Quarterly SMSF Update

Transcription

1 Quarterly SMSF Update August 2012 Presented by: Mark K Wilkinson Director Wilkinson Superannuation

2 Rulings and ATO ID s ATO ID s On 8 June 2012, the ATO issued the following IDs: > ATO ID 2012/52 SMSF: The issue raised was could a superannuation fund make an additional investments in a related trust. The trust had borrowings outstanding at 28 June 2000 which were not increased and were discharged prior to additional investment. In this case as the trust had not breached regulation 13.22D of SIS in the period between 29 June 2000 and the date of the additional investment, the additional investment could be made and Section 71(1)(j)(ii) of the SIS Act will apply. > ATO ID 2012/53: the fund made an original investment in a related unit trust prior to 28 June As at the 28 June 2000 the trust had borrowed money, and this borrowing was increased after 28 June 2000, before been discharged. The ATO ruled that an additional investment made in the trust would not be exempt under Section 71(1)(j)(ii), because the trust had not complied with Regulation 13.22D for the entire period that the fund held an interest in the trust Taxation Ruling TR 2012/6 - Disability insurance The Ruling, released on 4 July 2012, outlines the ATO position on the deductibility of disability insurance premiums, on policies held for the benefit of the fund members. In order for the premium for a disability insurance policy to be deductible (under s ITAA 1997), there must be a connection between that payment and a current or contingent liability of the fund to provide a "disability superannuation benefit" The extent to which a premium will be in respect of the fund's liability to provide disability superannuation benefits is worked out by reference to the nature of the event insured including whether the fund will be able to pay a benefit to a member following the occurrence of the insured event. The ATO has stated that it is: > Not necessary for the TPD insurance policy to contain a requirement that a members disability be assessed by two doctors one of whom is a specialist, but that they would expect that steps similar to this would be required. > It is also not necessary that the fund trust deed have a definition of disability that is identical to that contained in the policy. The Commissioner says it will suffice if the occasion of the insured event gives rise to a liability under or in accordance with the terms of the fund trust deed to provide a "disability superannuation benefit" to the member. > With regard to ill health the Commissioner considers the appropriate test is identical to that which 2 medical practitioners must certify for the payment of a "disability superannuation benefit". > A deduction for the entire premium will be allowed when the definition of disability within the policy is certain to meet the definition of "total and permanent disablement" and result in a fund liability. SMSFR 2012/1- limited recourse borrowing arrangements - application of key concepts 2

3 The ruling explains three key concepts central to the ability of a fund to borrow, these are: > what is an acquirable asset' and a 'single acquirable asset'; > maintaining or repairing the acquirable asset as distinguished from improving it, and > when a single acquirable asset is changed to such an extent that it is a different (replacement) asset. A single acquirable asset cannot be money and must be either a single asset (eg an individual real property) or a collection of identical assets that have the same economic value. For example, a fund may put in place a single borrowing arrangement to acquire 100 BHP ordinary shares (100 identical assets all with the same value both now and in the future). However, a single borrowing arrangement could not include the following variations: > 50 BHP ordinary shares and 50 BHP preference shares; or > 50 BHP shares and 50 Rio Tinto shares. These latter investments would require separate borrowing arrangements for each holding. Where a collection of assets is to be treated as a single acquirable asset (eg 100 BHP ordinary shares identified above), they must be treated as a block. For example, the fund could not sell just some of the shares to reduce its exposure to BHP either all of the shares must be sold or none. Likewise when purchasing the shares ATO argues that all shares must be brought at the one time and not over a period of time in instalments. The equivalent requirement for property investments is that as a general rule, only one individual property (on a single title) can be held under one borrowing arrangement (although a fund could, of course, hold multiple properties under separate arrangements). There are some exceptions to this general principle. Sometimes two or more land titles can be grouped together where there is a substantial physical feature that unifies them. For example, a factory built across 3 titles connects or unifies the 3 titles in a way which means those titles cannot, in practice, be dealt with separately. Another common situation where assets on separate titles can be dealt with together as a single acquirable asset is where State law effectively requires that to be the case (i.e. the lands titles office will not register the transfer unless both components are transferred together.). For example, laws that require a strata unit and a related car park to be sold together would mean that both the unit and the car park could be included under the same borrowing arrangement as a single acquirable asset. Repairs v Improvements A superannuation fund is able to borrow under a LBRA to carry out repairs and maintenance on an asset acquired under a LBRA. However they are only permitted to use borrowed money to repair or maintain the asset. The trustee is not permitted to borrow make improvements to an asset. If a trustee does borrow to make improvements to an asset they will have breached Section 67A of the SIS Act. Therefore the question of what is repair and maintenance? v what is an improvement? is an important one. The best place to start in answering this question is look at the definition of repair v improvement is the income tax law. 3

4 Repair is defined as remedying or making good defects in, damage to, or deterioration of an asset and contemplates the continued existence of the asset. A repair is usually occasional and partial. A repair restores the function of the asset without changing its character. Maintain on the other hand is work undertaken to prevent defects, damage or deterioration of an asset, or in anticipation of future defects, damage or deterioration, provided that the work merely ensures the continuing functioning of the asset in its present state. While to improve an asset means of the state or function of the asset is significantly altered for the better, through substantial alterations, or the addition of further substantial features to the asset. Accordingly as is clear from these definitions the important factor to focus on is whether the expenditure is going result in a substantial enhancement to the asset, with the result that the functionality has been enhanced or additional features have been added. The main area of focus on here is whether the same or different materials have been used, or you are using a modern day equivalent of materials used in the past, for example many repairs to buildings are made specifically to remove asbestos Similarly, the use of different material, whether it happens to be cheaper or more expensive than the original material being replaced, does not necessarily rule out the work being a repair. It needs to be borne in mind that repairing property to some extent improves the condition it was in immediately before repair. Whether the use of a more modern material to replace the original material qualifies as a repair is a question determined on the facts of each case. However what is determinative of whether something is a repair or improvement is whether it restores the efficiency of function of the property, without changing its character. ATO accepts that the use of different material may result in a minor and incidental degree of improvement in the property but still only restore the efficiency of function of the property. If the degree of improvement is more than minor and incidental, the expenditure will be regards as an improvement and will also not be deductible to the fund as it will be regarded as capital nature. The factors that have been taken into account in the past by the High Court in W Thomas & Co case and the Western Suburbs Cinemas case are: a) whether or not the thing replaced or renewed was a major and important part of the structure of the property; b) whether the work performed did more than meet the need for restoration of efficiency of function bearing in mind that 'repair' involves a restoration of a thing to a condition it formerly had without changing its character; c) whether the thing was replaced with a new and better one; and d) whether the new thing has considerable advantages over the old one, including the advantage that it reduces the likelihood of repair bills in the future. What if the asset is to be improved or changed in some way? Where a borrowing arrangement is used to acquire real property, it is not uncommon to do so with a view to making changes to that property at a later date. The rules governing superannuation borrowing allow some improvements to be made while the loan is in place but not if they fundamentally alter the character of the asset. If they do result in a very 4

5 substantial change, they are deemed to have effectively resulted in one asset (the original property) being replaced by another asset (the improved property). Replacements like this are not permitted while the loan is in place (although they are completely fine once the loan has been repaid). For example, a fund could not use borrowed funds to acquire a property and then do any of the following during the course of the loan: > subdivide as this would replace a single asset (the original property) with multiple assets and would not meet the single acquirable asset rules or the replacement rules; > build a house on it (assuming that the asset acquired with the borrowing was simply vacant land); > knock down (say) the house already standing on the property and replace it with several units or a commercial premises. > Build a substantial house on a small hobby farm ( assuming that no house was previously on the farm) as the asset changes from substantially farming to substantially residential However, the asset could be improved in other ways (without creating a replacement asset) as long as its essential character remained the same. For example, the following would be acceptable improvements to a house purchased as part of a superannuation borrowing arrangement: > extending a house to add new bedrooms; > adding a pool, entertainment area, new storey etc; > knock down an old house and rebuild a new one which is materially larger or constructed with superior materials. In each case the essential character of the asset remains the same it is a house. However, even these improvements cannot be financed with borrowed money the fund must use its own resources or money from external sources such as insurance pay outs etc. This is quite different to the situation that applies for repairs & maintenance (see Rule 1 on page 2). Repairs and maintenance can be financed via additional draw downs on the loan. Differentiating between the three groups (repairs / maintenance, improvements which don t result in a replacement asset and improvements which do result in a replacement asset) is often a matter of degree. The ATO has published a detailed ruling on this (known as SMSF Ruling 2012/1) which is a useful reference document. Purchasing a line of stock under a limited recourse borrowing arrangement Bought on market, an order placed with a broker may be filled over a period of time. Depending on the type of order, the shares may be acquired at varying prices over a day, week or possibly a longer time frame under separate buy contracts. An interesting question arises if a limited recourse borrowing arrangement (a LRBA ) is used to fund/part fund the acquisition. Namely, if the shares are purchased at varying prices and times under separate buy contracts, can they constitute a single acquirable asset (a SAA )? So what is the issue? Let s first break down the meaning of SAA. An asset is any form of property, including money (s 10 of the SIS Act) An acquirable asset is defined at s 67A(2) of the SIS Act as an asset, excluding money, which the trustee is not prevented by law from acquiring. 5

6 S 67A(3) then says that a SAA can extend to a collection of assets, each of which has the same market value and each of which is identical to the others. An example of a collection of shares of the same class in a single company is included to illustrate this concept. The EM to the Superannuation Industry (Supervision) Amendment Act 2010 stated that an acquirable asset is acquired at the time when the holding trustee gains a legal interest. This is at the time settlement of contract occurs. In the case of an order that is filled over the space of a single day, legal title to all the acquired shares would pass to the holding trustee on the same settlement day, and they would all be placed in the holding trust on that settlement day. Thus it would seem reasonable to argue that those shares could form a collection which comprises a SAA. In all of this, does it matter that various share parcels may have been acquired from different sellers at different prices? In my opinion, no. There is nothing in the legislation or EM or guidance issued by the ATO to suggest these are relevant matters. What if the order was filled over several days (or perhaps even a longer time period), so that the buy contracts could be grouped according to different settlement dates? Is it reasonable to argue, because the shares are all acquired under the same order, that they form a collection of identical assets and a SAA (albeit separate buy contracts)? Or would it be more reasonable to argue that only shares relating to same day buy contracts can form a SAA? Certainly when we look at disposing of shares, we would hope that an order to sell the asset that was executed over time (so that the collection of shares was not disposed of as a whole) would not breach s 67(A) of the SIS Act. Legislation Personal Property Securities Act As advisors in the self-managed superannuation fund market, we are continually called upon to advise other advisors or fund trustees on the implications of holding assets through a fund. A recent change in this area that some of us may have overlooked was the commencement of the Personal Property Securities Act 2009 (Act). This Act introduces some new concepts into Australian law regarding the concept of security involving personal property. The type of property covered by the new Act is all forms of personal property which is capable of transfer from the owner to another party, including chattels, intellectual property, debts and personal shares. Accordingly a licence that had been issued specifically to a particular entity and which could not be transferred would not be the type of property to which the Act applies. The Act also does not apply to land and fixtures. The Act introduces the new concept of security interest which is an interest in personal property provided for by a transaction, which, in substance, secures payment or performance of an obligation. What this means for superannuation funds is that, where fund assets are leased to third parties and a lender (mortgagor) to that third party takes a floating charge over the assets of the third party (and registers the interest), then the fund may lose its ability to recover those assets in the event of the third party going into liquidation. The best way to explain this is to be aware of the facts in a NZ case called Graham and Gibson v Portacom New Zealand Ltd which was decided under very similar legislation. 6

7 Portacom hired a portable room to a trading company for a period of longer than 12 months, after which time it was required to be returned to the company. As a result of the trading company getting into problems, the bank took action and appointed a liquidator. The liquidator had recourse to all of the company s assets, which it sold and transferred the net amount to the bank. Naturally Portacom was unhappy about this and took action in the High Court of New Zealand, against the purchaser of the portable room. The High Court held that the bank had the the highest security interest in all of the trading company s assets, which relegated Portacom to the status of a unsecured creditor against the trading company. This would imply that a fund that leases property to a third party risks losing those assets in the event of the lessee going into liquidation where a bank or other lender has registered a charge over the third party s assets. Fund trustees will want to protect the fund against this potential loss of assets and there are two ways they might do this. > Where a bank or other lender has not already registered a security interest in the company assets, then the fund could register a security interest over the assets they are leasing to the third party; or > Where a security interest has already been registered ( in say the form of a floating charge), the fund would need to register a purchase money security interest (PMSI) which has higher priority than a security interest. In order to be able to register these interests in the assets the fund will need to put in place a simple agreement between it and trading entity, which contains the minimum requirements to register a Security Interest Where self managed superannuation funds lease artwork or other fund assets to third parties, they are in the same position as Portacom and face the potential loss of assets in the event that the lessee goes into insolvency. To protect fund trustees from this risk, advisors need to be aware of the operation of Personal Property Securities Act, and ensure the trustee registers a security interest where appropriate. Announcements SMSF Auditors Draft legislation will amend the SIS Act to establish a new registration regime for "approved SMSF auditors". The legislation is designed to: > Establish registration requirements a person must meet to register and become an approved SMSF auditor; > Establish ongoing obligations of approved SMSF auditors, > Allow ASIC's to set competency standards ; > Allow ASIC's the power to control registrations; > Levy penalties including disqualification and suspension of approved SMSF auditors; > Impose imposed under the registration regime. Approved SMSF auditors will be required to meet a range of ongoing obligations including: 7

8 > undertake a minimum amount of continuing professional development training; > hold a current policy of professional indemnity insurance; > comply with any competency standards issued by ASIC; > comply with any auditing standards made by the AUASB; > comply with the auditor independence requirements prescribed by the regulations. The auditor must also provide a annual statement that they have met certain conditions, and provided ASIC with information regarding the number of funds they have audited over the period. The proposed amendments will commence on 31 January A person may apply to ASIC for registration as an approved SMSF auditor from this date. All auditors will be required to be registered with ASIC by 1 July 2013 to audit SMSFs after this date. 8

9 How will accountants deliver financial planning services? The last couple of months have seen a string of announcements that will have a significant impact on the way the professional accountant provides services to their clients in the superannuation and retirement area. Accountant ASFL The first was the press release by Mr Shorten, the Minister for Financial Services and Superannuation, regarding the removal of the accountants exemption and details of the SMSF Auditor registration process. Following the removal of the accountants exemption accountants will be required to obtain a limited Australian Financial Services Licence, in order to provide advice on self-managed superannuation funds and superannuation generally, as well as class of product advice on basic deposit products, general and life insurance, securities, and simple managed investment schemes. The license is not designed to enable accountants to provide product specific advice to their clients, rather it will enable low cost strategic advice to be provided. No draft legislation is currently available for this measure, however we have been assured that it will be available later this calendar year. Which it will need to be if accountants are going to be in a position to transition to the new system in the period 1 July 2013 to 30 June SMSF Auditors Registration The second part of Mr Shorten s announcement was that of auditor registration process. Auditors will need to meet the following requirements to be registered as an SMSF auditor: > hold a tertiary accounting qualification which includes an audit element, or have completed an audit component as part of a professional accounting training program; > be a fit and proper person; > hold professional indemnity insurance; > have 300 hours of SMSF audit experience in the three years prior to registration, subject to the transitional arrangements; and > pass a competency exam, subject to transitional arrangements. The transitional arrangements will smooth the way for auditors to be registered. > Auditors who sign off 20 or more audits in the 12 months prior to applying for registration, will not be required to sit the competency test; and > SMSF auditors who sign off an audit within 12 months of registration will be exempt from the 300 hours test. The transitional arrangements mean that as usual it will be much easier to register in the beginning of the process, rather than waiting a few of years before attempting to register. Exposure Draft: APES 230 Financial Planning Services As significant as the announcement of the replacement of the Accountant s Exemption and the SMSF Auditor Registration process are, in my view the major change is the release of Proposed Standard: 9

10 APES 230 Financial Planning Services which will potentially affect all accountants providing advice of a financial nature. The purpose APES 230 when it is implemented in final form is to: > Define what is regarded as a Financial Planning Service > Outline the information that needs to be conveyed to a client when a member ( a professional accountant) provides financial planning advice service > Defines the manner in which a professional accountant is able to be remunerated for financial planning services. Financial planning services as defined in the proposed standard is not limited to advice affecting a financial product. For example if an accountant were to advise a small business client on the issues that the client needs to consider with regard to their estate plan, this would be regarded a financial planning under the standard despite the fact that the accountant may not have recommended that the client invest in any financial product. Financial Planning advice is defined as follows: Means advice in respect of a client s financial affairs specifically related to wealth management, retirement planning, estate planning, risk management and related advice, including: a) Advice on financial products such as shares, managed funds, superannuation, master funds, wrap accounts, margin lending facilities and life insurance carried out pursuant to an Australian Financial Services Licence; b) advice and dealing in financial products as defined in section 766C of the Corporations Act 2001; c) taxation advice which is related to advice under (a) or (b); d) advice and services related to the procurement of loans and other borrowing arrangements, including credit activities provided pursuant to an Australian Credit Licence; and e) advice that does not require an Australian Financial Services Licence, such as real estate and non-product related advice on financial strategies or structures. Included in bold above are those areas of a financial planning service that would not normally be regarded as financial services by accountants. It can be seen that the definition is far wider than it is in the Corporations Act Having defined it in this way, the exposure draft then places responsibility on professional accountants to ensure that the service is delivered in accordance with the standard and that fees are not charged on a commission basis. The exposure draft places a great deal of emphasis on the manner in which the accountant is remunerated and specifically bans accountants from charging a fee based on the client s assets or funds under management. It also specifically bans the receipt in most cases of third party payments and soft dollar benefits, which will have a significant impact on current remuneration practices used in the mortgage broking industry. Given the removal of the accountant s exemption, the requirement to obtain a limited ASFL licence and the obligations that will potentially be imposed by APES 230 if it is introduced in its current form, accountants in coming months will need to consider how they structure their businesses in this area. 10

11 Cases Pabian Park Pty Ltd Superannuation Benefits Fund (a SMSF) and FCT In Pabian Park Pty Ltd Superannuation Benefits Fund (a SMSF) and FCT [2012] AATA 375 (21 June 2012), the AAT overturned a decision of the FCT to make a fund non-complying. This case is interesting, not just because the AAT overturned a decision to issue a notice of noncompliance, but because it gives some insights into the interplay of factors that the FCT is required to take account of in determining whether to issue a notice in cases of serious contraventions. Those factors are set out in sec 42A(5) of the SIS Act: > the taxation consequences that arise if the fund is made non-complying; > the seriousness of the contraventions, and > all other relevant circumstances. Before looking at that interplay, the main background facts are as follows: > the SMSF was established in 1994; > between February 2004 and February 2007, the SMSF loaned $307,000 to a related company. The company repaid $101,000 with interest and then a further $40,000 was loaned by the SMSF to the company in August 2007; > an ATO audit of the SMSF in October 2008 revealed an in-house asset breach; > following negotiations between the SMSF and the ATO, an enforceable undertaking was provided to the ATO in March 2009, which required the company to repay all loans by 30 September 2009; > the loan was not repaid by the agreed date, and in November 2009 the ATO issued a notice of non-compliance; > following an application for a review, the ATO confirmed its decision to make the SMSF noncomplying in April 2010; > in June 2010 the loans were fully repaid to the SMSF by the company. There was no dispute about the facts, nor that the SMSF had breached several provisions of the SIS Act, ie sections 62, 83, 84 and 109. PS LA 2006/19 sets out the factors that the FCT must consider under sec 42A(5) of the SIS Act: > The taxation consequences. The FCT acknowledges (para 30) that the consequences of making a fund non-complying will have a significant financial impact, and that a decision about non-compliance will turn on the particular circumstances of the case, the seriousness of the contravention(s), and the trustee s attitude to complying with the regulatory provisions. > The seriousness of the contraventions. There is a list of factors (para 33), any one of which may lead to the FCT deciding the contravention is serious. In this case, the loans were risky as the SMSF was being used as a lender of last resort and the loans represented over 40% of the SMSFs assets at 30 June Given this, the AAT concurred with the FCT that the contraventions were serious. 11

12 > Other relevant circumstances (para 64), such as: > Whether the trustee has rectified the contravention, entered into an enforceable undertaking or taken action to prevent the contravention recurring; > The trustee s level of skill and knowledge; > The compliance history of the fund before and after the contraventions; and > The events which lead to the contravention and whether these influenced the trustee s decision, including serious illness. The FCT submitted that although the breaches had been rectified, there was still a question of whether the SMSF had been fully restored (the question of whether all interest due on the loans, and whether the rate paid was commercial, was not resolved), and the delay in repayment and failure to comply with the undertaking weighed against him exercising discretion in favour of the SMSF. Whilst accepting the FCT submission, the AAT felt that there were other mitigating circumstances. Specifically, the distractions caused by the fact that Mrs Pabian was unwell at the time of issuing the notice of non-compliance, and the fact that the SMSF had been in existence since 1994, had no previous history of non-compliance, and was now compliant again. AAT conclusion on exercise of discretion The AAT said the crux of the matter was that the contraventions were serious and the SMSF did not rectify the breaches in a timely manner in accordance with the undertaking given to the FCT. However, the AAT felt that not to exercise discretion to overlook the breaches would be disproportionately harsh, given the 12 year history of prior compliance together with compliance since June Kelly v FCT (No 2) [2012] FCA 689 A recent case (Kelly v FCT (No 2) [2012] FCA 689) has highlighted issues for consideration when deciding whether or not a company is entitled to claim a deduction for superannuation contributions that it makes for directors. Firstly, and by way of background, the judge noted the following: 1. Section and following sections of the ITAA 1997, deal with the deduction of employer contributions for superannuation. Specifically, an employer can claim a deduction for contributions it makes for an employee for the purposes of providing superannuation benefits in the year in which it makes the contributions. For these purposes, the expanded definition of employee in s 12 of the Superannuation Guarantee (Administration) Act 1992 (SGAA 1992) is imported into the ITAA 1997 by s In the present context, s 12(2) of the SGAA 1992 is relevant in that it provides that a director who is entitled to payment for duties performed (as a director) is an employee of the company. 2. Case law has established that directors are not entitled to be remunerated for the services they provide as directors unless it is specifically provided for in the company s constitution or approved by shareholders. 3. Director remuneration is dealt with in the Corporations Act 2001 (Corps Act) in the form of what is referred to as a replaceable rule. What this means is that if the company constitution is silent on the matter, the rule in s202a(1) of the Corps Act will apply and provide that directors are to be paid the remuneration that the company determines by resolution. On the other hand, that rule can be 12

13 displaced, or modified by relevant provisions in the company s constitution. For instance, the constitution may provide that directors remuneration is to be determined by the board, or that directors are to be paid such remuneration as is determined by the company at a general meeting. In this particular case, the judge rejected the argument that the company was entitled to deductions for super contributions it had made for two directors, noting that although the company constitution provides that directors can be remunerated by way of resolution at a general meeting, there was no evidence of any resolution actually having been made. In other words, the key point is that it is not enough in itself for a company to have a mechanism via its constitution (either explicitly as in this case, or via a replaceable rule in the Corps Act, or even a combination of the two) for remunerating directors, action needs to be taken to establish an entitlement to remuneration consistent with the relevant provision. The judge also said that the fact that contributions were made did not in itself establish an entitlement to remuneration, nor did the fact that the company was trustee of a family trust, the trust deed of which provides the trustee power to pay directors. Some further relevant matters have previously been discussed in ATO ID 2007/144. To establish entitlement to remuneration in a particular year (and hence the right to deduct superannuation contributions made during that year), the resolution or meeting at which shareholders vote, must happen in the year. Neither the amount of remuneration nor the fact that it is paid in the succeeding year is relevant. Nor is how the company derives its assessable income. In the case discussed in the ID, the company s income was derived from a passive investment portfolio. Bornstein and Commissioner of Taxation (2012) The decision in Bornstein and Commissioner of Taxation (2012) AATA 424 (6 July 2012) provides a rare and unusual victory for a taxpayer. The taxpayer was the sole director and shareholder of the company from which he ran ran his business and as such was totally responsible for the operations of the business. As the taxpayer was due to travel overseas in the period 21 June to 8 July 2007 and he had always made his superannuation contributions towards the end of the financial year, the taxpayer attempted to get confirmation from his accountant as to when the employer superannuation contributions should be paid to the fund. Having received an indication from his advisor that employer SGC contributions could be made for the quarter ending on 30 June 2007 up to 28 days after the end of that quarter, the taxpayer then turned his attention to the Australian Taxation Office ATO website. It was there that he discovered a page that stated an employer could make super contributions in respect of an employee up until 28 July and still have those amounts credited to the quarter ending the previous June. As a result of his investigations the taxpayer made his contributions on the 10th of July 2008, following his return from overseas. He subsequently received confirmation from his superannuation fund that the contributions made on 10 July 2007 would be treated as contributions satisfying Superannaution Guarantee Assessment Act(SGC) obligation for the quarter ending 30 June Satisfied that the contributions made in July would be backdated to prior to 30 June 2007, the taxpayer then made additional contributions on 26 June The contributions made in June 2008 together with the contributions made in July 2007 resulted in the total contributions made for the year ending 30 June 2008, exceeding the taxpayer s concessional contribution cap. The taxpayer requested that the ATO exercise the discretion available under Section of the ITAA 1997 without success. 13

14 The Administrative Appeals Tribunal (AAT) stated that in order to exercise the discretion available under Section , that it must be satisfied that special circumstances existed and that the exercising of the discretion to treat the contribution as if it had been made in the previous period was consistent with the object of the legislation. In order for the circumstances to be considered special that is different or rare or unusual or otherwise distinguishable from the ordinary run of cases, the tribunal turned its attention to the following in forming the view that special circumstances did exist. > The taxpayer attempted to take advice from his accountant, which demonstrated that he was aware of his obligation and made an attempt to comply. > The information available on the ATO website could be seen to be confusing. > The taxpayer argued that he had been denied the opportunity to fix the error because the ATO did not notify him of his error prior to him making the subsequent contribution in June The next step for the AAT was whether the exercise of the discretion would be consistent with the objects of Division 292 of ITAA 97. The stated object of that Division is to ensure that the amount of concessionally taxed superannuation benefits that a person receives results from superannuation contributions that have been made gradually over the course of a person s life. The AAT took the view that the past contribution history of the taxpayer proved that he was building his superannuation benefits over his lifetime and that he had clearly intended the contribution to be made in a previous period. The final piece to the jigsaw was whether the excessive contribution was reasonably foreseeable at the time they were made. In this regard the judgement stated that the taxpayer, had he been properly informed, would have been aware of the consequences of making the contribution. However went on to state, I am nonetheless satisfied the discretion should be exercised in his favour. This is a case where it was clearly intended the taxpayer would make a gradual contribution towards his superannuation, as the legislative scheme intends. While he made mistakes in the way in which he sought to comply with rules, the legislative purpose would be frustrated if the taxpayer were penalised. This case is really interesting from the perspective that I am struggling to identify the issues that resulted in this taxpayer being successful, where all that went before him have failed. The only factor that may differentiate him to a small extent is the confusion as to the interaction between the SGC requirements and the timing of the making of a contribution. I guess we keep our fingers crossed that the AAT has determined to take a wider interpretation of the meaning of Section than they have in the past, and that a far greater number of taxpayers than have in the past receive a positive result when faced with an excessive contribution tax assessment. NTLG Superannuation Sub-Group The minutes for the NTLG Superannuation Technical Sub-group released in June 2012 contained a number of interesting question from practitioners In-house assets The example given was: 14

15 > The fund trustee purchases a residential property and leases it to a related party, with the consequence that it breaches the in-house asset rules. > At 30 June in the given year the in-house asset breaches the 5% cap. The question is does the residential property need to be disposed of during the following financial year, under a plan required to implemented under Section 82(4) of the SIS Act. Or if the trustee entered into an enforceable undertaking with the ATO, to never again allow the property to be leased to a related party, could the property be retained in the fund. The ATO response was: > Under Section 82 of the SIS Act a written plan to dispose of in-house assets to the extent they exceed 5% must be implemented and executed; > The in-house asset is the residential property and not the lease; > Accordingly the property must be disposed of, or a breach will occur. Reserves With increased investment in property and other lumpy assets there is increased use of insurance in funds to generate the capital to retain assets within a fund following the death of a member. The concern with these strategies is that if the policy proceeds are not immediately credited to a particular members account, then the proceeds may be considered to be a reserve for the purpose of the contribution rules contained in Section ITAA While the ATO refused to provide a definitive answer, they did make some useful observations. Firstly, if an insurance policy was paid from the general resources for the fund then in the ATO view the proceeds from an insured event would be income, profit or gain from the use of the funds capital - it would form part of the investment return. The ATO then pointed to SIS Regulation 5.03 which requires investment return to be distributed in a way that is fair and reasonable as between all members of the fund and the various kinds of benefits to each member. So the implication is that if the proceeds are distributed to all members in a fair and reasonable manner, then the proceeds will not be considered to be part of a reserve. Likewise if the premium is paid from a members account (other than the insured) then it is fair and reasonable for this amount to be credited back to that members account, and in this case the proceeds will not be taken to be credited from a reserve. Can a single acquirable asset be financed by two lenders under a limited recourse borrowing arrangement (LRBA), including one lender providing finance at the deposit stage, the other providing finance at settlement? In this regard Subsection 67A(1) of SIS Act provides an exception to the general prohibition, in subsection 67(1), that trustees of superannuation funds are not to borrow money or maintain an existing borrowing of money. To come fall into this exception, the borrowing must be made under an arrangement which satisfies the specific criteria set out in the subsection. 15

16 Those criteria do not include any restriction on the number of borrowings which might be included in the arrangement provided they are part of the arrangement that is entered into and the requirements in subsection 67A(1) are met. It must be clear from the arrangement that all monies borrowed are being applied as part of the one arrangement for the acquisition of a single acquirable asset. Also, for example, the rights of each lender (or any other person) must meet the conditions of paragraphs 67A(1)(d) and (e) of the SIS Act. Provided the requirements in subsection 67A(1) are satisfied, it is possible that money applied to acquire a single acquirable asset is able to be borrowed from two lenders under a limited recourse borrowing arrangement. When a fund borrows to make an investment - what issues need to be considered when borrowing from a related party The legislation is silent on who can lend to the superannuation fund. Consequently, the fund could borrow from any entity, including: > an unrelated third party such as a bank; or > a related party say a fund member, a family member, a business etc. The fund could even borrow from a related party (say a member) who has in turn obtained the finance from a bank or other financial institution. This option is often explored where fund members have an existing loan facility where they are able to draw down funds on favourable terms (perhaps because the lender has their home or other assets as security). A member might draw down on such a facility and then on-lend this money to his or her self managed superannuation fund. It is only the second loan (from the member to the fund) that must comply with the rules here (ie limited recourse etc). The terms and conditions of the original loan facility are not dictated by the SIS rules. Where a fund is borrowing from a related party, the question that is most often raised is do we need to charge an arms-length rate of interest. Previously we would have recommended that the loan is provided on an arms length basis. In particular, we believed it was prudent for the terms of the loan to be no more or less favourable to the fund than if the lender really had been an external party. However the most recent NTLG Superannuation Sub Committee dealt with a number of questions that now make clear that the ATO view is that an arms-length commercial rate of interest is not necessary in order to have a valid LBRA. The two questions asked were: Firstly, if a related party lender offers a discounted rate of interest to an SMSF under a section 67A borrowing arrangement, would the discount be considered a contribution received by the SMSF?: and Second, can an SMSF enter into a borrowing arrangement under section 67A of the Superannuation Industry (Supervision) Act 1993 (SISA) with a related party if a zero rate of interest is charged by the related party lender and only principal repayments, with no imputed interest, are made throughout the loan term in accordance with the loan agreement? With regard to the first question the ATO responded: "No. The absence of a requirement to pay interest on money loaned to the trustee does not increase the capital of the fund. A saving on an expense of an SMSF in the circumstances described is 16

17 analogous to the circumstances outlined in examples 2 and 5 in Taxation Ruling TR 2010/1 Income tax: superannuation contributions. The purpose of a person in offering a low interest loan to an SMSF does not fall for consideration if there has been no increase in the capital of the fund. The outcome is different if, for example, interest incurred by the fund is paid by a third party, forgiven or reimbursed. In all of those circumstances the capital of the fund is increased as the interest liability has been met by a third party or forgiven or an amount has been reimbursed to the SMSF." With regard to the second question as to whether it was necessary to charge any interest at all, the ATO stated: "Yes. A lower than market interest rate or the absence of a requirement to pay interest on money loaned to the trustee by a related party will not prevent the arrangement from being a borrowing for the purposes of section 67A of the SIS Act. The ATO recognises that while the obligation to pay interest may evidence the existence of a borrowing of money, it is not a necessary feature of such a borrowing (see paragraph 48 of SMSFR 2009/2). If such a borrowing is entered into between an SMSF trustee and a lender that is a related party of the fund, a fact that the borrowing is interest free does not cause a contravention of paragraph 109(1)(b) of the SIS Act as that fact does not make the terms and conditions of the borrowing more favourable to the related party lender than would be reasonably expected if the parties were dealing with each other at arm's length in the same circumstances. Further, as noted in ATO Interpretative Decision ATO ID 2010/162, subsection 109(1A) of the SIS Act applies after an investment to which paragraph 109(1)(b) applies has commenced and is interpreted in that context. As a result, if such a borrowing is entered into between an SMSF trustee and a lender that is a related party of the fund, for example by refinancing the original loan, a fact that the borrowing is interest free does not cause a contravention of subsection 109(1A) for the same reasons as stated above in relation to paragraph 109(1)(b) of the SIS Act. Note: The ATO initial response has been prepared on the basis that the arrangement is, in fact, a borrowing for the purposes of section 67A of the SIS Act A borrowing, for the purposes of section 67A of the SIS Act, is an arrangement for the payment of an amount of money from one party to another where the parties intend that it will subsequently be repaid to the lender. Although a borrowing arrangement will commonly involve an interest charge, the absence of interest will not, of itself, preclude an arrangement from being a borrowing. To determine whether a related party transaction does, in fact, amount to a borrowing, the ATO will consider any documentary evidence that is available together with any other evidence, for example whether any repayments of the amount borrowed are made. Further information is available in SMSFR 2009/2 on the ATO's view of the meaning of a borrowing in the relevant context. It should also be noted that Taxation Ruling TR 2010/1 Income tax: superannuation contributions explains the circumstances in which the forgiveness of a loan may constitute a contribution by the lender to a superannuation fund." The information outlined above makes clear that a loan provided from a related party will breach the contribution rules, the arms-length income requirements or Section 109 of the SIS Act. However care needs to be taken to ensure that arrangement does validly form a loan, because if this is not achieved then the loan will be classified as contribution and potentially have dramatic excessive contributions tax consequences. 17

18 General information only This presentation is provided as general information only and does not consider your specific objectives, situation or needs. You should not rely on the information in this presentation or disclose it or refer to it in any document. We accept no duty of care or liability to you or anyone else regarding this presentation and we are not responsible to you or anyone else for any loss suffered in connection with the use of this presentation or any of its content. Disclaimer This paper represents the opinion of the author(s) and not necessarily those of the Institute of Chartered Accountants in Australia (the Institute) or its members. The contents are for general information only. They are not intended as professional advice - for that you should consult a Chartered Accountant or other suitably qualified professional. The Institute expressly disclaims all liability for any loss or damage arising from reliance upon any information in these papers. 18