the trustee of a superannuation fund has no way of knowing what other CDBIS payments an individual may be receiving, they cannot determine what offset eligibility an individual may have as it too is now affected by the defined benefit income cap.  As a result, this figure is no longer provided on the PAYG summary for CDBISs.

Each individual may still be eligible for the offset but must self-assess their eligibility and complete the tax return appropriately at Item T2.

Where the sum of the taxed and tax-free components of the CDBIS payments exceeds $100,000, there is no offset available on the untaxed element.

Where the sum of the taxed and tax-free components of the CDBIS payments is below $100,000, an offset is available on the difference between that total and the individual’s defined benefit income cap (which may not be the full $100,000 for all pensioners).

Daughter’s rental of residential property connected with SMSF didn’t breach sole purpose test but that’s not the end of the story

Last month’s Full Federal Court decision in the Aussiegolfa case [Aussiegolfa Pty Ltd (Trustee) v Commissioner of Taxation [2018] FCAFC 122] may have resulted in a significant setback to the ATO in its thinking on the sole purpose test but it doesn’t mean SMSFs are free to lease residential property to related parties without restriction.

In the Aussiegolfa case, an SMSF owned units in a unit trust and that trust leased residential property to the daughter of one of the SMSF members.  In the original decision, the Federal Court found the lease arrangement with the daughter caused a breach of the sole purpose test but this decision was overturned on appeal.

In short, the Full Federal Court confirmed several factors needed to be considered in order to determine whether the sole purpose test had been breached.  One such factor was whether the SMSF had suffered any detriment or “dissipation” as a result of the lease of the property to the daughter of the SMSF.  In this case, the daughter paid rent on arm’s length commercial terms/market rates and consequently the SMSF did not suffer any detriment as a result of her tenancy – the SMSF continued to receive the same return from its investment as it had from previous (unrelated) tenants.

The Court found that transactions between an SMSF (or a trust in which an SMSF invests) and a related party which are undertaken on arm’s length commercial terms/market rates weigh in favour of the sole purpose test not being breached – but this is simply one factor that needs to be considered.

In addition, remember that compliance with the sole purpose test does not mean that other breaches of the Superannuation Industry (Supervision) Act would not arise.  In the Aussiegolfa case, the SMSF’s investment in the unit trust was found to be an in-house asset.  If the fund had owned the property directly and leased it to a related party, the value of the property would also have been caught as an in-house asset.  Remember SMSFs are restricted from having no more than 5% of their assets invested in in-house assets. 

In our next quarterly webinar, we’ll be exploring the full ramifications of the Aussiegolfa case for both the sole purpose test and investments in unit trust.  Click here for further information and to register.

Data – bringing it back home

Data is the mother of all knowledge and as we all know - knowledge is power.

Humanity is defined by data. It is the currency through which we are revealed both individually and collectively. The data that defines us is our most private thing. Human data provides the collectors and possessors of that information with power that can be used to influence and impact us for many purposes.  

We would all rather give our individual data to those who are simply trying to help us. For example, our doctors who collect data on medical conditions from us to diagnose our illnesses and advise on treatments. However, most of us also recognise that the data collected on our personal health can be used to create information that will be used by the medical and pharmaceutical industries collectively to develop new treatments and cures that will benefit humanity generally.

We also accept that governments collect personal data from us (usually through legislative fiat) to decide where to build new schools and hospitals (which is great) but also to impose taxation upon us to pay for those schools and hospitals (which isn’t always that great!).

Before the fourth industrial revolution was wrought by digital technology, data was often quite difficult to acquire, and information was therefore expensive to create. Usually, only governments had the resources and the influence to acquire enough of it to produce reliable, useful, actionable information.

This has now irrevocably and completely changed.

The power of the digital revolution enables previously unimaginable volumes of data to be collected and turned into actionable information with relative ease by many players – most of them commercial technology organisations.

So, what does all this mean?

It means the data that defines us (our likes, preferences and fears) is now available to almost anyone willing to pay for it – and they do.  It clearly has great commercial value.

This phenomenon has occurred over an extremely short period. Facebook is arguably the most famous (or infamous) collector and possessor of digital data for commercial use and was founded two years after my youngest son (who is currently in year 9) was born. Facebook is not yet out of puberty and look at the power we have chosen to bestow.  As the world’s greatest orator might have said:

 “Never before in human history has so much wealth been created from so many, by so few, so quickly.”

As recent events have shown, the broader community has become more aware of this power but is still wrestling with the challenge of what to do about the free data we all give away.

A similar challenge exists in the business to business world and I will be exploring that in my next blog

Can an attorney under an Enduring Power of Attorney (EPOA) make or renew a binding death benefit nomination (BDBN) for a member?

Historically this question has been difficult to answer.  While there does not appear to be any restriction in the Superannuation Industry (Supervision) Act or Regulations (SIS) which would prevent a person acting under an EPOA from completing and signing a BDBN, until recently there has been no legal authority confirming the situation.

However, in a recent case, the Supreme Court of Queensland has confirmed that an attorney has the power to make, renew or extend a BDBN on behalf of a member [Re Narumon Pty Ltd [2018] QSC 185].

In this particular case, Mr Giles was a member of the John Giles Superannuation Fund.  Mr Giles made five BDBNs between 2010 and 2013.  The latest was dated 5 June 2013 and was in the form of a lapsing nomination which would expire after three years (ie 5 June 2016).

Mr Giles lost capacity in November 2013 and in March 2016 his attorneys, Mr Giles’ spouse and his sister, signed a document to extend the June 2013 nomination for a further three year period.  The June 2013 BDBN provided for 5% of Mr Giles’ benefit to be paid to his sister and the remainder divided equally between his spouse and minor child (47.5% each).  At the same time, Mr Giles’ attorneys also signed a second document – a new BDBN – which slightly altered the allocation of benefits to exclude Mr Giles’ sister. This change was made as protection in case the June 2013 nomination was otherwise considered invalid because Mr Giles’ sister was not a dependant and therefore not eligible to receive a death benefit from the fund.  Mr Giles’ sister was one of the attorneys who signed the new BDBN and hence was not disputing her exclusion.

In relation to the attorney issue, the Court held that:

  • there does not appear to be any restriction in SIS which would prevent an attorney under an EPOA from executing a BDBN on behalf of a member,
  • there was nothing in the deed itself which would prevent an attorney signing a nomination for a member, and
  • therefore, the question of whether an attorney could execute a nomination depended on the relevant Power of Attorney Act.

In terms of the relevant Power of Attorney Act, the Court further held that the making of a BDBN:

  • was a financial matter,
  • was not a matter which must be performed personally (ie it was not a testamentary act), and
  • therefore could be delegated to an attorney.

However, the renewal of the BDBN or the making of the new BDBN would only be valid if the transaction was not a conflict transaction.  This was because one of the attorneys or their relatives benefited from the transaction and the EPOA document did not authorise Mr Giles’ attorneys to enter into a conflict transaction (of any particular type or generally).

Ultimately the Court decided:

  • the extension of the original BDBN was not a conflict transaction because the attorneys did no more than confirm the nomination made by Mr Giles himself.  It was therefore valid, but
  • the new BDBN was a conflict transaction (because there was a change, albeit small, to what Mr Giles had proposed) and, in the absence of Mr Giles’ EPOA document allowing such a conflict, the new BDBN was invalid.

Interestingly the Court also considered the fact that the June 2013 BDBN (legitimately extended in 2016) included a benefit payment to Mr Giles’ sister and concluded that:

  • as expected she was not Mr Giles’ dependant (for SIS purposes) at the time of his death and was therefore ineligible to receive a death benefit directly from his superannuation balance, but
  • this did not make the entire BDBN invalid; it simply meant that the payment to her could not be made.  The payments to Mr Giles’ spouse and minor child were unaffected.

This case provides some welcome certainty on the issue of attorneys making/renewing/changing BDBNs on behalf of members.  However, it also emphasises:

  • the importance of ensuring, where appropriate, EPOA documents specifically deal with the issue of whether attorneys are to be able to make, renew or change a BDBN, and
  • where applicable, the EPOA documents specifically deal with whether or not attorneys are able to enter into conflict transactions.  Given that the attorney will often be a family member who might ordinarily expect to benefit from the superannuation death benefit (eg a spouse), this is particularly important for superannuation matters.

Going forward attorneys seeking to make, renew or change a BDBN on behalf of a member should exercise their powers taking into account:

  • the member’s wishes,
  • the terms of the fund’s trust deed, and
  • the terms of the EPOA document.

Eeeek! My client just got an Excess Transfer Balance Determination!

The majority of SMSFs lodged their Transfer Balance Reports to report the 30 June 2017 value of the members’ pension accounts in the final days of the 2018 financial year.  In what must surely be a record for the ATO, excess transfer balance determinations then began issuing three to four days later.

So, if you’ve received a determination you didn’t expect, what went wrong?

Remember, an excess transfer balance determination is issued when the ATO believes the value of the client’s:

  • retirement phase pensions at 30 June 2017, plus
  • the starting value of any new pensions commenced since that time, less
  • the value of any lump sum commutations since 30 June 2017 (cashed out or rolled over to another fund)

exceeds the $1.6m Transfer Balance Cap.

We’ve identified three common scenarios where this can happen.

 

Pensions in other funds were missed at 30 June 2017

It was common practice in the lead up to 30 June 2017 for members of SMSFs to request that the trustee “roll back” to accumulation phase the amount necessary such that the member’s total pension value in all funds was no more than $1.6m at 30 June 2017.

We’ve seen situations where the individual was also drawing a pension from another superannuation fund at that time, but this external pension was missed in calculating the amount which needed to roll back to accumulation phase in the SMSF.  Accountants in this situation may need to revise the 30 June 2017 member balances for the SMSF and lodge an amended TBAR.

Importantly, remember that if the documentation prepared before 30 June 2017 expressed the roll back along the lines of “whatever is required” to ensure the retirement pension balances in both the SMSF and other funds were exactly $1.6m in total at 30 June 2017, then amending the TBAR (and updating the member’s pension accounts in the member statements) is correcting an existing error.  The amendments are needed to accurately reflect the true position at 30 June 2017.  It is not backdating documents.  In contrast, if the roll back documentation was expressed in terms of fixed amounts being rolled back to accumulation phase and it turns out those amounts were miscalculated, the issue is different entirely.  In that case, the client does, in fact, have an excess and should act promptly to carry out a commutation now.

One of the many benefits of having an SMSF in the 2016/17 year was the ability to prepare documents that allowed for the fact that precise amounts were simply not known at the time.

 

Clients who qualified for the transitional rule and commuted their excess before 31 December 2017

There is a small group of individuals whose total pension value at 30 June 2017 was greater than $1.6m but less than $1.7m.  Provided the excess above $1.6m was withdrawn as a lump sum commutation or rolled back to accumulation phase on/before 31 December 2017 (and there had been no other credits to their transfer balance account in that time), the individual is not liable for excess transfer balance tax.

However, due to a systems error, some individuals who qualified for the transitional rule incorrectly received an excess transfer balance determination.  Clients in this situation need to report the problem to the ATO who will check the eligibility rules were met and then manually revoke the determination.

 

Wind ups of SMSFs & commutations not being reported

The event reporting deadlines for SMSFs are quite different to APRA funds.  Consider the situation of an individual drawing an account based pension from an SMSF.  The value of the pension account was $850,000 at 30 June 2017.  To facilitate the wind up of the SMSF, the bulk of the pension account of $852,000 is commuted to a lump sum on 15 June 2018 and rolled over to an APRA fund.  A new pension is commenced in the APRA fund on 18 June 2018 with an amount of $852,015.

The earliest the SMSF is required to report the lump sum commutation is 28 October 2018.  However, the APRA fund was required to report the new pension commencement by 29 June 2018 (ie within 10 business days of the event).

Without the reporting of the lump sum commutation, the individual will appear to have an excess transfer balance of $102,015 (ie $850,000 + $852,015 - $1.6m) and the ATO will issue an excess transfer balance determination.  This situation can be corrected by the SMSF now lodging a TBAR to report the lump sum commutation.

However, this potentially confusing (and somewhat scary) situation could have been avoided altogether if SMSF accountants remember to report lump sum commutations such as this at the same time as they prepare the rollover benefits statement.

If you’ve received an excess transfer balance determination for a client and need help correcting the situation, feel free to give our tech team a call.

A new year, what happens with pension balances that have grown?

A great many retired SMSF members with large superannuation balances adjusted their pension accounts back to $1.6 million on 30 June 2017.  This was done to reflect new rules at the time that placed a limit, called the Transfer Balance Cap, on pension accounts.

Twelve months on, at least some of these pension accounts have grown above $1.6 million.  It’s a natural consequence of taking as little as possible out of the pension account and investing in assets that produce a lot of income, growth or both.  Particularly for younger retirees, it is entirely possible that the combination of income and growth can be enough to completely replace (and more) the amounts that have been drawn out as pension payments.

So what happens now?  Does another adjustment need to be done to reduce the pension accounts back down to $1.6 million at 30 June 2018?

In short, no.

The Transfer Balance Cap is not a cap on the amount in superannuation or even the amount in a “retirement phase” pension (generally speaking, a pension being paid to someone who has retired).

It is a limit on the amount that can be used to start retirement phase pensions.

The reason it prompted a lot of people who already had pensions to take action at 30 June 2017 was that there was a special once-off check when the new rules came in.  In future, retirement phase pensions will only be checked against the limit when they start.  (There are also some special rules that also ensure the test is carried out when someone inherits a superannuation pension from a spouse.)

So in 2018/19 and onwards it will be entirely possible and in fact common to see pension accounts above $1.6 million.

My client made a $25,000 concessional contribution to his SMSF in June which won’t be allocated to his member account until July.

When will the unallocated amount first count towards his Total Superannuation Balance? 

Your client has undertaken an unallocated contribution or contribution reserving strategy (note, strictly speaking the unallocated amount isn’t a “reserve” for superannuation or tax law purposes although it is commonly called one).

In our view, the unallocated amount will first count towards your client’s Total Superannuation Balance in the year in which the contribution is made, not the year in which the contribution is allocated. 

Why?

An individual’s “Total Superannuation Balance” is the sum of the value of all of an individual’s superannuation interests (with some modifications for individuals with defined benefit pensions and a few other things).  For accumulation and account-based pension interests, the value of the superannuation interest is not simply the closing balance of the member’s account.  Instead, it is the total amount of superannuation which would become payable if the individual had voluntarily caused their interest to cease at that time [ITAA 1997 s.307-230, ITAA 1997 s.307-205(2)].

In our view, if the individual had requested the closure of their account at the end of the financial year, we expect that the SMSF trustee would have immediately allocated to the individual the amount of their unallocated contribution.  It would be highly unlikely that an individual would “walk away”, leaving the unallocated contribution amount behind.

This is why, in our view, your client’s unallocated contribution amount will first count towards their Total Superannuation Balance in the year in which the contribution is made.  This means unallocated contribution or contribution reserving strategies are not a way in which an individual can control their Total Superannuation Balance to remain below a particular threshold (eg $1.6m if the individual was seeking to make non-concessional contributions in the following year).

Note, you don’t need to change the way you report the contribution for the purpose of the SMSF Annual Return to get the Total Superannuation Balance to calculate correctly.  The unallocated contribution is already required to be reported in the SMSF Annual Return in the year in which the contribution is made (and you lodge a “Request to Adjust Concessional Contributions" [NAT 74851] to reallocate the contribution to the following year for contribution cap purposes).

But it does mean you can’t rely solely on the individual’s SMSF member statement for the year the contribution is made to determine their Total Superannuation Balance.  The unallocated contribution amount will also need to be added on.  Whether this amount is gross or net of the 15% contributions tax will depend on the fund’s accounting treatment.  For example:

  • If the contributions tax has been deducted from the unallocated contribution amount, it is the net amount which needs to be added on.
  • If the contributions tax has been deducted from the member’s existing balance, it is the gross amount which needs to be added on.

Super Thresholds for 2018/19 Financial Year

With a new financial year upon us, it is time to make ourselves familiar with the various superannuation related thresholds applying for the 2018/19 financial year.

Our 2018/19 Facts & Figures publication will be available for our Super Insights subscribers shortly, but in the meantime, some of the more commonly used thresholds are detailed below:

Name of Threshold

Total Super Balance at 30 June 2018

Amount for 2018/19 Financial Year

Concessional contributions cap

not applicable

$25,000

Non-concessional contributions cap – standard

less than $1.6m

$100,000

$1.6m or more

$nil

Non-concessional contributions cap – bring forward mode

less than $1.4m

$300,000

(3 year bring forward period)

at least $1.4m but less than $1.5m

$200,000

(2 year bring forward period)

CGT cap

not applicable

$1.48m

Low rate cap

not relevant

$205,000

Transfer balance cap

not relevant

$1.6m

Defined benefit income cap

not relevant

$100,000

 

Of course, don’t forget not everyone is eligible to make contributions, use bring forward mode or draw benefits from superannuation  If you think you’d benefit from a refresher on the fundamental rules around superannuation, take a look at our SMSF Fundamentals on-line course https://www.heffron.com.au/heffron/training/smsf-fundamentals

How many actuarial certificates will I need in 2017/18?

From 1 July 2017 there are three major changes affecting funds paying retirement phase pensions and claiming a tax exemption on some or all of their investment income (exempt current pension income or ECPI).  Will some of these create the need for a fund to have more than one actuarial certificate in a year?

The three major changes are:

  • The tax exemption is no longer available for non retirement phase pensions (ie transition to retirement pensions where the member has not met a full condition of release);
  • Some funds are no longer allowed to claim their exemption using the “segregated” method; and
  • Some funds must claim their ECPI using the segregated method for part or all of the year.

We have previously explained which funds cannot be segregated in our blog Segregating in SMSFs beyond 1 July 2017In a nutshell, if a fund cannot be segregated it will always need an actuarial certificate to claim any ECPI.  Just one certificate will be required and it will cover the entire financial year, even if the fund had periods during the year when it was entirely providing retirement phase pensions.

This includes some weird and wonderful cases where actuarial certificates have never been obtained before – see our blog New and interesting scenarios where an actuarial certificate is required for ECPI.

But what about funds that can be segregated?  What has changed for them?

The challenge for these funds is that if there is any period during the year when they are entirely in pension phase (providing retirement phase pensions only) they must claim their ECPI for that period using the segregated method.  This is the case even where there are other periods during the year when they are not entirely providing retirement phase pensions.

Consider the following fund:

  • 1 July 2017 – a mixture of pension and accumulation accounts
  • 1 November 2017 – moves entirely to retirement phase pensions
  • 1 March 2018 - receives a contribution which remains in accumulation phase

Assuming this fund is allowed to be classified as segregated, it will claim its ECPI as follows:

  • 1 July 2017 – 31 October 2017 : actuarial certificate method
  • 1 November 2017 – 28 February 2018 : segregated method
  • 1 March 2018 – 30 June 2018 : actuarial certificate method

In other words, all investment income between 1 November 2017 and 28 February 2018 will be ECPI automatically (no actuarial certificate required).

The fund will need an actuarial certificate to claim any ECPI in either of the other two periods.  (Although of course, if no income is actually received during either of those periods there is nothing to prevent the accountant choosing not to obtain an actuarial certificate and therefore claim no exemption for that time).

But how many certificates? One covering the entire year or two (one for each period)?

While there has been some confusion created about this recently, the law is quite clear – it is one certificate for the entire year and it should provide only one percentage.  This is applied to all income other than income that was earned on segregated assets.  This means it will effectively be applied to all investment income received before 1 November 2017 or after 28 February 2018.

Interestingly the same percentage will be applied to all relevant income (ie excluding the segregated period).  This is despite the fact that the relative values of pension accounts might be very different in the first and second “mixed” periods.  What if, for example:

  • Only 40% of the fund was in pension phase for the first period; and
  • 80% of the fund was in pension phase for the second?

A single percentage (let’s say 60%) would be applied to all the relevant earnings (any investment income before 1 November or after 28 February).

In fact, even if there had been no pensions at all during the first 4 months of the year, the actuarial percentage would be applied to earnings during that part of the year as well (and of course the percentage applied to the last four months of the year would be much lower than might be expected because it would have been dragged down by the fact that no pensions were provided at all in the first phase of the year).

(Technically if there are no pensions at all during the first part of the year the trustees could obtain a different type of actuarial certificate stating that the assets were segregated non pension accounts at that time.  This is very unusual and we have ignored that possibility here.)

Importantly, no matter how many periods there are during the year, the actuary will only ever provide one certificate containing one percentage which is applied to all income received at a time when the fund is not segregated.

 This is going to lead to some really weird results.

New and interesting scenarios where an actuarial certificate is required for ECPI

From 1 July 2017 some funds providing retirement phase pensions are no longer allowed to be classified as segregated when it comes to claiming a tax exemption on some or all of their investment income (exempt current pension income or ECPI).  We have explained who, how and why in our blog Segregating in SMSFs beyond 1 July 2017.

This does create some new scenarios where these funds will now need actuarial certificates to claim their ECPI.

This article provides some examples.  Note that it only relates to funds that cannot be classified as segregated.  The position for funds that can be classified as segregated is quite different – the exact opposite in fact.

Example 1 - Funds that are exclusively providing retirement phase pensions all year

These funds would normally have claimed all investment income as ECPI without an actuarial certificate.  Whether the trustee realised it or not, they were only exempt from the actuarial certificate requirement because their ECPI was being claimed using the segregated method.

These funds will now need an actuarial certificate.  And funnily enough it will give a percentage of 100%.

Tip : since it is only funds that have members with both retirement phase pensions and a total superannuation balance of more than $1.6m at the previous 30 June which cannot segregate, it may be difficult to imagine how Example 1 would actually occur in practice.  Surely anyone with more than $1.6m cannot be entirely in retirement phase pensions? However, remember that this may be applicable for many funds from 1 July 2018 (their pension balances were below $1.6m at 30 June 2017 but higher at 30 June 2018).  Also remember that total superannuation balance includes benefits in other funds – a member with a $1.5m retirement phase pension in their SMSF at 30 June 2017 but $0.3m in another fund at that date would rule their SMSF out of being allowed to segregate as early as 2017/18.

Example 2 - Funds that are entirely providing retirement phase pensions for most of the year

If little or no income is received when the fund has accumulation balances, accountants for these funds often chose not to obtain an actuarial certificate for the “unsegregated” period. 

For example, a fund that had a mixture of pension and accumulation accounts on 1 July but cashed out the accumulation account entirely on 5 July and was 100% providing retirement phase pensions for the rest of the year.  If the only investment income received in the first five days of the financial year was $100 bank interest, accountants would often simply pay tax on that interest and claim income beyond 5 July as ECPI.  If they were not claiming any exemption on income earned while the fund was “pooled” (unsegregated) there was no need to obtain an actuarial certificate.

In the new world, if this fund is not allowed to segregate it will be required to obtain an actuarial certificate for the whole year to claim any ECPI.  Depending on the amount of time the fund had a mixture of accumulation and pension accounts and the relative sizes of the two types of accounts, the actuarial percentage may be 100% or it may be less.  Importantly, it does not matter how much income was received in that “mixed” period.  A fund that received no income during that period may still find their actuarial percentage is only (say) 95% and this 95% must be applied to all income received throughout the year.

Example 3 – Funds that move from 100% accumulation phase to 100% pension phase during the year

In the past, many funds would just treat all investment income received after the pension(s) started as exempt from tax and pay tax on income received before that date.  No actuarial certificate would have been required.

In the future, for funds that cannot be classified as segregated, an actuarial certificate will be obtained for the whole year and be applied to all income received during the year.  If a major asset such as a property was sold after the pensions started in (say) December the capital gain would not be entirely tax exempt.  It would be subject to the actuarial percentage that would relate to the whole year (including five months where there were no pensions at all).

Tip : again it may be difficult to see how this would actually happen since it is likely that a fund in this  position would have no members with retirement phase pensions in their SMSF at the previous 30 June. Remember, however, that if any member had a retirement phase pension in another fund at the previous 30 June and also had a total superannuation balance of more than $1.6m at that time, the SMSF will be ineligible for the segregated method for ECPI.

 

These are just three examples where the new world will be profoundly different to the old.  Time to re-set some longstanding paradigms for all of us.

My client’s SMSF has a reserve account and the trustee made an allocation from it on 1 July 2017 to a pension account.

Given such action is now contrary to the ATO’s new position expressed in SMSF Regulator’s Bulletin 2018/1, is the ATO likely to take action in relation to the fund?

As you have mentioned, the ATO’s new position is that reserve allocations may not be made to pension accounts (this includes both retirement phase pension accounts and transition to retirement pensions).  Where allocations are made from a reserve, they must be made to accumulation accounts only.

However, many trustees made reserve allocations in the 2017/18 financial year before the release of SMSFRB 2018/1 in March 2018.  If these reserve allocations were made to pension accounts, is the ATO likely to take action?

In a welcome move, the ATO has now confirmed that they will not devote compliance resources to funds where:

  • the establishment of the reserve was permitted by SIS and the fund’s governing rules,
  • the facts do not indicate that the reserve was used by the trustee as a means of circumventing the Government’s 1 July 2017 reforms (eg the establishment of the reserve was a consequence of the cessation of a defined benefit pension arrangement),
  • there was an established practice to make reserve allocations on a fair and reasonable basis to all member accounts (including pension accounts) prior to 30 June 2017, and
  • no further reserve allocations have been made to pension accounts since the release of SMSFRB 2018/1 on 15 March 2018.

For further explanation of the ATO’s new views on reserves, refer to Issue #4 of Super Insights.

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Adding Back LRBA balance to Total Super Balance

In the lead up to 30 June 2017 you may recall the Government announcing that they intended to amend the Total Superannuation Balance provisions in situations where an individual was a member of an SMSF with a limited recourse borrowing arrangement (LRBA) in place.  Specifically the Government had intended for a share of the fund’s outstanding loan balance to be apportioned to each affected member and counted towards their Total Superannuation Balance.

This “adding back” of the loan balance may have restricted the ability of affected individuals to:

  • make further non-concessional contributions to superannuation without exceeding their cap,
  • trigger a “bring forward” for non-concessional contributions,  
  • utilise the “catch up” of unused concessional contribution rules, or
  • segregate the fund’s assets for tax purposes.

Due to backlash at the time, the proposals were referred for further consultation.

A Bill has now been introduced into Parliament to give effect to the Government’s proposals [Treasury Laws Amendment (2018 Superannuation Measures No. 1) Bill 2018].  In a pleasing move, the “adding back” of a proportion of the outstanding loan balance will only apply where the LRBA was entered into on or after 1 July 2018 and:

  • the individual, whose superannuation interests are supported by the asset held under the LRBA, has met a condition of release with a nil cashing restriction (ie reached age 65, retired, is permanently incapacitated or is terminally ill or injured), or
  • the lender is a related party of the fund members.      

Younger individuals who enter into an LRBA where the lender is a commercial lender (or indeed an unrelated party) may not be affected by these measures (unless they were say terminally ill).

The proportion added back is intended to be based on the individual’s share of the total superannuation interests that are “supported” by the asset held under the LRBA, as calculated by the following formula:

Outstanding loan balance x (value of that member’s supported superannuation interests/value of all supported superannuation interests)

 

In cases where only one member’s interests in the fund are supported by an asset held under an LRBA, the entire outstanding loan balance at a particular 30 June would be added to the member’s Total Superannuation Balance at that 30 June.

Among other things, this new measure would ensure that any SMSF member that had met a relevant condition of release could not:

  • withdraw funds in order to reduce their Total Superannuation Balance below $1.6m, then
  • lend money to their SMSF to acquire an asset under an LRBA, and subsequently
  • make additional non-concessional contributions tax effectively (ie their non-concessional contributions cap would be $nil).

And note, the legislation would capture any new LRBA for individuals in this position, not simply those where a related party lends money to the fund.

Consider the following examples.

Example 1

Josh (52) is the sole member of his SMSF which holds $1m in accumulation phase.  His SMSF enters into an LRBA in July 2018 to acquire a property worth $1.2m.  The SMSF pays $600,000 of the acquisition costs from its assets and borrows to pay the remaining $600,000.

At 30 June 2019, the value of the SMSF’s “other” assets remained the same, the property had increased to $1,210,000, and the amount of the outstanding loan was $599,000.

 

At acquisition time

30 June 2019

Assets

 

 

“Other” Assets

$400,000

$400,000

Property

$1,200,000

$1,210,000

 

$1,600,000

$1,610,000

Liabilities

 

 

LRBA loan

($600,000)

($599,000)

Net assets

$1,000,000

$1,011,000

Josh’s account balance

$1,000,000

$1,011,000

 

If Josh’s SMSF had borrowed from an unrelated party his Total Superannuation Balance at 30 June 2019 would be $1,011,000 and:

  • His non-concessional contributions cap for 2019/20 (ie the following year) would be $100,000, and
  • He would have the ability to trigger a “bring forward” in 2019/20 with a $300,000 bring forward amount.

In contrast, if Josh’s SMSF had borrowed from a related party his Total Superannuation Balance at 30 June 2019 would be $1,610,000 (ie $1,011,000 + the outstanding loan balance of $599,000) and:

  • His non-concessional contributions cap for 2019/20 (ie the following year) would be $Nil, and
  • He would not be able to trigger a “bring forward” in 2019/20.

In Josh’s case, the identity of the lender may play a critical role in the event that his SMSF needs additional contributions in order to meet its obligations under the LRBA loan agreement 

Example 2

Laura (age 66) is working full-time and is the sole member of her SMSF, which holds $2m in accumulation phase.

She withdraws a lump sum of $500,000 on 1 June 2019 which reduces her total accumulation account balance to $1.5m on 30 June 2019.

On 30 June 2019, Laura lends $500,000 to her SMSF under an LRBA and the SMSF acquires a property for $1.5m (using $1m of its remaining $1.5m funds and the $500,000 borrowed funds) and the position of her SMSF is as follows.

 

30 June 2019

Assets

 

“Other” Assets

$500,000

Property

$1,500,000

 

$2,000,000

Liabilities

 

LRBA loan

($500,000)

Net assets

$1,500,000

Laura’s account balance

$1,500,000

 

Under current law, Laura’s Total Superannuation Balance at 30 June 2019 would be $1.5m and, as this is less than $1.6m, her non-concessional contributions cap in 2019/20 would be $100,000.  In the future, as the SMSF repays the LRBA loan, the net value of the SMSF will increase and Laura’s Total Superannuation Balance will again approach $1.6m.  However, prior to reaching $1.6m, she could withdraw another lump sum and enter into another LRBA to acquire another asset. The withdrawal would again reduce her Total Superannuation Balance enabling additional non-concessional contributions.

Under the proposed law, regardless of the identity of the lender, Laura’s Total Superannuation Balance at 30 June 2019 would be $2m (ie $1.5m + the outstanding loan balance of $500,000).  As a result her non-concessional contributions cap would be $Nil in 2019/20.  Withdrawing funds and entering into a new LRBA would no longer increase Laura’s capacity to make non-concessional contributions.

Pension planning for 30 June 2018

Winter has arrived and that means it is time to get all our pre-30 June planning finalised.

One area which is always worth addressing early is pensions – have we done everything we need to do and is there anything extra we should be thinking about for 2017/18?

In this article, we provide a few tips.

Pay the minimum

Most obviously, pay the minimum amount required before 30 June 2018.  Remember that “paid” means:

  • For cheques – the cheque is dated on or before 30 June 2018, is held by the trustee on or before 30 June 2018, is banked promptly and the balance in the SMSF’s cheque account at the time the cheque was written was sufficient to cover the payment.  While the cheque can be presented to the bank after 30 June 2018, it is important that it occurs quickly and is honoured; and
  • For electronic transfers – almost always means that the money actually appears in the individual’s bank account on or before 30 June 2018.  Given that 30 June 2018 is a Saturday,  it’s not enough to process an on line transfer at 11pm on 30 June 2018 and hope for the best - you’ll need to get in earlier than that!

2017/18 is the first year where only “superannuation income stream benefits” (pension payments) count towards the minimum.  Unlike previous years, partial commutations no longer count.  This also means that all payments counting towards the minimum must be paid in cash rather than by transferring assets (often referred to as in specie payments) since only lump sums such as commutations can be paid in specie.

But don’t pay too much as a pension payment

In the new world of limited pensions (thanks to the $1.6m Transfer Balance Cap) getting money into retirement phase pensions has never been harder.  That makes it more important than ever to ensure that those with these pensions who take more than the minimum pension consider other options as well:

  • Should the “extra” amount be drawn from the member’s accumulation account in preference to simply taking a higher pension?  The higher the pension account relative to any accumulation accounts, the more of the Fund’s investment income that will be tax exempt;
  • Was the extra amount actually a partial commutation of the pension?  (Remember this is not a decision that can be made now, it had to be made in advance of the commutation.)  If this step has not been taken for 2017/18, it is something to consider for 2018/19.  A commutation allows a member to remove the amount of the commutation from his or her Transfer Balance Account.  This might be useful in the future if the member’s spouse dies and the member inherits more pension accounts, or the member makes downsizer contributions and wants to convert them to a retirement phase pension.

Don’t forget transition to retirement income streams

Now that transition to retirement income streams no longer give the paying superannuation fund a tax exemption on its income (because they are not classified as retirement phase pensions) it’s easy to forget that they are still pensions.  It is still important to meet the minimum pension requirements for these income streams.  Admittedly one of the big downsides of failing to do so (loss of the tax exemption) is no longer in place.  But not paying the minimum pension is still:

  • A breach of superannuation law;
  • A trigger to recalculate the tax free / taxable components of the pension balance; and
  • Exposes the member to the risk that any payments which have been taken will be treated as lump sums for tax purposes which, unless the member has unpreserved money, will be early release payments and taxed at the member’s marginal tax rate (with no recognition of any tax free component, no use of the low rate threshold etc)

And remember, the ability to elect for a payment to be taxed as a lump sum instead of a pension payment (which was great for many under 60 as it reduced their personal tax bill) is no more .  The taxable part of any TRIS payment will be at the member’s marginal tax rate (less a 15% offset).

Watch out for retirement and age 65

In all the effort to prepare for 30 June 2017 and then lodge the 2016/17 annual returns (with all the complexity around CGT relief) it’s easy to miss the fact that some members will have reached 65 or retired during 2017/18.  That means their transition to retirement pensions have become retirement phase pensions which has some important consequences:

  • The $1.6m Transfer Balance Cap applies from the moment they turned 65 (regardless of their work status at the time) or from the moment they told the trustee they had retired;
  • If they need to “roll back” part of their transition to retirement phase pension to comply with this and it wasn’t done at the time, do so now for two reasons.  Firstly it will minimise the penalties to the member for exceeding their cap.  Secondly it will ensure the 2018/19 minimum pension is not based on the higher balance.

There will be more to do in 2018/19 – we’ll provide an update on that in July!

Market linked pension update

One of the more crazy elements of the 1 July 2017 superannuation changes was the treatment of market linked pensions.

Recent press articles have highlighted that there is a problem without necessarily explaining what it is.  The key lies in understanding how amounts are added to or subtracted from the Transfer Balance Account for these pensions.

Instead of just valuing these at an amount equal to the account balance for Transfer Balance Account purposes, the legislation provides a formula.  The formula is more or less:

  • Work out the “next” payment due from that pension
  • Annualise it (eg if it’s $3,000 per fortnight, multiply $3,000 by 365/14)
  • Multiply that annualised amount by the number of years the pension has left to run (because remember market linked pensions last for a specific number of years, the annual payments are worked out so that the final year’s payment is 100% of the remaining balance).

This doesn’t make sense on a number of levels:

  • There’s an account balance which is the absolute maximum the member can ever get out of this pension – what is the logic for using anything else?
  • There’s no such thing as a fixed “next payment” from these pensions.  They are more flexible than (say) defined benefit pensions where the payments are often fixed and defined as (say) $3,000 per fortnight or $6,000 per month etc.  So how should one determine that next payment?  Presumably it’s “whatever actually gets paid”.  But then, how do we work out the period to which that relates? If there’s no requirement to take payments at a fixed frequency such as fortnightly or monthly, how do we annualise the “next” payment.

(And it’s almost as if Treasury realised this at the last minute because market linked pensions are valued using their account balance for Total Superannuation Balance purposes. What a shame no-one told the people writing the Transfer Balance Cap provisions.)

But an even worse problem is now receiving significant press coverage (at last).

Not surprisingly these pensions change sometimes – if a member transfers from one fund to another, their market linked pension is technically fully commuted (stopped) and then re-started in the new fund.

There are a range of problematic issues with re-starting the pension but this article just focusses on the first step – stopping the old pension.

It would be reasonable to assume that the formula used to add this pension to the Transfer Balance Account in the first place would also work to reduce this when the pension is fully commuted (although a new amount would be added when the pension started again in the new fund).

However, the wording in the law is sufficiently vague that two camps have emerged:

  • View 1 (of which I’m a member) says : the formula involves calculating the value of the pension “just before” a commutation amount is paid.  If you’re calculating something “just before” a key date, you should do the calculation as if that event (in this case the commutation) wasn’t happening.  This would mean the calculation would be based on whatever the “next payment” would have been if the pension hadn’t been commuted (with all the problems that entails, there would at least be an amount to calculate!);
  • View 2 says : while the formula does involve calculating the  value of the pension “just before” a commutation amount is paid, the formula used to do this depends on a “next payment”.  If this pension is fully commuted, there will never be a next payment.  In other words, it will be $nil and so will the commutation value for the purposes of this Transfer Balance Account.  That is, the commutation of the pension would not result in any reduction in the amount counted towards the Transfer Balance Cap.  That’s clearly crazy since the new pension that starts in its place will add more to the Transfer Balance Account.  This view would see the same money being counted twice for anyone who changes their market linked pension on or after 1 July 2017..

The example provided in the Explanatory Memorandum to the legislation ignores a number of practical problems but is at least consistent with View 1.  (And probably all parties would agree that that this is surely what the lawmakers intended to achieve.)

However, even the EM is ultimately subject to the law and there is enough ambiguity for plenty of people who have carefully considered this law to land at View 2.

It would seem that the ATO’s position is that we need a legislative change to resolve this issue which puts the job firmly in the lap of Treasury.  Many industry participants have already identified this and explained the problem to Treasury and the recent publicity will hopefully expedite their consideration of it.

For now, the safest approach for those close to or over the $1.6m Transfer Balance Cap would be to leave market linked pensions untouched. Those who have already made the change might receive an assessment from the ATO under View 2 although hopefully they will hold off doing so until the issue is resolved.  Clearly the current position cannot continue.

Stay tuned.

My client’s wife died in August 2017. On her death, her acc based pension automatically reverted to him. When do I need to complete a TBAR to report the reversion of the pension and what do I show?

The TBAR system revolves around the reporting of “events”, hence the name “events-based reporting”. 

The reversion of the pension will not count towards your client’s Transfer Balance Cap until the first anniversary of his wife’s death (ie August 2018).  However, the “event” which triggers reporting is not the counting of the pension towards the cap but rather the reversion of the pension in August 2017.

The due date for lodgement of the TBAR will depend on whether the fund is an annual or quarterly reporter for TBAR purposes.

If the fund is an annual reporter, the TBAR will not be due until lodgement of the fund’s SMSF Annual Return for the 2017/2018 financial year (ie May 2019).

However, if the fund is a quarterly reporter, the TBAR will be due on 28 October 2018.  This is the due date for quarterly reporters for any event in the 2017/18 financial year.

Whether a fund is an annual or quarterly reporter depends on the Total Superannuation Balances of the fund members as at 30 June 2017 (if a retirement phase pension was in place at that date) or as at 30 June of the year immediately prior to the first retirement phase pension commencing.  If a member of the fund had a Total Superannuation Balance of $1m or more at the relevant date, the fund is a quarterly reporter.  All other funds are annual reporters.

When completing the TBAR, you will need to report the date of death value of the pension and an “effective date” equal to the date of death of the original member.  For quarterly reporters, this will almost certainly mean processing the fund’s accounts to August 2017 in time to meet the 28 October 2018 deadline even if it is not (at that time) possible to complete the full 2017/18 year end.

My client’s husband died in March 2018.  On his death, his account based pension automatically reverted to her.  When will the value of this pension count towards her Total Superannuation Balance?

Your client became the “owner” of the pension on the day of her husband’s passing.  This means the value of the pension counts towards her Total Superannuation Balance immediately in March 2018 (although remember that Total Superannuation Balance isn’t actually used for anything other than as at the end of a financial year).

In contrast, the value of the pension (calculated at March 2018) won’t count towards her Transfer Balance Cap until the first anniversary of his death (March 2019).

For example, Sean died on 3 March 2018 and his pension automatically reverted to his wife Katie (age 63).  The value of Sean’s pension was $1m on the day of his passing and is expected to be worth $1.03m on 30 June 2018.

Katie is also drawing her own account based pension which was worth $0.45m on 30 June 2017 and is expected to be worth $0.5m on 30 June 2018.  She has no other superannuation interests and is contemplating making a non-concessional contribution in either June or July 2018.

Katie’s Total Superannuation Balance at 30 June 2017 is $0.45m (that is, the value of her pension account at that date - Sean was still alive so she does not include his pension at that time).  This means her non-concessional contributions cap is $300,000 in the 2017/18 financial year (assuming of course that she had not triggered bring-forward mode in the previous two years).

However, Katie’s Total Superannuation Balance is estimated at $1.53m on 30 June 2018 (that is, the value of both her original pension account and the pension which reverted to her).  This means her non-concessional contributions cap is expected to be only $100,000 in the 2018/2019 financial year.

Inheriting Sean’s pension means that Katie’s non-concessional contributions cap is far lower in the 2018/19 financial year and beyond even though Sean’s pension will not count towards her Transfer Balance Cap until 3 March 2019.

Increasing Maximum SMSF Members from Four to Six

As part of last week’s Federal Budget, the Government confirmed that they intend to legislate to increase the maximum number of members that can belong to a single SMSF from four to six, with this change to apply from 1 July 2019. 

In this article, Lyn touches on some of the things to consider in relation to this proposal.

There are potentially a number of perils in adding additional members (eg adult children) to an SMSF.  For example, parents risk being “out-voted” by their children in the running of the fund without adequate controls.

But conversely there can be a number of benefits depending on the situation.  For example, building up balances for the adult children can help in addressing liquidity issues on the death of the parents or as a way of mitigating some of the impact of the ALP’s plans to scrap cash refunds for franked dividends –Meg covers this issue in detail here https://www.heffron.com.au/blog/article/could-children-in-the-fund-help-beat-the-alp-proposal-to-remove-franking-credit-refunds).

However, it is important to note that the Trustee Acts of some states/territories (eg NSW, QLD, VIC, WA and ACT) only allow a maximum of four individual trustees.  SMSFs looking to take advantage of the increased membership would generally need to have a corporate trustee unless those state Acts were changed.

In addition, some trust deeds would also need amendment as they limit member numbers to no more than four.  The Heffron trust deed does not include such a limitation.

We’ll be covering the pros and cons of including adult children in their parents’ SMSF in our upcoming Heffron Super Intensive Day. 

But in the meantime, we are keen to hear your thoughts – do you have clients likely to want to take advantage of this proposal?  If so, what is their driver?  Pop us an email at technical@heffron.com.au

Transfer Balance Account Reporting – Final Position

Following on from Meg’s blog article earlier this month, the ATO has now responded to calls from the SMSF industry to simplify reporting and reduce unnecessary work when it comes to TBARs and whether or not accumulation balances also need to be reported.

In this article, Lyn clarifies the new ATO position.

Thankfully common-sense has prevailed and 30 June 2017 accumulation balances only need to be reported in a TBAR in limited situations. 

A copy of the ATO’s new instructions for completing TBARs can be found here https://www.ato.gov.au/Forms/Super-Transfer-Balance-Account-Report-Instructions/.  Some of the relevant information in relation to reporting accumulation values is not very user-friendly so we’ve taken the opportunity to clarify the rules below.

 

Scenario 1 - Member has only accumulation/TRIS balances in the SMSF at 30 June 2017

Generally speaking, a TBAR is not required at all for members who have accumulation/TRIS balances only.  However, trustees may choose to use the TBAR to report an accumulation/TRIS value in limited situations where not doing so might disadvantage the member.

Where a member has an accumulation account/TRIS, the amount to be included in the member’s Total Superannuation Balance is the “total amount of superannuation which would become payable if the individual voluntarily closed their account on that day”.  In theory this figure should take into account the costs to dispose of fund assets, tax on disposal, administration/wind up costs etc.

However, these costs are rarely included in either the fund’s financial statements or the figure reported as the member’s “closing account balance” on the 2017 SMSF Annual Return.  This may mean that the value reported on the Annual Return over-states the member’s Total Superannuation Balance.  Where this over-statement would materially impact the member (eg they would otherwise be over $1.6m and therefore have a non-concessional contributions cap of $nil AND are wanting to make non-concessional contributions in the 2017/18 financial year), a revised value should be reported via the TBAR.

We should note that the TBAR instructions do not specifically mention that the same rules apply for a TRIS but since they are treated in the same way for TBAR purposes (ie neither are retirement phase pensions), it would be reasonable assume that the same concepts would apply for these income streams.

 

Scenario 2 - Member has only retirement phase pension interests in the SMSF at 30 June 2017 and all of these pensions are account based pensions

in this situation, there is no accumulation balance to report on the TBAR and a $nil accumulation value is not required.

The TBAR will simply report the 30 June 2017 value of the pensions.

Since no accumulation value has been reported on the TBAR, the ATO will calculate the accumulation value for Total Superannuation Balance purposes as:

  • the member’s Closing Account Balance (shown in Section F on the 2017 SMSF Annual Return) less
  • the value of the retirement phase pensions reported via the TBAR.

In this case $nil.

 

Scenario 3 - Member has only retirement phase pension interests in the SMSF at 30 June 2017 but at least one of these pensions is a market linked, lifetime, life expectancy or flexi pension

In this situation, a $nil accumulation value needs to be reported on the TBAR in addition to the usual pension values.

 

Scenario 4 – Member has both accumulation/TRIS and retirement phase pension interests in the SMSF at 30 June 2017 and all of these retirement phase pensions are account based pensions

As per scenario 1 above, the accumulation/TRIS value only needs to be reported in the TBAR if the trustee is wanting to report a value lower than the value shown in the Annual Return.

The 30 June 2017 value of the pensions will need to be reported in a TBAR as usual.

Because no accumulation value has been reported on the TBAR, the ATO will calculate the member’s accumulation value for Total Superannuation Balance purposes using the same method as above (ie the difference between their Closing Account Balance from the 2017 SMSF Annual Return and the value of the retirement phase pensions reported via the TBAR).

 

Scenario 5 - Member has both accumulation and retirement phase pension interests in the SMSF at 30 June 2017 and at least one of these retirement phase pensions is a market linked, lifetime, life expectancy or flexi pension

In this situation, the member’s 30 June 2017 accumulation value must be reported in a TBAR in addition to the usual pension values.

If you need to report an accumulation/TRIS value, you do so by:

  • completing sections A to D as usual
  • at question 11, selecting “Total super balance”
  • at question 15, selecting “Accumulation phase value”
  • at question 17, effective date = 30 June 2017
  • at question 18, the accumulation/TRIS value (if needing to report $nil, enter “0.00”)
  • leave question 20 blank
  • complete the remainder of the form as usual

The reporting of 30 June 2017 accumulation/TRIS values (if required) is due by 8 September 2018.  The date for reporting 30 June 2017 pension values remains 2 July 2018.

If you have already lodged a TBAR reporting pension values but not accumulation/TRIS values and now need to report an accumulation/TRIS value, you do not need to cancel the original report and lodge a new one.  Simply complete a new TBAR reporting the accumulation/TRIS value.

For further explanation of the new TBAR requirements in respect of accumulation values, register for our webinar on 24 May 2018.

Click here for further information on our webinars.

Transfer Balance Account Report update

We learned something new – and weird – about the new Transfer Balance Account Reports (TBARs) last week.

In a nutshell, the TBAR prepared to report pre-existing pensions at 1 July 2017 will also need to include accumulation balances in almost all cases.

If these accumulation balances are not reported, there is a risk the ATO will unintentionally double count any retirement phase pension reported on the TBAR when it comes to calculating the individual’s Total Superannuation Balance (TSB).  This is not consistent with the current instructions for the TBAR and the ATO is in the process of updating these.

The issue has now been reported in a couple of online publications but this article puts a little more flesh on the bones.

Huh?

The ATO needs to understand each and every person’s Total Superannuation Balance for a range of reasons including:

  • To see whether they can make non-concessional contributions in 2017/18 (and if so, whether they can bring forward one or more future years’ $100,000 limit);
  • To assess whether a particular fund is allowed to operate on a segregated basis for tax purposes; and
  • In future, to check whether an individual is eligible for the “catch up” concessional contributions that start from 1 July 2018.

It’s an important number.

In future, it will be a figure that the ATO can work out from the SMSF Annual Return for members with a balance in an SMSF.

At 30 June 2017, however, it’s tricky.

In theory, the ATO could just take the Closing Account Balance shown for each member on their SMSF’s 2016/17 Annual Return (Section F).  (They would then add any other balances reported for other funds.)

But the annual return does not provide a breakdown between pensions and accumulation accounts.  Plus for some pensions, the figure needed for the Total Superannuation Balance is not just the amount shown on the annual return – there is a special calculation carried out to value the pension for both TBAR purposes and the Total Superannuation Balance.

So the ATO has decided to do the following to determine a member’s Total Superannuation Balance as at 30 June 2017:

  • If no TBAR is lodged, they will use the figures shown on the annual return (effectively assuming that the entire balance for each member is in accumulation phase) – this makes sense;
  • If a TBAR is lodged, they will use the TBAR figures instead of the annual return figure as long as:
    • There were no contributions into the fund during the year for that member; or
    • An accumulation balance is explicitly reported in the TBAR (including a $nil value) (the relevant spot is Question 15)
  • Otherwise they will use the sum of both the TBAR and annual return figures.  This is the problematic part!

The examples below show how an SMSF member could easily end up with the wrong amount being recorded as their Total Superannuation Balance if the fund’s reporting is not as the ATO expects.

Example 1

Jane and John have been in pension phase (account based pensions) for many years and no contributions were made to their fund in 2016/17.  They each had $2m in their SMSF at 30 June 2017 (in retirement phase pensions) and so each rolled back $400,000 to accumulation phase on 30 June 2017 to fall within the new $1.6m Transfer Balance Cap.

Their SMSF’s TBAR for each of them should show:

  • Retirement phase pension values of $1.6m; and
  • Accumulation accounts of $400,000

If no accumulation balance is reported on the TBAR, the ATO will underestimate Jane and John’s Total Superannuation Balance as the ATO will only count the amount shown on their TBAR ($1.6m each).

 

Example 2

Mike and Marcia are in precisely the same position as Jane and John at 30 June 2017.  However, they each made contributions to their fund during 2016/17.

Like Jane and John, their SMSF’s TBAR should show both their retirement phase pension values and their accumulation accounts.

However unlike Jane and John, if they do not do so, the outcome will be different for them.  Instead of underestimating their Total Superannuation Balance, the ATO will actually overestimate it.  This is because it will be calculated as:

  • The $1.6m retirement phase pension value reported on the TBAR; plus
  • Their $2m member balance shown on the annual return

That is, a total of $3.6m for each of them.

 

Does it matter?

In fact in these two examples, none of the key superannuation tests will be affected if their Total Superannuation Balances are misreported:

  • None of the members are able to make further non-concessional contributions and this will be correctly determined by the ATO even if their Total Superannuation Balances are under or over reported in line with the examples above;
  • The same applies for their fund’s ability to be treated as segregated for tax purposes
  • Overstating the Total Superannuation Balance has no impact on the amounts assessed against the Transfer Balance Account – these will be based exclusively on the TBAR.

However, it will mean that the amount shown on MyGov for the member will appear very strange to the member and the fund has technically misreported figures to the ATO (although it is unlikely the ATO will take draconian action as a result).

But it could be important.

If Mike (say) had a $1.0m retirement phase pension at 30 June 2017 but did receive contributions during the year, the situation would be entirely different.  Assuming he meets the relevant age or work tests, he is allowed to make non-concessional contributions during 2017/18.

However, if his TBAR does not show a $nil accumulation balance at 1 July 2017, his Total Superannuation Balance will be calculated by the ATO as follows:

  • Values reported via the TBAR ($1m); plus
  • Balance reported on his SMSF’s annual return (also $1m).

That is, a total of $2m.

If he makes non-concessional contributions during 2017/18, the ATO will assume these are in excess of the permitted level ($nil for someone with more than $1.6m in superannuation) and issue the relevant assessments.  Even if the reporting is corrected, there will obviously be a fairly anxious wait for the member and action will need to be taken very quickly.

As a result, we expect that trustees who have already lodged their TBAR without reporting the accumulation balances (including $nil if applicable) at 1 July 2017 may need to re-report.

However we know the ATO is still looking for alternatives that are less onerous so for now, watch this space.  We understand the ATO is unlikely to start using the Total Superannuation Balance information until September / October 2018 so there is some time to decide what to do.

For those using specialist superannuation software, a software update may be required before TBARs will automatically include accumulation balances.

Could children in the fund help beat the ALP proposal to remove franking credit refunds?

As the Bank Inquiry dominated news headlines in recent days the government announced a change that will certainly be very welcome for some families with Self Managed Super Funds (SMFS). Until now the most people allowed in an SMSF fund was four – the government has announced it intends to allow the limit move to six people.  The timing is especially useful since some families are reviewing their SMSF arrangements in the light of the ALP plans to scrap cash refunds for franked dividends.

One way to mitigate the impact of the ALP proposal is to include adult children in the SMSF so that the franking credits generated by the parents’ share portfolio can at least be used to pay the tax generated by the children’s super rather than being wasted.

But there are some problems with this idea

To put some real figures around this issue, let’s assume an SMSF has two members and $1.5m in assets (combined). Both members have retired, stopped making contributions and are receiving pensions from their fund.

The fund earns around 4% in investment income each year (a combination of dividends, rent, interest) in addition to any growth in the value of their assets.  Around 50% of the investment income is franked dividends.  This means that in addition to receiving the cash dividends of $30,000 (4% x 50% x $1.5m), the fund will receive franking credits – these will be around $12,857.  Under current law, the fund would pay no tax and would receive a tax refund of $12,857.

Under the ALP proposal the fund would still pay no tax but would not receive the $12,857 refund.  In other words, if the ALP measure is introduced as planned, the fund (and therefore the members) will be $12,857 poorer every year.

What if the couple included their adult children in the fund?

If the children are working, their employer could contribute to the fund, creating more taxable income (which in turn will use up the franking credits rather than wasting them).  Or the children could make personal contributions for which they claimed a tax deduction.

Let’s say the employer contributions made for the children were as high as possible ($25,000 each).  At the moment, only two children could be included in the SMSF before the four member limit was reached so this would help but would not entirely solve the problem.  Adding the children’s contributions would now mean the fund would use $7,500 of the franking credits (the amount of tax that would normally be due on the contributions).  But the family would still waste the rest of the franking credits ($5,357).

(Note that it would also be possible – and reasonable – to make sure that the benefit of being able to use some of the franking credits passed to the parents rather than being a windfall for the children, given that it would be the parents’ investments that created the opportunity in the first place. This is something that would be worked out by the fund’s accountant)

Is there any way of making sure the fund uses up all of the franking credits?  In fact, it is difficult. Even if the children transferred their own superannuation balances into the fund (and so the fund paid income tax on some of its investment income), this would also mean that the fund would have more investments and probably more franking credits. 

Really what the fund needs is more taxable contributions.  This is why large funds (such as industry funds and retail funds) not affected quite so much by the ALP proposal.  Even though these funds might have many more pensioners than an SMSF, they also have many more members receiving employer contributions.  It is also why the latest announcement about increasing the limit on SMSF members to six will be particularly interesting to those with larger families.  Parents in this position with four children (or two children and their spouses) with the maximum rate of taxable contributions would be able to use all the fund’s franking credits.

Of course, this relies on couples conveniently having family or others who can direct large contributions to the fund and want to do so.

Nonetheless, where feasible, it is likely that including children and possibly even extended family in an SMSF will be a common response if Labor’s proposal is introduced.  As the figures above show, it will certainly help make better use of the franking credits that might otherwise be wasted, particularly in a pension fund.

But there are downsides to including the couple’s children in their fund.

Firstly, new members are generally also required to be trustees of the fund.  This means the children become decision makers when it comes to the running of the fund.  There are some protections that can be put in place but at the very least the fund’s trustees must make decisions with the interests of all members (including the children) in mind.  Even now (when funds are limited to four members), if one parent dies there is a risk that the children (combined) have more control over the fund than the surviving parent.  In a six member fund (four children) this problem exists from day one.

If a couple has too many children (more than two at the moment or more than four in the future) , some must miss out.  This may not be a problem (who really wants to belong to their parents’ superannuation fund anyway?).  But it does create the potential for the children who are not in the fund to feel they have been excluded.

Finally, adding the children to the parents’ fund may disrupt the children’s own superannuation planning – at the very least it may delay their ability to set up their own SMSF with their spouse.  It is also an arrangement that will need to be unwound at some point – for example, once the parents die, will the children want to continue combining their superannuation arrangements?  Even this has some solutions – the children could routinely roll out most of their superannuation contributions to their own fund, the contributions just need to be made to (and taxable in) their parents’ fund.  But then life starts to become more complicated.

So while adding children to an SMSF may provide a better tax result by making sure more of the franking credits are used, it won’t necessarily be right for every family.

What is “deemed segregation” when it’s at home?

With some new rules for actuarial certificates coming in from 1 July 2017, the term "deemed segregation" has popped into the SMSF vernacular.  What does it actually mean and why is it important?

Traditionally, describing an SMSF as "segregated" generally meant the trustee had made a decision to allocate specific investments to a particular member account or group of accounts (eg all pension accounts).

The term is legally significant in that it comes directly from the terminology used in Section 295-385 of the Income Tax Assessment Act 1997.  This is the provision that basically says:

  • funds can claim a tax exemption on investment income earned on "segregated current pension assets" (exempt current pension income or ECPI).  Segregated current pension assets are assets supporting retirement phase pension accounts; and
  • providing the only pensions being provided are linked to account balances (eg market linked, account-based etc) the fund can claim this exemption without needing an actuarial certificate.  (Importantly funds providing defined benefit pensions still need an actuarial certificate regardless.)

Deemed segregation is when the ATO describes a fund as segregated even though the trustee has not made any formal decison to do so.

This will happen when:

  • the fund is entirely and exclusively providing retirement phase pensions; and
  • it is legally allowed to operate on a segregated basis (see our blog Segregating in SMSFs beyond 1 July 2017 to understand which funds cannot segrgate and which ones can).

In the past, common industry practice was to assume that a fund will only be deemed to be segregated if it is entirely supporting retirement phase pension accounts for the full financial year.  From 1 July 2017, however, the ATO will be policing their view that in fact a fund could go through a period of deemed segregation if it is exclusively providing retirement phase pensions at any point during a given financial year.

For example, a fund that has a mixture of accumulation and retirement phase pension accounts from 1 July - 30 November and then moves entirely to retirement phase pensions from 1 December would be deemed to be segregated from 1 December.  If a contribution was made later in the same financial year (say May) and this remained in an accumulation account, the deemed segregation would end at that time.

So why is deemed segregation such a hot topic?

It's because the ATO considers that if a fund is deemed to be segregated for a period during a financial year, ECPI must be claimed using the segregated method for that period. In the example above, the fund could no longer simply obtain an actuarial certificate for the whole year and apply that to all investment income.  Instead the fund would claim its ECPI:

  • using the segregated method for the period between December - May; and
  • using the actuarial certificate method for the rest of the year (before December and after May).

Of course, this only applies to funds that are actually allowed to segregate.  But it does mean that those funds that can segregate must consider themselves segregated for a time if they are entirely providing retirement phase pensions at any time during the year.

My client is currently in receipt of a transition to retirement income stream (TRIS).  He will turn 65 next month.  Does his TRIS automatically become an account based pension on his 65th birthday?

And is the minimum pension for the current year recalculated on his 65th birthday?

Whilst a TRIS automatically becomes a retirement phase pension on the recipient’s 65th birthday, it doesn’t automatically become an account based pension. 

In the absence of your client undertaking a “stop & restart”, he’ll continue to receive the same pension as before.  It won’t be called an account based pension, but it will have all the same features as an account based pension, ie:

  • the 10% maximum will no longer apply and there’ll be no restrictions on lump sum commutations (subject to the fund’s trust deed),
  • the fund will start receiving a tax exemption on the investment earnings associated with the TRIS balance,
  • the balance of the TRIS on your client’s 65 birthday will count towards their $1.6m transfer balance cap, and
  • on death the pension can revert to any eligible beneficiary (usually only the surviving spouse) regardless of their age or retirement status (assuming Treasury Laws Amendment (2018 Measures No 4) Bill 2018 is passed in its current form). 

For simplicity, once your client turns age 65, we’d differentiate his pension from a “normal” TRIS, by calling it a “retirement phase TRIS”.

Because the pension is just continuing to your client, his minimum pension for the current year will remain at the amount you have already calculated for this year based on his TRIS balance at 1 July.  You do not need to recalculate his minimum pension until the following 1 July – at that point his minimum pension will be calculated based on a 5% draw down factor because he will be 65.

For some clients where the size of their TRIS balance would cause them to exceed their transfer balance cap, it may make sense to “stop & restart” the pension with a lower account balance.  We covered these issues in detail in our November 2017 edition of our Super Insights publication.  If you are not already a subscriber, see here for our technical support packages to sign up today.

When super policy becomes a crazy game

Sometimes the lunacy of politicians (both sides) amazes me when it comes to superannuation policy.  Although perhaps that fact in itself is amazing since I have been working in superannuation for nearly 30 years and should have learnt better by now.

The Opposition Treasury Spokesman recently re-iterated some of Labor’s superannuation policies which were reported here but the full explanation is readily available on their website here.  These reports don’t specifically cover their earlier announcements about changes to franking credits to make them non refundable but this is also clearly part of the mix.

Essentially the problem for any politician today is that superannuation in retirement phase looks like a very juicy pot of potential tax revenue that is currently largely untouched.

There are two ways of changing that:

  • Tax the payments (benefits) people receive from their superannuation funds, or
  • Tax the income received by the fund itself so that it has less money with which to pay benefits. 

The first approach - taxing the benefits paid out of super directly - would unwind the very generous treatment introduced by the Coalition back in 2007.  From 1 July 2007, anyone over 60 has been able to receive any amount from a conventional superannuation fund and pay no tax.  (I say “conventional” because there is a small number of funds that don’t pay tax while their members are building up their superannuation entitlements but do pay tax when the money comes back out again.  Most of us are not in these funds.)

I would be prepared to bet that no politician has the courage to adopt this approach.

So both the major parties are currently taking the easier second option of focussing on taxing investment income (dividends, rent, interest etc) received by the funds that are paying pensions. 

Winding back tax concessions funds paying pensions

Historically, once a superannuation fund member started taking a pension the fund stopped paying income tax on the earnings it received from the assets supporting that pension.  Paying less tax meant more money built up in the superannuation funds and therefore higher benefit payments to members.

Years ago, the ALP proposed to change this by introducing a policy to say:

  • Fundamentally it’s OK that superannuation funds pay no tax on their earnings if their assets are being used to pay out pensions to retirees; but
  • Only up to a point.

The ALP proposed to achieve this by placing a limit of $75,000 on the amount of tax free income a fund could receive for each pensioner each year.  A fund with two members receiving pensions, therefore, could receive up to $150,000 of its dividends, rent, interest etc tax free.  If the fund earned more, this would be taxed at the usual superannuation fund tax rate of 15%.  Before this policy could be legislated, the ALP lost power.

The Coalition approached the same problem slightly differently.  Their approach was that instead of directly capping the amount of tax free investment income a fund could earn, they would cap the amount that could go into the sorts of pensions that created this income in the first place.  They did this by making two changes from 1 July 2017:

  • Firstly, only pensions being paid to people who had actually retired would be entitled to give rise to this tax free income in their superannuation fund (this is why transition to retirement pensions were specifically excluded from the definition of “retirement phase” pensions and only retirement phase pensions create tax free investment income);
  • Secondly, the amount that could be put into a retirement phase pension was capped at $1.6m.

This second change was really designed to achieve something very similar to the ALP policy in allowing tax free income to be generated in superannuation funds for retirees but “only up to a point”.

In fact, the two policies also give very similar outcomes under a number of scenarios.

Imagine a fund generates around 5% income on its assets.  Capping the amount that can be put into a retirement phase pension at $1.6m means that the tax free income generated in the fund thanks to that pension will be around $80,000 (5% of $1.6m) which is quite similar to Labor’s $75,000 limit.

Over time, if the $1.6m pension account grows because its investment returns are higher than the pension payments withdrawn, the tax free income might be higher.  But all pension balances eventually start to reduce courtesy of the compulsory draw down rates.  At that point, the current rules are entirely likely to result in much less tax free income than Labor’s $75,000 (particularly if the Labor policy involved some indexation of the $75,000 threshold).

Where the two policies really deviate would be in their treatment of capital gains.  Selling assets and realising capital gains might well result in a far more than $75,000 of taxable income in a single year, even for funds that traditionally fall well within the $75,000 per person threshold.  For this reason, Labor previously floated some complex workarounds to spread capital gains over a number of years – although I notice that these are not discussed on their website.  Perhaps because it would be even more obvious that it involves yet more complexity.

So conceptually the two approaches look like variations on a theme – designed to achieve more or less the same thing but in different ways.  And in both cases, designed to continue the practice of tax free investment earnings for pension funds but only up to a point.

This is why the recent comments from Chris Bowen on ALP policies are completely bewildering to me.  He has indicated that if elected, the ALP would do both – they would keep the existing $1.6m pension cap introduced by the Coalition and overlay their $75,000 per person limit.

To me this is taking a simple policy that achieves 90% of what you’re after and then adding three times as much complexity to achieve the final 10%.

I refuse to believe that the $75,000 per person limit will actually add much to the Government’s coffers over and above what is already being achieved by the new rules.  There are some large savings mentioned on Labor’s website but this is presumably relative to the position before 1 July 2017 when the $1.6m pension limit did not apply.

Labor will no doubt argue that this is a “belt and braces” approach that will allow them to be really really sure that they are constraining the tax concession they are targeting. I’d argue it’s actually just a belt plus another belt - which would look stupid on any set of pants.

SMSFs and reserves - new guidance from the ATO

The ATO has recently issued its first guidance on reserves in SMSFs via a brand new series of publications called "SMSF Regulator's Bulletins".  The new Bulletins (SMSFRBs) allow the ATO to flag compliance issues it is concerned about or actively monitoring relatively quickly without the formality of other publications such as SMSF or Tax Rulings etc. It also explains how the Commissioner would apply particular legislation if asked via a formal process such as a private binding ruling. In that sense it is perhaps similar to a Taxpayer Alert but with a regulatory focus as well as a tax one.

This first publication (SMSFRB 2018/1) provides some contentious views (and reversals of previous views) on reserves in SMSFs.

We covered these in detail in the March edition of our Super Insights publication.  If you are not already a subscriber, see here for our technical support packages to sign up today.

One of the highlights was the ATO's complete reversal of their position when it comes to making reserve allocations to pension accounts.  In the past, the Regulator has taken the view that for a reserve allocation to be "fair and reasonable" it is necessary that all member accounts in the fund (including both pension and accumulation accounts) receive the same reserve allocation in relative terms.  In other words, a trustee wishing to allocate reserves via (say) an extra interest rate of 4% in a fund with two members would simply apply an additional 4% to all their member accounts - both pension and accumulation accounts alike. 

The new position (expressed in SMSFRB 2018/1), however, appears to be that the total reserve allocation would be calculated as 4% of all the various member accounts but it would only be allocated to accounts not yet in retirement phase (eg accumulation accounts).  If one or both of the members didn't have an accumulation account, we asume a new one would need to be created.

While this issue has (not surprisingly) grabbed the headlines in SMSF publications, what is perhaps even more interesting is the very strong language the ATO adopts when talking about reserves in SMSFs generally.  It signals a clear focus by the Regulator on asking SMSF trustees to defend any practice that involves creating, adding to or removing funds from a reserve. This is despite the fact that many SMSFs have legally operated reserves for a number of years and some funds have little choice but to have one if they have terminated a defined benefit pension.

We raised a number of issues on this publication with the ATO during the consultation process and will continue to do so now that it has been published. These, together with some thoughts on how existing reserves can be dealt with are all covered in our March 2018 Super Insights publication.

Does the minimum pension need to be paid in the year the pensioner dies?

It depends on whether the pension reverted (continued automatically) to a reversionary beneficiary such as the spouse on death or stopped.

Where a pension reverts on death, the pension continues albeit to a different person.  As a result, the minimum calculated for the deceased for year of death carries across to the reversionary.  Any amount not paid prior to death, must be paid to the reversionary by 30 June.  The minimum amount for the reversionary on the following 1 July is then recalculated using the reversionary’s age.

In contrast, where a pension does not revert on death, the pension ceases on date of death.  This means the minimum also ceases on date of death.  That is, no minimum payment is required for the “old” pension (to the deceased) in the financial year of death.  A minimum for any new pension will determined if and when a new pension is commenced for an eligible beneficiary.

Company Directors & Gainful Employment

It is a well established principle that company directors are not considered common law employees, unless they are also engaged under a contract of employment to provide non-director duties.

So, if a director is not a common law employee, can they ever qualify as “gainfully employed” for the purpose of making superannuation contributions after age 65? Conversely, if they cease to be a director after age 60, is that sufficient to satisfy the retirement definition?

We recently sought clarification of these issues from the ATO and can now confirm:

  • Whilst not common law employees, directors are included as employees for the purpose of the Superannuation Industry (Supervision) Act & Regulations.  Specifically, under section 15A(2) “a person who is entitled to payment for the performance of duties as a member of the executive body of a body corporate is, in relation to those duties, an employee of the body corporate”.
  • This means a director of a company who is entitled and paid fees for their services as a director would qualify as gainfully employed [SIS Reg 1.03(1)].  For individuals aged between 65 and 74, provided they were gainfully employed for the requisite minimum of 40 hours in no more than 30 consecutive days, voluntary employer or personal superannuation contributions could be made.
  • Similarly, where a director has received remuneration for their services as a director and subsequently ceases that directorship, an arrangement under which they were gainfully employed has come to an end.  For individuals aged 60 or over, where that cessation occurs after their 60th birthday, they will have met the second limb of the retirement definition and thus satisfied a condition of release [SIS Reg 6.01(7)].  This will be case even if the individual has continued in other forms of gainful employment.

Of course, given the incentive post 1 July 2017 for individuals to satisfy a retirement definition and commence a pension which will generate tax exempt earnings in the fund, the ATO is likely to pay closer attention to such arrangements.

If you have any concerns about whether you or your client is gainfully employed or has satisfied a retirement definition, feel free to give the team at Heffron a call.

CGT relief – five traps emerging at the pointy end of the year

We are definitely at the business end of 2017/18 when it comes to discovering just where the submerged rocks lie for CGT relief under the 2017 Superannuation Reforms.

We have written more broadly on this before - see our previous publication, Heffron Super News, Issue # 142 and for subscribers to McPherson Superannuation Consulting’s SuperTech newsletter, the December 2016 edition.

However, as is always the case, new tips and traps emerge all the time and we’ve shared below just five that have come to our attention as we help advisers, accountants and trustees navigate the rules and lodge their 2016/17 annual returns.

Which aspects of the CGT relief are a “choice”?

Funds can choose whether or not they adopt the CGT relief.

They can also choose whether they do so for all or just some assets.

And they can choose whether (under certain circumstances) tax on any capital gains triggered as part of opting into the relief is dealt with in 2016/17 or deferred until the asset is sold in the future. 

But they can’t choose which method applies.  Whether it is the so-called “segregated method” or the “proportionate method” will be a matter of fact and will depend entirely on whether or not a particular asset was entirely devoted to providing pensions on 9 November 2016:

  • If it was, only the segregated method is ever possible for those assets – never the proportionate; and
  • If it was not, only the proportionate method is ever possible for those assets – never the segregated method.

And of course it’s entirely possible that neither method is available if the fund or asset doesn’t meet the conditions required for the applicable method.

The interplay between the method available for CGT relief and the method used to calculate a fund’s tax exempt income (ECPI) in 2016/17

While the CGT relief method is not something funds can choose, they can make some choices about how they claim their ECPI in 2016/17 while the ATO is not devoting compliance resources to ensuring that their view of how the law works is applied (see our article ECPI – what is different in 2017/18 to understand that ATO view). In fact many funds might use both methods to claim their ECPI in 2016/17 depending on the circumstances.

However, this does not change anything about their CGT relief – the segregated or proportionate method will apply based on their position at 9 November 2016 no matter how they claim their ECPI in 2016/17.

Dealing with losses when carrying forward gains under the proportionate method

For some funds it will make perfect sense to opt into the CGT relief on assets that are currently in a loss position where the proportionate method applies.  But those losses are then recognised in full in 2016/17; they cannot be deferred in the same way as capital gains.

For example, consider a fund that will opt in to CGT relief for two assets – one with an unrealised gain of $100,000 and one with an unrealised loss of $40,000.  Both have been held for more than 12 months and the fund’s actuarial percentage for 2016/17 is 75%.

It is tempting to assume that if the trustee intends to defer the capital gain trigged by adopting the relief, the following amount would be reported as the “deferred notional gain” on the fund’s 2016/17 annual return:

($100,000 - $40,000) x 2/3 x (1 – 75%) = $10,000

But in fact this is quite incorrect.

The fund should instead report a capital loss of $40,000 and a deferred notional gain of:

$100,000 x 2/3 x (1 – 75%) = $16,667

This deferred notional gain would be recognised (and taxed) when that asset is eventually sold. The $40,000 loss must be recognised immediately.  It would be used to reduce normal capital gains made in 2016/17 and carried forward in the usual way if the gains were not enough to use it up in full. Importantly, however, it would be entirely excluded from the deferred notional gain calculation.

Is CGT relief really worth it if both members only have $1.5m in super pensions?

CGT relief is not always valuable (and in fact we explain a number of cases where it is not in our CGT relief technical paper – see below).  But it is also easy to under value it when it doesn’t look all that useful right now.

If the two members above were receiving a transition to retirement income stream during 2016/17, CGT relief is still available even though their balances were less than $1.6m at 30 June 2017. 

If the members have now retired (ie post 1 July 2017) and there is little chance that their balances will increase above this level in the future, it is tempting to imagine that the CGT relief is not particularly valuable.  Surely the fund will be 100% in pension phase in the future anyway?

But remember that when one of the members dies, it is entirely possible that the survivor will wind down some of their own retirement phase pension so that they can keep the deceased’s pension running and leave as much as possible in superannuation.  At that point the fund will return to having a combination of accumulation and pension accounts – CGT relief would once again be valuable. Don’t underestimate the impact that future events have on the value of the decisions being made today.

Oops – I missed it the first time

The decision to opt in to the CGT relief for a particular asset is an irrevocable one. An amendment to the tax return can’t change this.

However, the ATO has recently clarified that where the tax return has been lodged with (say):

  • no election to opt in made at all; or even
  • a response that indicates the fund has specifically chosen NOT to opt into the relief

an amendment can be submitted that effectively changes this to opting in.  (We expect the argument is that the irrevocable part of the election can only ever apply to a positive choice to take up the relief.  No decision or even a decision not to opt in doesn’t constitute an election for this purpose.)

So if your fund has mistakenly ignored CGT relief and already lodged their 2016/17 return, it’s not too late to change things.  If your fund has already lodged a return with a positive election to opt in, then unfortunately that cannot be changed.

 

If you’re struggling with CGT relief, you’re not alone.  Heffron has helped countless advisers, accountants and trustees understand the rules and make their decisions.  We can review a specific fund’s circumstances and provide a report on which method applies together with our recommendation as to whether the fund opts in, defers etc (see our CGT relief review service).  We have guides you can use to explain the rules for clients (CGT relief fact sheets), minute templates (CGT relief minutes) and technical papers (CGT relief paper).  Let us help you deal with CGT relief quickly, efficiently and cost effectively so that you can get back to the important work of getting the most out of SMSFs for yourself or your clients.

A new opportunity to top up superannuation balances

With all the recent focus on new limitations on super, it’s easy to forget that there is also at least one new rule that helps those still saving to put more into their super account with the best possible tax treatment.

Until this year, there were really only two ways for most people to voluntarily make extra superannuation contributions.

The first was to ask an employer to divert some of their salary to their fund as extra super (known as “salary sacrifice” contributions).  This is valuable for those paying high rates of personal tax because they escape income tax on the money used to make salary sacrifice contributions.

The second method was to put in extra money as what’s called a “non-concessional” contribution.  Non-concessional contributions are not tax deductible.  If there’s no tax deduction available, most people opt for paying down their mortgage rather than putting more into super!

In the past, very few individuals could make a superannuation contribution for which they claimed a personal tax deduction.  Those who could were typically people running a business in their own name or not working at all – it was rarely possible for a traditional salary earner.

That’s all changed from 1 July 2017. 

These days, anyone can claim a tax deduction for contributions they make to superannuation from their own money.  There is a limit of $25,000 pa and unfortunately any contributions made by an employer will also use up the limit.  But the new rule does open up some new opportunities.

Have you ever thought about salary sacrifice contributions and then decided it’s all too hard because you have to make regular payments and commit to them in advance?  (And then of course there is the hassle of changing your instructions with your company’s payroll department if you change your mind!) 

Have you ever received a bonus and thought afterwards “I paid a lot of tax on that bonus, I wish I had put some of it into super as an extra salary sacrifice contribution”? 

Have you ever reached the end of the financial year with more cash than expected and wondered if there is any way you can contribute it to super and reduce your personal tax bill at the same time?

Do you have an employer who is not able to organise salary sacrifice contributions for you?  Or does your employer reduce other salary-based benefits if you deliberately opt for less salary and more super?

If so, it’s time to think differently in 2017/18 because there is now a second path.

In the new world, virtually anyone can decide in (say) June to put an extra deposit into superannuation and claim a personal tax deduction for it.  There are some issues to watch:

  • Remember the $25,000 annual limit includes any superannuation provided by an employer such as compulsory (Superannuation Guarantee) or salary sacrifice contributions.  For some funds this amount is not immediately obvious – check carefully with your employer and fund before making the extra contribution;
  • Just like an employer contribution this extra contribution will be taxed in the fund.  For most people the rate is 15% but for some it is as high as 30% (generally only for those earning salary, superannuation and other income of more than $250,000 pa);
  • There is paperwork to do.  Unlike salary sacrifice contributions which are automatically tax deductible to an employer, personal contributions are only tax deductible if you specifically ask your fund to treat them that way within certain time frames and the fund agrees to do so;
  • Anyone over 65 needs to meet certain rules to be able to make superannuation contributions;
  • Claiming a tax deduction for your personal contributions will mean they are potentially taxed again when you eventually take the money out of superannuation.  Generally this is only relevant if you take the money out before you turn 60 or under certain circumstances when you die;
  • It won’t be worthwhile for anyone paying very little personal income tax (particularly those whose personal tax rates are less than or similar to the normal superannuation rate of 15%).

Of course some people will still choose to use a salary sacrifice arrangement with their employer and make these contributions regularly.  There is something simple and comforting about knowing you are adding to your superannuation every fortnight / month without having to do anything to make it happen.

But effectively this new rule allows everyone to have the tax benefits of salary sacrifice contributions with the flexibility of non-concessional contributions.

[An edited version of this article appeared in The Australian on 6 March 2018]

Super Concepts buys More Super

It was pretty big news in SMSF circles today when SuperConcepts announced they had bought More Super.

SuperConcepts (AMP) is probably the country’s largest SMSF administrator.  Perhaps not surprisingly given the dollars at their disposal, the AMP business has everything – they own their own software (SuperMate), offshore processing operations, multiple SMSF administration brands, financial / investment products (via the AMP business), Australian financial services licensee for accountants (SMSF Advice), financial planning network and no doubt many other components I haven’t even imagined.

More Super just adds “more” to an already big story.  Compared to others in this industry it was already a sizeable business and when combined with AMP the result is just … huge.

But there is one fascinating thing about the SMSF industry that this change highlights : even in an environment where the largest one or two players dwarf everyone else, AMP still only administers around 5% of the country’s SMSFs

And we still have an industry where smaller players can not only survive but even thrive.

I would be surprised if many in the sizable group of “middle sized” independent administrators are racing to change their plans for sale in the wake of this news.  (Or maybe I should just speak for Heffron here – we’re not!)

So why are SMSF administration businesses able to do this when so many other industries have become “winner takes all” propositions – pushing out anyone but the dominant few?

I suspect part of the answer lies in the fact that we started from a very disaggregated place.  Everyone has read the statistics at one point or another – showing how many funds are looked after by firms that have fewer than 5 or 10 or 20 etc.  Aggregation is definitely happening, it will continue and probably even speed up but there is a long way to go.

Another helpful influence is that while administrators are still highly disaggregated there is a relatively small number of providers of software to those administrators (Class, BGL and even AMP’s own version SuperMate).  This puts very sophisticated technology in the hands of quite small administration businesses allowing them to benefit from scale they don’t have themselves.

And finally, with SMSFs in particular, the golden egg is finding new and better ways to better serve trustees and the professionals who advise them.  At the end of the day these are the people who matter when it comes to getting the best possible retirement outcomes for SMSF members.  Fortunately there are a great many ways to do that – meaning that many different business and service models are possible.  Scale and size will be great for some but the ability to be independent, nimble (particularly with technology development) and responsive to a range of different client needs will also be handy.  That’s why the SMSF industry is such an exciting place to work – it is just like the funds themselves, full of choice and variety with amazing opportunities to do something differently tomorrow.

Government moves to fix TRIS complexity

Traditionally when a transition to retirement income stream (TRIS) reverted to a spouse on the death of the original pensioner, the TRIS status of the original pension was academic.  Regardless of how the pension started, the surviving spouse inherited a pension unencumbered by the usual restrictions associated with a TRIS because the death of the original pensioner effectively ‘freed up’ the entire balance to become ‘unrestricted non-preserved’ superannuation. 

However, the addition of the ‘retirement phase’ concept on 1 July 2017 added some complexity which currently causes some constraints to remain even after death and changes the position for those transition to retirement pensions that revert to another beneficiary on death.

In what has now been agreed is an omission from the law, under current legislation, any pension that commences as a TRIS does not automatically become a ‘retirement phase’ pension when it automatically reverts to (say) a spouse on the death of the first member of a couple.

Instead, the treatment of the ongoing pension (if it commenced as a TRIS) depends on the age and retirement status of the new recipient (ie the reversionary pensioner).  This is the case even if the pension had already become a ‘retirement phase TRIS’ in the hands of the original pensioner before they died.

This deficiency in the current law means that if the person nominated as the reversionary pensioner has not yet retired/reached age 65 etc by the time of the original pensioner’s death, there is an argument that the pension simply cannot revert    However, even if the pension is considered to have reverted, the compulsory cashing rules have not been satisfied as the death benefit pension is not a ‘retirement phase’ pension.

This would mean the fund’s eligibility for exempt current pension income in respect of that pension account would cease immediately and the trustee/member would need to act quickly to stop the TRIS and restart a retirement phase pension.  But in doing so the member would have lost the benefit of the usual 12 month delay in an amount counting towards their transfer balance cap.

However in a welcome move, the Government has now released draft legislation which if passed in its current form, will ensure that an auto-reversionary TRIS can always be paid to a reversionary beneficiary (provided they are an eligible recipient - eg spouse) regardless of the age or work status of the reversionary beneficiary.  There will be no need to ‘stop & restart’ the TRIS, the fund’s eligibility for exempt current pension income will continue uninterrupted and the reversionary beneficiary will benefit from the 12 month delay in their transfer balance cap.

This common-sense change is proposed to apply from 1 July 2017 but is subject to the passage of legislation through Parliament.

SMSF. Crypto. Bitcoin.  What’s all the fuss?

Why is there so much focus on SMSFs and Bitcoin?

Mainly because it’s new and sexy.  Whenever there is a new and exciting investment, early movers want to get started.  These days, the largest pot of potential investment cash is often an individual’s superannuation.  Thanks to compulsory superannuation at a relatively high level for a long time now, even youngsters in their 30s and 40s potentially have large sums locked up for retirement.

(Did you know that someone with a salary of $50,000 ten years ago who has experienced wage increases of only 3% each year could have grown their superannuation to around $50,000 today if their fund earned even just 2% more (ie 5% pa) over that period?)

But how does one invest superannuation money in Bitcoin?

This is where SMSFs enter the conversation.

On the whole, large funds are subject to exactly the same rules as SMSFs (in fact SMSFs are generally more constrained) but a range of factors get in the way of quickly opening up new opportunities for large fund members.  Internal policies that apply thorough vetting to anything new, governance committees that are nervous about taking risks, trust deeds or other internal documents that simply prohibit it, concerns about additional costs (which would end up affecting all members not just the few who take up the new opportunity) to name just a few.

SMSFs, on the other hand, can respond to anything immediately.  Want to buy diamonds?  Want to buy mushroom farms?  Want to buy racehorses?  Want to buy Bitcoin?  There will almost always be compliance hoops to take care of and in a few cases, there are specific rules governing particular types of investment.  But there are generally very few assets an SMSF cannot buy at all.

This “nimbleness” is exactly one of the things that sets SMSFs apart from the rest of the slow and ponderous superannuation industry.

And sometimes that’s the problem.  There’s very little to stop someone in charge of their own superannuation fund racing headlong into an exciting new thing.  But there is also virtually no protection when something goes wrong.

Some people will make a killing on cryptocurrencies.  And some people will lose their shirts. 

Given the very generous tax concessions given to superannuation funds including SMSFs, we shouldn’t be surprised that the ATO (as the regulator of SMSFs) and auditors of SMSFs (as their whistle blowers) tend to instinctively view anything new with concern.  Sometimes that concern is just based on ignorance.  Sometimes it is founded on a genuine appreciation of risk and fear that some people making important investment decisions actually do not understand what they are doing.

Right now both are probably applicable for cryptocurrency.

Not surprisingly there are plenty of articles currently being published expressing concern about cryptocurrencies.  The best I’ve read so far is this one from ASF Audits – Why Cryptocurrency is SMSF Kryptonite

But there are also plenty in support and highlighting some points that are absolutely true:

  • An SMSF can invest in cryptocurrency providing some important compliance rules are followed.
  • The technology underpinning cryptocurrency is surely here to stay – regardless of whether the large range of specific currencies (Bitcoin, Ethereum, Dash, Monero and more) survive in their current form.
  • As George Bernard Shaw said once "all great truths begin as blasphemies".  Everything was new once and many activities that are somewhat mainstream today were probably once viewed with the same suspicion that now surrounds cryptocurrencies.  As entities that are always on the front line of innovation, SMSFs experience this a lot!
  • As mentioned earlier, some people will make a killing investing in these assets.

I have an SMSF and I won’t be buying cryptocurrencies for now for several reasons:

  • I don’t really understand it well enough to be confident I would be making an informed decision.  My adviser doesn’t either – so I’d be on my own;
  • I’m kind of intrigued about it and would actually love to have a dabble “just because” – but that’s exactly the wrong thing to be doing with my retirement savings.  I should do that with my own money otherwise I’ve breached one of the most important superannuation rules we have: the sole purpose test.

But this isn’t something just restricted to crypto - my SMSF doesn’t have any direct property for exactly the same reasons!

On the other hand, my colleague Andrew Smith is our CTO.  He knows far more about this than I do.  In fact he’s even played around with inventing his own currency and knowing his history with new and innovative ideas, he will probably be one of the people to make a killing!  It may be an entirely appropriate investment for his SMSF.  If he does invest some of his superannuation money in some form of cryptocurrency, I’ll be flagging just a few things I want him to be careful about:

  • Make sure you are doing this with a genuine focus on growing your retirement savings – if you just want to have a play, it will be very hard to look your auditor and the ATO auditor in the eye and say you’ve satisfied the sole purpose test.  This is particularly hard if you have JUST created your SMSF and put all your money into Bitcoin.  Would someone genuinely focused solely on growing their retirement savings put all their eggs into that particular basket?
  • Your SMSF needs to be able to prove that it owns what it says it owns – this is pretty easy in the “non virtual” world where things like bank statements, share registers etc provide some conventional methods of supporting ownership;
  • Cryptocurrency isn’t currently included in the definition of “money” for superannuation law purposes. This means there are rules about who you can buy it from – only ever buy your coins from an external party, not yourself or family or people you’re in business with;
  • Make sure you can show how you are protecting yourself from fraud or natural events such as the death of the trustees (who own the wallet);
  • Remember that the assets will belong to the superannuation fund.  If your sell some of your Bitcoin, the money needs to go into your SMSF not your own pocket.  You also can’t spend it on things for you (or family or anyone else) – it can only be spent on buying things for the SMSF.

Other than that, go for your life and make a killing!

ECPI - capital gains and losses in funds that cannot be “segregated”

One of the many benefits traditionally enjoyed by funds entirely in pension phase was that when an asset was sold, any capital gain was completely disregarded.  Not only was there no tax paid on that particular capital gain but the fact that the gain was ignored entirely meant it also did not “use up” capital losses that the fund might have been carrying forward from previous years.

But what does the future look like on this front?

The traditional treatment of capital gains was potentially hugely beneficial.  Many funds have large capital losses carried forward from the days before they started their pensions and have been able to leave those intact for the proverbial rainy day when they are once again paying tax on some or all of their investment income.

So how will this change in the future (2017/18 and beyond)?

For some funds, the rainy day has arrived.  Many funds that were 100% in pension phase are now back to having a combination of pension and accumulation accounts.  (The classic case here is a fund where one or more of the members had more than $1.6m in pension phase at 30 June 2017 and chose to prepare for the 2017 reforms by “rolling back” some of their balances to accumulation phase.)

Unfortunately, when it comes to dealing with capital gains and losses, the treatment of these unsegregated or pooled funds is far less generous than the treatment of 100% pension phase funds.

In particular, for these funds, any current and historical capital losses are firstly offset against any capital gains before the actuarial % is applied to any remaining gain.  This means that even if the fund’s actuarial % is 99% (indicating that the fund is exempt from tax on 99% of its investment income), a $100,000 capital gain will completely use up a $100,000 carried forward capital loss.  (Logically one would think it should only reduce the carried forward capital loss by $1,000 – the portion of the new gain that is to be taxed.)

Unfortunately this is just the way the law works - even funds with a very small accumulation balance will find that they are using up their carried forward capital losses at pace – with every single dollar of capital gain they realise from 1 July 2017.

Eventually many funds with accumulation balances may return to a position where they are once again 100% in pension phase.

But even then, how will their capital gains and losses be treated if they are no longer allowed to have segregated assets?  (Remember some funds are no longer allowed to be classified as segregated even if they are 100% in pension phase – see our article Segregating in SMSFs beyond 1 July 2017.)

There is slightly better news here.

Funds that claim their ECPI using the “segregated” method are specifically allowed to disregard any capital gains and capital losses under s 118-320 of the Income Tax Assessment Act 1997.  Whilst, this provision will no longer apply to funds that are not allowed to segregate even if they are 100% in pension phase, another provision in the same Act (s 118-12(1)) provides a more general ability to ignore new capital gains under these circumstances.  It states that:

 A capital gain or capital loss you make from a CGT asset that you used solely to produce your exempt income or non-assessable non-exempt income is disregarded.

Translated, this means that a fund where 100% of the income is exempt from tax because 100% of the balances are in pension phase all year will be able to disregard capital gains.  For these funds, new capital gains will therefore stop “using up” any capital losses that are being carried forward from previous years.

ATO SMSF Lodgement Extension

The ATO announcement this morning advising that they will be extending the due date for lodgement of SMSF Annual Returns strongly indicates the complexities around the CGT Relief is proving challenging, as we, at Heffron, predicted would be the case.

Heffron has been at the forefront of the 2017 superannuation reform, creating products and services that provide practical solutions. 

If you have one or multiple funds that are affected by the super reform and aren’t sure on the rules then get in touch with our team to discuss the multiple services we’ve introduced specifically to help deal with these rules.

From our Masterclass Course, in March, through to our CGT Relief Review service, technical papers or even our full Administration services.  All services are designed to help practitioners apply the rules to real life situations.   

For example, our CGT Relief Review Service includes:

  • identifying which CGT relief method is applicable for each fund asset
  • our recommendation as to whether the trustee does or does not opt into the relief for particular assets
  • where relevant, our recommendation on whether the trustee defers tax on the capital gain triggered by opting in; and
  • highlighting any other issues we identify as part of our review.

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Death and transfer balance cap reporting

A question that has already come up in our practice several times relates to clients who died before 1 July 2017.

In particular, if the deceased had a retirement phase pension, what (if anything) should be reported for that pension when the Fund’s first TBAR (Transfer Balance Account Report) is lodged later this year.

Like most superannuation issues, it depends.

What if the pension was non reversionary?

If the pension was non reversionary (did not automatically continue to a new beneficiary) then from a superannuation and TBAR perspective, there was actually no pension in place at 30 June 2017.  This means there is nothing to report on the TBAR at 30 June 2017, no pension account to “roll back” to $1.6m by 30 June 2017 and no payments to make from that pension during 2017/18. 

In our view, if this pension was the sole income stream in the Fund, no CGT relief is available because none of the fund’s members needed to “do anything” to address the 2017 super reforms. 

Of course, the Fund can continue to claim a tax exemption on its investment income until the death benefit is dealt with (providing this happens as soon as practicable).  Interestingly this applies even though the “pension” balance may be much higher than $1.6m.  Let’s say the deceased’s pension balance (the sole balance in the Fund) was $5m when they died in April 2017.  If the trustee sells all the assets in 2017/18 to pay this out as a lump sum, the Fund will be able to do so entirely CGT free in any case.

If the balance was ultimately used to start a new pension in September 2017, the usual rules would apply just like any other new pension.  There would be TBAR reporting (based on the value of the balance at the time the new pension started), new minimum pension calculations and the maximum amount that could be dealt with in this way would be $1.6m (potentially lower if the beneficiary already has their own retirement phase pensions that have not been commuted).

What if the pension was reversionary?

The situation is quite different if the pension was reversionary.  Remember that reversionary pensions normally just continue in place to a new beneficiary – while the “owner” changes, the pension continues on.

Under this scenario there was a pension in place at 30 June 2017 and TBAR reporting will be required.

The 30 June 2017 balance will need to be reported for the new beneficiary.  It won’t have any impact on his or her transfer balance cap until 12 months after death – giving us until April 2018 to ensure the new beneficiary has no more than $1.6m assessed against their transfer balance cap in the example above.

What if the pension was a TRIS?

The situation is much more complex if the pension was originally a TRIS.  This is an area on which the ATO’s consultation process seems to have stalled (we are crossing our fingers that this means Treasury has finally shown some interest in a legislative solution). 

The 2017 superannuation changes altered many of the traditional superannuation strategies and none more so than the best way to deal with death benefits.  For this reason we are devoting our next masterclass series to both the strategies and practicalities of dealing with death in the new world.  We will review the issues that have stayed the same and explain the implications of everything that has changed.  Register as soon as you receive your invitation to avoid missing out.

Government reaffirms commitment to ensure LRBAs aren’t used to circumvent contribution caps

Draft legislation has been released for comment aimed at closing off two avenues in which the Government considers LRBAs could be used to circumvent contribution caps.

The first of the Government’s proposed changes will include a member’s share of the outstanding loan balance of an LRBA in the member’s Total Superannuation Balance.  It will only apply to SMSFs and Small APRA Funds (SAFs).

In other words, a single member fund with a $2m asset and $500,000 LRBA (so net balance of $1.5m) will – under the new provisions – have a Total Superannuation Balance of $2m rather than $1.5m.

Since one of the main uses of Total Superannuation Balance is to limit a member’s future contributions, increasing it in this way will have the effect of:

  • stopping a member from making non-concessional contributions to superannuation if his or her share of the gross assets of the fund exceeds $1.6m (the example of the single member fund above); and
  • stopping a member from carrying forward unused concessional contributions from 1 July 2018 if his or her share of the gross assets of the fund exceeds $500,000.

This measure is only proposed to apply to LRBAs entered into from 1 July 2018. It is something trustees and their advisers need to be aware of if considering new LRBAs as it will potentially impact their feasibility if future non-concessional contributions were anticipated to repay the borrowing.

The second of the Government’s proposed changes ensures that expenditure is also taken into account when determining whether the non-arm’s length income tax rules apply to a transaction.  Whilst not necessarily a SIS breach, remember that if considered to be non-arm’s length, income is taxed at 47% not the concessional 15% rate (or 0% for income earned on assets supporting a retirement phase pension).

The proposed changes have not been specifically limited to LRBAs and therefore apply to any “unreasonably low” expenditure incurred in deriving income.  Arguably it addresses a gap that has always existed in the non-arm’s length income provisions – they only required that the income received in relation to a particular asset was arm’s length and did not explicitly prevent SMSFs from achieving a similar result by artificially suppressing costs.

Clearly, however, the main target is LRBAs involving loans from related parties where the arrangement is not on arm’s length terms.  For example, where the interest rate charged is less than the rate charged by a third party financial institution or is not in accordance with the safe harbour provisions of PCG 2016/5.

The proposed changes would mean that under these circumstances, the income (including capital gains) earned by the asset acquired under the LRBA would be taxed as non-arm’s length income (albeit the interest would be a deductible expense under the usual rules).

This second change is proposed to apply to income derived from 1 July 2018, regardless of whether the arrangement was entered into before 1 July 2018, and effectively gives legislative backing to what the Government attempted to do with the safe harbour rules.  Presumably this would include any capital gain realised after 1 July 2018 regardless of when the growth in the asset actually occurred.

These measures are open for consultation until 9 February 2018.  We’ll let you know how they proceed.

First Excess Transfer Balance (ETB) determinations to be issued in January 2018

Well we know what the ATO will be doing over Christmas. 

While we expect few SMSFs have lodged any reporting for the new Transfer Balance Cap (the $1.6m limit on transfers to retirement phase pensions), the ATO plans to start issuing its first excess transfer balance determinations from January 2018. These are the new notices that will alert individuals that they have exceeded the limit and set a deadline for taking action.  Those who don’t do so within the required timeframe will effectively have their entire pensions cancelled.

What issues will this present?

  • Unfortunately the first ETB determinations will be too late to help many of those with small excesses who potentially qualified for special treatment (retirement phase pensions at 30 June 2017 that were between $1.6m and $1.7m and no new pensions since then).  These people were able to avoid an excess altogether (and the associated tax consequences) but only if they took action to remove the excess before 31 December 2017.  The release of the first ETB notices in January 2018 will be too late to alert anyone who hadn’t taken the necessary action by 31 December 2017.  Note, members of SMSFs who formally documented the rollback of any potential excess above $1.6m on/before 30 June 2017 are not required to take action before 31 December 2017.  For these individuals, any potential excess has already been dealt with and simply needs to be finalised as part of the completion of the fund’s 2017 financial statements (by the due date for the lodgement of the SMSF Annual Return eg 15 May 2018);
  • We may see our first instances of the different timing requirements for APRA funds (which have been reporting since October 2017) and SMSFs (which are not yet required to report anything) creating “fake excesses”.  For example, a fund where the SMSF has reported the 30 June 2017 pension but not a subsequent commutation and rollover to an APRA fund may find that the only records the ATO has on file will be the 30 June 2017 pension and the new pension in the APRA fund.  The commutation will need to be reported urgently to avoid a misunderstanding by the ATO.

We expect the latter problem will become a vastly bigger issue in the future when all SMSFs have reported their 30 June 2017 pensions.  Despite all the concessions made to SMSFs to ease the reporting burden, we expect the work created by being out of sync with APRA funds and receiving unexpected excess notices from the ATO will prompt many to report early when members are transferring between the two systems.

If you receive an ETB determination for a client which you weren’t expecting, feel free to send us a copy for review.  It may be a case of a timing issue like that above or a problem with the information reported.

Downsizer contributions and First Home Saver Superannuation Scheme (FHSSS) passed

The Bills necessary to make both the above measures law have now received Royal Assent.

Both were May 2017 budget measures and will take effect from 1 July 2018.  (Further changes to the Superannuation Industry (Supervision) Regulations 1994 will be required but these do not require a vote in parliament and are expected to progress smoothly.

To very briefly re-cap, the “downsizer contributions” measure is designed to encourage older Australians to downsize their home.  The incentive is that they are allowed to make contributions to superannuation after 65 when they sell an eligible dwelling without meeting a work test and regardless of the size of their existing superannuation balance.  There are of course limits, rules and deadlines but a few features include:

  • Only dwellings sold (contracts exchanged) after 1 July 2018 can be used to trigger eligibility for one of these contributions.  The person does not have to be over 65 when the dwelling is sold (or even when the settlement proceeds are received) but they do have to be over 65 when the contribution is made and there are time limits for making the contribution after sale;
  • The maximum contribution is the sale proceeds of the dwelling, capped at $300,000 (or $300,000 each for a couple);
  • There is no requirement that the contribution actually comes from the sale proceeds or that the sale actually occurs as a result of an intention to downsize (the contributor might in fact buy a more expensive home or even none at all);
  • There are rules around the nature of the dwelling but in most cases any Australian unit or house that has been held for more than 10 years and is at least partially exempt from CGT because of the “main residence” exemption will be eligible
  • The contribution can be made in multiple individual amounts but can only be triggered from the sale of one dwelling

The FHSSS is also related to housing but is generally relevant at the opposite end of the age spectrum.  It is designed to help individuals buy their first home by allowing them to extract some of their superannuation contributions to do so.  The new rules relate only to contributions made on or after 1 July 2017 and it will only be possible to release them from 1 July 2018.  Both personal and employer contributions are eligible for this scheme but in the case of employer contributions, only the amount over and above compulsory (superannuation guarantee) contributions are considered.  There is a maximum (formula) amount and when the contributions are released to the individual, any part that does not relate to the individual’s personal contributions for which they have not claimed a tax deduction (non-concessional contributions) will be taxed – albeit at a concessional rate.  The scheme has been designed so that the tax treatment favours contributing money to superannuation and then asking for it to be released rather than simply saving it in their own name for most individuals.

Both were promoted as part of the Government’s strategy to ease pressure on housing prices. We expect the downsizer contributions measure to be more useful for most SMSF members and in fact it presents some interesting planning opportunities particularly since there are no upper age or balance limits.  We expect that a great many SMSF members will look to take advantage of the scheme at some point in their retirement, although the potential impacts on social security entitlements and aged care fees will need to be carefully considered.

Segregating in SMSFs beyond 1 July 2017

Understanding when a fund is "segregated" for tax purposes is critical in applying the tax rules to SMSFs providing pensions.  An important rule change from 1 July 2017 means that some funds are no longer classified as segregated even if they very much look like it - for example, they are entirely in pension phase.  In this article we explain which funds are actually no longer allowed to segregate for tax purposes and what that means when it comes to their tax exemptions.

So what are the new rules?

From 1 July 2017, a fund cannot have any assets classified as segregated at any time during a particular financial year if, at the previous 30 June:

  • any member had a total superannuation balance of more than $1.6m (and remember, total superannuation balance includes not just the balance in the SMSF but all superannuation in every fund to which the member belongs); and
  • any of those members with more than $1.6m also had a retirement phase pension from any fund (not necessarily the SMSF).

If a fund cannot be classified as segregated it simply means that it cannot claim its tax exemption (ECPI) on the segregated basis.  The fund is still eligible for an exemption but under the "pooled" method.

Example 1

Mary and John both have $1.6m retirement phase pensions at 30 June 2017 and small accumulation balances.  They have no other superannuation.  During 2017/18 they fully withdraw their accumulation balances and their pension balances grow slightly during the year because their fund's investment earnings exceed their pension payments.  At 30 June 2018 their balances are $1.65m each (all in pension phase).

Their SMSF cannot be classified as "segregated" for tax purposes during 2018/19 even if it remains entirely in pension phase throughout the year (ie no new contributions are made for either of them).  The fund will instead claim its tax exemption for 2018/19 under the normal rules for "pooled" funds.  These are found in Section 295-390 of the Income Tax Assessment Act 1997.  The SMSF will need an actuarial certificate to say that the fund is 100% exempt from tax.  This is because only funds that are segregated (and covered by Section 295-385) are allowed to claim a tax exemption without obtaining an actuarial certificate.

If Mary and John both withdraw large amounts from their pension accounts during 2018/19 and by 30 June 2019 their balances are under $1.6m, the situation will change again for 2019/20.  For 2019/20 their fund will be allowed to be classified as segregated.  It can claim a tax exemption on all of its investment income for the year without needing an actuarial certificate if no further contributions are made.  If contributions are made during the year (or the fund has a mixture of pension and accumulation accounts for some other reason) the Fund will need to claim its tax exemption in two parts - on the segregated basis while it is entirely in pension phase and via an actuarial certificate during the "mixed" phase.

Example 2

Stacey and Mark both belong to the Stacey & Mark Superannuation Fund (an SMSF) and their entire balances will provide retirement phase pensions throughout 2017/18.  Their total superannuation balances have never been more than $1m.  Stacey's mother Anne is also a member of the fund.  She has a small accumulation account ($100,000) in their fund and traditionally the trustees have invested Stacey and Mark's balances quite separately to Anne's.  They have treated the fund as segregated for tax purposes.  Unfortunately Anne had $2m in another SMSF at 30 June 2017, of which $1.6m was providing a retirement phase pension.  This means that the Stacey & Mark Superannuation Fund is not allowed to be segregated for tax purposes any more.  It doesn't matter that Anne's large balance is in another SMSF, nor does it matter that Anne doesn't have a pension in the Stacey & Mark Superannuation Fund.  Simply the facts that:

  • she is a member of the Stacey & Mark Superannuation Fund;
  • she has more than $1.6m in total superannuation balances at 30 June 2017; and
  • she has a retirement phase pension "somewhere"

is enough to compromise the ability of the Stacey & Mark Superannuation Fund to segregate its assets for tax purposes.

The trustees could still invest the money separately and allocate investment earnings on the basis of the different assets chosen for each member. However the fund's tax return would be prepared as if all the assets are shared.  The tax exemption would be based on an actuarial certificate.

Feel free to add your own scenarios to the comments box and we'll let you know whether or not the fund can segregate from 1 July 2017.

ECPI - What is different in 2017/18?

The terms "segregated" and "pooled" (or "unsegregated") have been part of the superannuation landscape for 30 years (since superannuation was first taxed in 1988).  From 1 July 2017, however, the way we think about these terms for pension funds needs to change profoundly.

Traditionally, pension funds were segregated under only two circumstances:

  • funds that were entirely in pension phase all year (often referred to as "segregated by default"); and
  • funds where the trustee set aside specific assets to support one or more pension accounts and kept these quite apart from the assets supporting members' accumulation accounts.

Being segregated (or not) was important in determining whether the fund needed an actuarial certificate.  For the last 10+ years, funds have been able to claim a full tax exemption on any income earned on segregated assets without needing an actuarial certificate.  Funds holding assets that were supporting pensions but were not segregated needed an actuarial certificate to support their tax exemption.

Conceptually that did not change from 1 July 2017.

But two things did change:

  1. During 2016/17, the ATO clarified its view that a fund paying only pensions at any point during the year would be considered segregated (by default) for that period but pooled or unsegregated for the rest of the year.  Given that it was way out of step with common industry practice in SMSFs, the ATO agreed to take a fairly relaxed view on this during 2016/17 and earlier years but signalled that the Commissioner would expect the law to be applied in this way from 1 July 2017 (subject to the second change below);
  2. From 1 July 2017 some SMSFs (and only SMSFs) are actually legally prohibited from having any segregated assets for tax purposes.  Assets that might look segregated (eg in a fund that is 100% in pension phase) are actually given a new name - "disregarded small fund assets" - and are never treated like segregated assets.

Taken together the impacts are significant.

Change 1 means that a fund that is allowed to be segregated in the future (subject to Change 2!) might actually have to claim their tax exemption by breaking the year up into multiple smaller periods.  For example, if the fund was entirely in pension phase from July - October, received a contribution in October and converted that contribution to pension phase in January, there might be three distinct periods with different rules for tax exemptions :

  • July - October : the fund would claim a tax exemption on all investment income (as it was 100% in pension phase and therefore segregated by default)
  • October - January : an actuarial certificate would be required and the % shown in that certificate would be applied to any income earned in this period
  • January - June : back to 100% pension phase - so all income would be tax exempt.

Selling a property in (say) December would potentially produce a very different result to selling the same asset for the same price two months later in February.

Change 2 means the exact opposite - funds that we may have assumed are segregated all year (or even for just part of the year) will now be considered unsegregated or pooled all year.  A great example here would be a fund that had two members, all in retirement phase pensions (no accumulation accounts) where they are not allowed to segregate.  Even though the fund is entirely in pension phase, an actuarial certificate (stating the obvious - that 100% of the fund's investment is exempt from tax) would be required. 

So who cannot segregate in the future?  We've covered this in another article.