TH9 Solving the common issues and contraventions in SMSF audit

TH9 Solving the common issues and contraventions in SMSF audit Shirley Schaefer FCA Partner Superannuation BDO Advisory (SA) Pty Ltd & BDO Audit (SA) Pty Ltd Chartered Accountants Australia and New Zealand is a trading name for the Institute of Chartered

SMSF Common Contraventions While a superannuation trust deed may provide for other or ancillary purposes for the operation of a Self Managed Superannuation Fund (SMSF), it is the provision of retirement benefits for members that is the primary purpose. The SMSF must be established for the sole purpose of providing for retirement benefits for members 1 and the investments or assets must enable the SMSF to meet this sole purpose. The sole purpose test is the overarching test of compliance for the SMSF. The specific investment rules or investment restrictions within the Superannuation Industry (Supervision) Act & Regulations 1993 (SISA & SISR) follow this fundamental principal of SMSF establishment. This paper looks at four of the more common contraventions that found within SMSFs by SMSF auditors. The paper is not intended to be an extensive technical guide. Borrowings by SMSFs Generally SMSFs are prohibited from borrowing monies 2. There are only limited circumstances in which SMSF s can borrow money. These include: borrowing to pay beneficiaries (where the borrowing is for <90 days and <10% of the value of the fund s assets); borrowing to pay superannuation surcharge payments (where the borrowing is for <90 days and <10% of the value of the fund s assets); borrowing to settle securities/investment transactions (where the borrowing is for <7 days and <10% of the value of the fund s assets); and borrowing in accordance with the limited recourse borrowing arrangements (LRBA) 3. For the borrowing arrangements to meet the LRBA exception outlined above it must have the following features: the loan is used to acquire an asset permitted under SIS; the asset is held on trust for SMSF; the trustee must have the right to acquire remaining interest in the asset by payment of instalments; the loan is non recourse; and existing assets of the fund are not used to secure the borrowing. In 2012 the ATO released a ruling on Limited Recourse Borrowing Arrangements (SMSFR 2012/1). This ruling was broadly supported by SMSF industry participants as it took a practical approach to the interpretation of LRBA s. The following are the main points taken from the ruling: In determining what is an acquirable asset and single acquirable asset : Both proprietary rights (legal form) and the substance of the asset acquired need to be taken into account. If the asset can be dealt with separately on different 1 Section 62 SIS 2 Section 67 SIS 3 Section 67A & 67B SIS

titles, then it will be more than one asset. Consideration also needs to be given to specific laws of a State or Territory that may prevent the assets being dealt with separately. In distinguishing between maintaining, repairing and improving a single acquirable asset: There is no need to distinguish between maintaining and repairing, as both are allowed to be funded from borrowed moneys under section 67(A) of SISA. Maintaining means work done to prevent or in anticipation of future defects, damage or deterioration of an asset to ensure the functional efficiency of the asset is maintained in its present state. Repairs refer to restoring the functional efficiency of the asset without changing its character and may include restoration to its former appearance, form, state or condition. Improvement refers to when the functional efficiency of the asset or the value of the asset is substantially increased. Care needs to be taken with improvements so that the asset is only improved, rather than becoming a new or replacement asset. Consideration of both the proprietary rights and the physical object is required to determine if the character of the asset as a whole has fundamentally changed. Borrowings under an LRBA cannot be used to improve an acquirable asset, but money from other sources could be used to improve (or repair or maintain) that asset. Jupiter Super Fund The Jupiter Super Fund is a small SMSF with only one member and an average annual balance of $60,000. The fund composition and balance has not changed substantially in a number of years and the member makes limited contributions to the fund each year. The member is a stockbroker by profession and uses his expertise to manage his SMSF. The Jupiter Super Fund actively trades in listed shares throughout the year. The average value of each share trade is approximately $20,000. The bank account of the Jupiter Super Fund is overdrawn regularly as a result of these share trades, however, the bank account overdrawings are rectified usually within 3 days (as share trades are settled). A bank account overdrawing is prima facie a borrowing These bank account overdrawings are therefore a contravention of s.67 of SISA The period for which the bank account is overdrawn is below the 7 day time limit of s.67(3) The value of each overdrawing exceeds the 10% of assets threshold of s.67(3) The time limit and assets threshold tests must both be met to meet the exemption provided by s.67(3) Juno Super Fund The Juno Super Fund has $500,000 in assets for two members. The trustees of the fund have most of the fund invested in longer term bank deposits and as such the bank account of the fund does not hold a significant balance. The Juno Super Fund has taken out life insurance policies over the lives of the members and the payment of the life insurance policy premiums has been set up as a direct debit to the bank account on a monthly basis. Because the trustees maintain a low bank account balance it is not uncommon for the payment of the insurance premiums to regularly put the bank account into an overdrawn position. The trustees rectify the bank account overdrawing by making additional contributions to the Juno Super Fund as soon as they are advised that the account is overdrawn, however, it usually takes 10 to 14 days to rectify the bank account. A bank account overdrawing is prima facie a borrowing These bank account overdrawings are therefore a contravention of s.67 of SISA Payment of expenses by the fund is not an exemption under s.67of SISA

Neptune Super Fund The Neptune Super Fund has acquired a commercial property from an unrelated party using a LRBA to finance the acquisition of the asset. The borrowing has been provided by a Roman Commercial Bank. As auditor of the Neptune Super Fund you have been provided with the following documentation A contract for purchase of the property (single title reference) A lease agreement between the Security Trustee and the Neptune Super Fund A lease agreement between the Neptune Super Fund and an unrelated tenant A loan agreement from Roman Commercial Bank (taken out by the Security Trustee) that provides for recourse to the assets of the Neptune Super Fund in the event of default by the Security Trustee A copy of the property title, showing the Security Trustee as the owner of the property and a mortgage registered by the Roman Commercial Bank (no other charges or encumbrances are registered) This LRBA arrangement is considered in light of the requirements of SISA as follows: The borrowing has been used to acquire a single acquirable asset (the property is on a single title and has been acquired from an unrelated party The asset is not subject to a charge, except for lender s security (no other charges are registered on the title) The asset is NOT held on trust (the Security Trustee has leased the property to the Neptune Super Fund implying that the Security Trustee holds the property in its own right, rather than holding it for the benefit of the members of the Neptune Super Fund). The SMSF does NOT have the right to acquire the legal ownership (the loan agreement has been established with the Security Trustee, rather than the Neptune Super Fund, therefore the Neptune Super fund is not a party to any arrangement to acquire the legal ownership). The lender s right to recoup the loan is NOT limited to the asset acquired by the LRBA (the loan agreement specifically provides recourse to all of the assets of the Neptune Super Fund). In House Assets By far the most complex investment prohibitions and rules are around investments by a SMSF in or with a related party. These are commonly known as in house assets. An in house asset is a loan to, lease to or investment in a related party of the SMSF. In house assets are limited to 5% of the total value of an SMSF s assets. A related party is defined in section 10 of SISA as: A member of the fund A standard employer sponsor of the fund Part 8 associate of an entity referred to above A Part 8 Associate is a complex definition and can be found in sections 70B to 70D of SISA: Part 8 Associate of an individual A relative of the individual; Each member and trustee (or director of the corporate trustee) of the fund;

a partner of the individual or a partnership in which the individual is a partner (including spouses & children of the partners); A trustee of a trust (in the capacity of trustee of that trust), where the individual controls the trust; and A company that is sufficiently influenced by, or in which a majority voting interest is held by: o the individual; or o Part 8 Associate of a company Another entity that is a Part 8 associate of the individual because of another paragraph of this section or because of another application of this paragraph. partner of the company or a partnership in which the company is a partner; if a partner of the company is an individual the spouse or a child of that individual; A trustee of a trust (in the capacity of trustee of that trust), where the company controls the trust; Another entity (in this paragraph called the controlling entity) where the company is sufficiently influenced by, or a majority voting interest in the company is held by: o the controlling entity; or o o Another entity that is a Part 8 associate of the controlling; or 2 or more entities covered by the preceding subparagraphs; Another company (in this paragraph called the controlled company) where the controlled company is sufficiently influenced by, or where a majority voting interest in the controlled company is held by: o the company; or o o Another entity that is a Part 8 associate of the company because of another paragraph of this section or more entities covered by the preceding subparagraphs; and if a third entity is a Part 8 associate of the company because of paragraph (d) of this subsection an entity that is a Part 8 associate of that third entity because of section 70B or 70D or because of another paragraph of this section. Part 8 Associate of a partnership a partner in the partnership; if a partner in the partnership is an individual any entity that is a Part 8 associate of that individual because of section 70B; and if a partner in the partnership is a company any entity that is a Part 8 associate of that company because of section 70C. It is important to remember when determining whether an entity is a related party, you need to look beyond the SMSF s own interest in the entity. For SISA purposes, control is based on the SMSF s interest, the interest held by an members of the fund (and their spouses) and interests held by the SMSF s related parties (and their spouses). It will be important to ensure that the relationship of all owners of a company or trust to the SMSF and its members are known. There are a number of exceptions to the in house asset restrictions listed in section 71 of SISA. These include:

a life policy issued by a life insurance company a deposit with an ADI an investment in a pooled superannuation trust, where a trustee of the fund and the trustee of the pooled superannuation trust acted at arm's length in relation to the making of that investment an asset which the Regulator, by written notice given to a trustee of the fund, determines is not an in house asset of the fund an asset which the Regulator, by legislative instrument, determines is not an in house asset real property subject to a lease, or to a lease arrangement enforceable by legal proceedings, between a trustee of the fund and a related party of the fund, if, throughout the term of the lease or lease arrangement, the property is business real property of the fund an investment in a widely held unit trust property owned by the superannuation fund and a related party as tenants in common, other than property subject to a lease or lease arrangement between a trustee of the fund and a related party an asset included in a class of assets specified in the regulations. The most common exceptions (or exclusions) from the in house asset rules and limits are: the lease of business real property to a related party; investment in a related trust or company, where that company or trust is un geared and its main asset is business real property 4 ; investments in related entities that existed prior to 11 August 1999 and only became in house assets because of the change of definition of related party at that time; and investments acquired under the transitional rules to the in house asset tests. As a large part of the exceptions to the in house asset rules revolve around the concept of business real property it is important to understand what constitutes business real property. Firstly, the property must be real property; i.e. freehold or leasehold interest in land. Secondly the property must be used wholly and exclusively for business purposes (or used in someone s business). The ATO has issued guidance on what constitutes business real property. This can be found in SMSFR 2009/1 business real property for the purposes of SISA. The ruling provides a significant number of examples as to the ATO s interpretation of the definition of business real property, covering primary production and vacant land, holiday rental property, hotel or bed & breakfast operations, business operated from the member s home and letting and sub letting of property. The ruling can be a useful tool in understanding the ATO s view on their interpretation of the definition of business real property. Due to the change in SIS legislation that became effective from 11 August 1999, the legislators included transitional rules that could be applied for investments/assets acquired for the 10 years to 30 June 2009. This was implemented to allow SMSFs to change their investment arrangements, particularly in relation to investments in related entities. The 4 Regulation 13.22A-13.22D SISR

following classes of investments/transactions were permitted to be made up to 30 June 2009 and would not be counted towards the in house asset limit: unit trusts/companies reinvestment of distributions or dividends into new units/shares geared unit trusts/companies investment of new capital to a maximum value of the loan outstanding as at 11/8/99 unit trusts/companies payment of additional capital requirements on partly paid units or shares held at 11/8/99 Any investments made in related entities after 30 June 2009, either by way of distribution or dividend reinvestment or by way of new capital introduced, is measured as an in house asset and cannot exceed 5% of the market value of the assets of the SMSF. It is important to note that it is only the new units or shares acquired after 1 July 2009 that will count towards the in house asset thresholds. Any units or shares held/acquired prior to this date under the transitional rules will continue not to be counted/classified as an in house asset. It is permitted for a SMSF to hold in house assets, there are just specific limitations and compliance sections that need to be tested to ensure the acquisition or holding of the in house asset complies with the relevant SISA requirements. The specific compliance sections that need to be tested when reviewing a transaction with a related party include: Section 82: Where a SMSF holds in house assets that exceed 5% of the value of the SMSF s assets at 30 June of each year, the trustees are obliged to implement a written plan to dispose of the in house asset by the 30th June of the next financial year. The in house asset ratio is measured as the market value of the asset divided by the market value of the total of the fund s assets at 30th of June of each year. Section 83: Prohibits a SMSF from acquiring an in house asset when the in house asset ratio already exceeds the 5% threshold or that causes the fund s in house asset ratio to exceed 5% at the date of acquisition. The in houseasset ratio is measured as the market value of the asset divided by the market value of the total of the fund s assets at the date of acquisition. Section 84: Requires the trustee of a SMSF to take all reasonable steps to comply with the in house asset rules and restrictions. It could be suggested that knowingly entering into a transaction that breaches the in house asset restrictions would not be considered taking all reasonable steps. Section 85: A SMSF trustee must not enter into an arrangement to avoid the in house asset restrictions. This could include entering into an arrangement with an unrelated party, with a separate arrangement to then pass on the asset/transaction to a related party of the SMSF; or obtaining false valuations to misstate the in house asset ratio. Pluto Super Fund The Pluto Super Fund was established in the early 1990 s with two members and two individual trustees. The assets of the Pluto Super Fund consist of cash, shares and managed funds and tourist park cabins. The tourist park cabins are leased (on an arms length basis) to the members to use in their business. The members own and operate a tourist park. The tourist park cabins represent 40% of the market value of the asset s of the Pluto Super Fund. The ATO has previously reviewed the operations of the Pluto Super Fund (in 1996) and the arrangement with the tourist park cabins was compliant at that time. However, with the change to the definition of a related party in 1999 (and changes to the in house asset rules from 11 August 1999), the arrangement regarding the leasing of the tourist park cabins to the member s business became an in house asset (where new leases were entered into after 11 August 1999). The tourist park cabins do not meet the definition of business real property (to be exempt from the in house asset restrictions) as the Pluto Super Fund did not

have any interest in the underlying land to which the tourist park cabins were attached. To meet the definition of business real property, the Pluto Super Fund would need to have either a freehold or leasehold interest in the land as well as the tourist park cabins. As a consequence the Pluto Super Fund held in house assets from at least 30 June 2000. No written in house asset plan had been implemented by the trustees to dispose of the tourist park cabins by 30 June 2001 a breach of section 82 of SISA. Each time the Pluto Super Fund entered into a new lease with the member s to lease a tourist park cabin to them, they were acquiring an in house asset (in most cases > 5% of the market value of the assets of the Pluto Super Fund) a breach of section 83. In addition the trustees had not taken all reasonable steps to comply with the in house asset restrictions a breach of section 84. The lack of knowledge of the trustees (or the failure of previous advisors and accountants to identify this contravention) is not considered by the ATO to be a defense against this section. On identification the trustees of the Pluto Super Fund took action to dispose of the in house asset (the tourist park cabins). The trustees were in the process of selling their business, including all plant and equipment. The in house asset position was rectified within 15 months. Mars Super Fund The Mars Super Fund was established in the 1990 s. The assets of the Mars Super Fund included an investment in a related unit trust (the Mars Unit Trust). The investment in the Mars Unit Trust was originally entered into prior to 11 August 1999 and between 11 August 1999 and 30 June 2009, distributions payable to the Mars Super Fund were reinvested into new units in the Mars Unit Trust. The investment in the Mars Unit Trust is exempt from the in house asset restrictions by virtue of the exemptions outlined in sections 71A 71D of SISA. In addition to the investment in units, the Mars Super Fund held, as an asset, an amount owing from the Mars Unit Trust by way of a beneficiary loan account (unpaid present entitlement). This asset is considered separately to the super fund s investment in units. At 30 June 1999 the value of the beneficiary entitlement account was nil. By 30 June 2014 the beneficiary entitlement account was $200,000. The beneficiary entitlement account (by the virtue that it represented more than the unpaid present entitlement from the 2014 financial year) is an in house asset. The trustees of the Mars Super Fund should have had a written in house asset plan in place to dispose of the in house asset (repay the beneficiary entitlement account to the Mars Super Fund) as soon as the value of the beneficiary entitlement account exceeded 5% of the market value of the assets of the Mars Super Fund a breach of section 82. In addition any acquisition (or increase) in the beneficiary entitlement account that caused the in house asset ratio to exceed 5% of the market value of the assets of the Mars Super Fund is a contravention of section 83. Finally, the fact that the trustees of the Mars Super Fund allowed the beneficiary entitlement account to exceed 5% of the market value of the assets of the Mars Super Fund would be considered to be a contravention of section 84. To rectify these contraventions that beneficiary entitlement account will need to be repaid to the Mars Super Fund, either by way of cash payments, or alternatively it may be possible to transfer assets of the Mars Unit Trust directly into the Mars Super Fund (as an in specie payment). Mercury Super Fund The Mercury Super Fund was established in the 1990 s. The assets of the Mercury Super Fund include an investment in a related unit trust (the Mercury Unit Trust). The investment in the Mercury Unit Trust was originally entered into prior to 11 August 1999 and between 11 August 1999 and 30 June 2009, distributions payable to the Mercury Super Fund were reinvested into new units in the Mercury Unit Trust. Additionally, new units were acquired in the Mercury Unit Trust in the 2011 financial year.

The quantum of units invested in the Mercury Unit Trust, up to 30 June 2009, are exempt from the in house asset restrictions by virtue of the exemptions outlined in sections 71A 71D of SISA. However, the units acquired in the 2011 financial year represent an in house asset of the Mercury Super Fund (this was identified by the auditor of the Mercury Super Fund and reported to the ATO). The principal asset of the Mercury Unit Trust is business real property and is leased to the member s business as their principal place of commercial operations. The property was revalued in the Mercury Unit Trust in the 2013 year and this saw a significant increase in the value of the property and as a consequence a significant increase in the value of investment in the Mercury Super Fund (from $400,000 to $2,500,000 the property had been improved over the years). The ATO conducted an audit of the Mercury Super Fund and as well as the in house asset contravention identified by the auditor, the ATO also identified that the acquisition of units in the Mercury Unit Trust during the period 11 August 1999 to 30 June 2009 were a contravention of section 66 of SISA. Section 66 of SISA prohibits the acquisition of assets from related parties, with some exceptions. One of the exceptions is that a SMSF can acquire assets from related parties if they meet the following conditions: the asset acquired is an in house asset per s.71(1); or would be an in house asset apart from transitional rules; and the asset is acquired at market value; and the acquisition does not result IHA > 5% The ATO determined that the units in the Mercury Unit Trust had been acquired between 11 August 1999 and 30 June 2009 at $1 per unit. Due to the recognition of the significant increase in the value of the underlying property of the Mercury Unit Trust in the 2013 financial year (and consequently the increase in the value of the units of the Mercury Unit Trust) the ATO concluded that the Mercury Super Fund had not acquired these units at market value at that time; in contravention of section 66 of SISA. The ATO did not conclude that there had been a contravention of the in house asset restrictions between 11 August 1999 and 30 June 2009 (only in the 2011 financial year). However, rectification of the contravention of section 66 of SISA was required. The trustees of the Mercury Super Fund were required to dispose of the units in the Mercury Unit Trust that were acquired in contravention of section 66 of SISA (ie the units acquired between 11 August 1999 and 30 June 2009). The trustees determined that the Mercury Super Fund should acquire the underlying property from the Mercury Unit Trust. The property is business real property and there can be acquired from a related party without contravening section 66. The property is to be acquired from the Mercury Unit Trust with a Limited Recourse Borrowing Arrangement (that meets the necessary conditions of section 67A of SIS). This will provide cash to the Mercury Unit Trust. The Mercury Unit Trust can then redeem the units held by the Mercury Super Fund (effectively disposing of the units acquired by the Mercury Super Fund in contravention of section 66 of SISA). Provision of financial assistance to members & relatives Financial assistance provided to members or relatives is prohibited under SIS 5. The concept of financial assistance is broader than simply a cash loan to a member. Financial Assistance could include the payment of expenses on behalf of 5 Section 65 SIS

the member, the deposit of super fund monies into another bank account of the member, or the use of a super fund asset as security for personal loans. The ATO has issued guidance on what it considers to be the relevant factors when considering if a SMSF has provided financial assistance to a member or a relative. This can be found in SMSFR 2008/1 giving financial assistance using the resources of a SMSF to a member or relative of a member that is prohibited for the purposes of s.65(1)(b) of SIS. The ruling provides examples in relation to what the ATO believes will constitute the provision of financial assistance. Many of the examples concentrate on where the resources of the SMSF are used for personal use, rather than on just the provision of cash assistance. The ruling can be a useful tool in understanding the ATO s view on their interpretation of section 65 and the provision of financial assistance. Apollo Super Fund The Apollo Super Fund is being audited for the year ended 30 June 2014. Included in the assets of the Apollo Super Fund is a loan to a relative (an aunt) of one of the members. The loan is supported by a written loan agreement (prepared by a solicitor) and interest is payable on the loan at the rate of 7% per annum. The loan was provided to the relative to enable them to enter an aged care facility (to assist in paying the bond required before the relative s residence was sold). The trustee, who is a barrister & solicitor, has asserted to the auditor that the loan is permitted as it represents less than 5% of the market value of the assets of the Apollo Super Fund. If the value of the loan is less than 5% of the market value of the assets of the Apollo Super Fund, then there will be no contravention of the in house asset restrictions (sections 82 84 SISA). However, there is no allowable limit under section 65 of SISA. An aunt is included in the definition of relative in section 10 of SISA and therefore the loan to the aunt is a contravention of section 65. To rectify this contravention the loan must be repaid in full to the Apollo Super Fund. Diana Super Fund The Diana Super Fund is being audited for the year ended 30 June 2013. The assets of the Diana Super Fund include listed shares and managed funds and a bank account. The auditor has requested the bank statements as part of his audit and has noted that the bank account appears to only be in the name of the members (with no indication that the bank account is held for or on account of the Diana Super Fund). This may represent a contravention of section 52B(2)(d) and regulation 4.09A of SISA/SISR, unless the auditor can find additional information that indicates that the fund is clearly held for or on account of the Diana Super Fund. In addition, the bank account of the Diana Super Fund is included on a single bank statement that includes a personal home loan bank account. Further investigations by the auditor indicate that the amount of interest charged to the home loan bank account has been reduced by the credit in the bank account of the Diana Super Fund (the bank account is being used as an offset account for the home loan). This is clearly using the financial resources of the Diana Super Fund to provide financial assistance to the members of the Diana Super Fund, in contravention of section 65. The trustees will be required to transfer the bank account to a bank account that is clearly for the Diana Super Fund and to ensure that the account is not classified as an offset account for the member s home loan. In addition, the members should ensure that any benefit lost by the Diana Super Fund (in foregone interest income) is repaid to the super fund. Early Access of SMSF Benefits

Monies contributed to a superannuation fund are required under SISA to be preserved (retained in the superannuation system) until the members are able to access those benefits in accordance with SISA/SISR. There are three categories of superannuation benefits as defined by the SISR: Preserved (retained in the superannuation system until condition of release is met). Restricted non preserved (are not preserved but cannot be released until a condition is met). Preserved benefits accrued before 1/7/99 in an employer sponsored fund are restricted while the member is an employee of the employer. Upon terminating employment, the benefits become unrestricted and can be paid out if a condition of release has been met. Unrestricted non preserved (have already met a condition of release and can be paid out). Preserved benefits cannot be accessed until a condition of release, as prescribed by SISA/SISR, is met 6. The following are the prescribed conditions of release: achieving age 65 years; retirement (post preservation age); ceasing work after age 60 years; death; terminal medical condition (as certified by two medical practitioners); permanent disability (as certified by two medical practitioners); temporary disability; permanent departure from Australia; compassionate grounds; severe financial hardship; commencement of a Transition to Retirement Income Stream; and superannuation benefits < $200. With changes to the taxation of benefits from 1 July 2007 it is important to remember that turning 60 years of age is not of itself a condition of release. Benefits cannot generally be accessed until a member has reached their preservation age. The following table outlines a members preservation age, which depends on their date of birth: Date of Birth Pre 1 July 1960 Preservation Age 55 years 1 July 1960 30 June 1961 56 years 1 July 1961 30 June 1962 57 years 1 July 1962 30 June 1963 58 years 6 Regulation 6.17 SISR & Schedule 1 SISR

1 July 1963 30 June 1964 59 years Post 30 June 1964 60 years Benefits can be withdrawn as either lump sum payments or an annual income stream (pension). Early access to superannuation benefits represent a contravention of Regulation 6.17 and if not rectified (returned to the SMSF) they will be taxed in the hands of the member at a non concessional income tax rate. Minerva Super Fund The Minerva Super Fund is undergoing an audit for the year ended 30 June 2014. The super fund only has one member and the member is 50 years of age. The assets of the Minerva Super Fund are cash at bank representing 85% of the fund and collectible assets, representing 15% of the fund. The member has provided the auditor with a copy of the bank statement of the Minerva Super Fund, the balance agrees to the amount shown in the financial statements of the Minerva Super Fund. Due to the significance of cash as an asset of the Minerva Super Fund the auditor has requested a bank confirmation certificate. The request for the bank confirmation resulted in the member admitting that he may have doctored the bank statements that were provided to the auditor. The member has further advised that over the past two years he had withdrawn most of the cash from the bank account of the Minerva Super Fund and that cash was stored in the member s home safe. The previous auditor of the fund had been aware of this and had requested that the member sign a statutory declaration attesting to the existence and value of the cash held in the safe. The member then provided the original bank statements to the auditor, showing a significantly lower balance in the bank account of the Minerva Super Fund. The member then advised that the cash had been used in his business and at this point in time the cash could not be returned to the Minerva Super Fund. The member had been attempting to rectify the position by returning monies to the bank account. The auditor identified the following SISA/SISR contraventions: Regulation 6.17 accessing superannuation benefits without meeting a condition of release Section 65 provision of financial assistance to a member Sections 82 & 84 contravention of the in house asset restrictions Section 62 contravention of the sole purpose test The member then provided the auditor with a written loan agreement between the Minerva Super Fund and the member s business (including the requirement to pay interest to the Minerva Super Fund at a rate of 5% per annum). However, rectification of the contraventions will only be achieved by repayment of the monies to the Minerva Super Fund (including the interest due on the loan). Conclusion In many cases, contravention events will breach more than one section or regulation of SISA/SISR, as demonstrated in the examples above. It is important that the auditor can identify all contraventions that have occurred. When identifying the different contraventions, it is important to remember that different values may be ascribed to different contraventions. For example a loan to member may have the following contraventions and values: Section 65 the whole of the loan Section 82 the amount of the loan > 5% of the market value of the fund s assets

Section 83 the amount of the loan acquired that caused that in house asset ratio to exceed 5% Vesta Super Fund The Vesta Super Fund was established in 2009. The fund has four members, father, mother, daughter and son in law. The Vesta Super Fund was established to acquire farming property (on two titles) via Limited Recourse Borrowing Arrangements. The farming property was then leased to a partnership of the daughter and son in law (a related party). The lease of the property is a lease of business real property and is therefore exempt from the in house asset restrictions. The documentation and structure of the Limited Recourse Borrowing Arrangement is in order and there is no contravention of section 67A of SISA. The Vesta Super Fund has not received any rental income from the farming partnership for the past three years. The related party has cited a lack of surplus cash as the reason that the rental income was not paid to the Vesta Super F und. The Vesta Super Fund has brought a the amount of outstanding rental to account as a debtor of the fund (it represents 15% of the fund s assets). The lease arrangement between the Vesta Super Fund and the farming partnership was established by a written lease arrangement drafted by a legal firm. The following contraventions were identified: Section 65 provision of financial assistance to a member or relative Section 66 & 83 acquisition of an in house asset > 5% Section 82 & 84 no written in house asset plan in place to dispose of the in house asset and the trustees have not taken all reasonable steps to comply with the in house asset restrictions Section 109 no arms length transactions. The terms of the lease agreement were not followed, no action was taken by the trustees of the Vesta Super Fund to recover the amount of rental outstanding (per the lease agreement) and no interest was charged on the amount of rental outstanding (per the lease agreement) In addition the bank account of the Vesta Super Fund has been overdrawn for the past two years (due to the non receipt of rental income and the payment of interest on the LRBA loans. This is a contravention of section 67 of SISA. Finally the auditor qualified their audit report in relation to section 62 of SISA the sole purpose test. The auditor did not believe that the Vesta Super Fund was being maintained with the sole purpose of providing retirement or death benefits to the members or their beneficiaries. In order to rectify the identified contraventions the trustees are required to: Prepare a written in house asset plan outlining how the excess in house asset (rental debtors > 5% of fund assets) will be disposed of Apply interest to the outstanding rental debtors in accordance with the written lease agreement Prepare a formal repayment schedule for repayment of the rental debtors and actually repaying the amounts owing to the Vesta Super Fund Rectify the overdrawn bank account balance (by way of collection of rental debtors or making additional contributions) The key issue for the trustee is how they are going to finance the repayment of the rental debtors. Repayment of this amount would dispose of the excess in house asset and rectify the bank account overdrawing at the same time. The following was suggested as alternatives: The farming partnership could borrow monies to make payment of the rental debtors

The father (age > 65 years) could take a lump sum benefit from the fund, that was paid by the Vesta Super Fund inspecie; ie the rental debtor asset was transferred to the father. This would rectify the contraventions associated with the rental debtor account, but would not rectify the overdrawn bank account. The older members (mother and father) could make additional non concessional contributions to the fund (both are still employed) the father culd than take cash benefits from the Vesta Super Fund. He could gift the cash to his daughter, who would then contribute the cash to the farming partnership and the farming partnership would repay the rental debtor owing. Before any of these suggestions could be agreed between the members or actioned, the bank exercised its security under the LRBA and appointed a Receiver and Manager to the property. The property is now being marketed for sale. The members have agreed that the instructions of the Receiver and Manager should be extended to sell the farm (property, livestock and equipment) as a going concern. This should: Provide sufficient cash to the farming partnership to rectify the rental debtors (including interest payments) Provide sufficient cash (after the repayment of the bank loans) to rectify the overdrawn bank account It is then the intention of the members to transfer the remaining cash (members benefits) to other super funds and wind up the Vesta Super Fund.

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