Self-Managed Superannuation Funds as wholesale clients One of the means of classifying a client as a wholesale client for the purposes of the financial services laws is to obtain a certificate from an accountant to the effect that the client meets either the income or assets individual wealth tests. However, these tests are not straightforward and raise a number of issues when the client is an SMSF. Somewhat surprisingly, this area of law has received little consideration in the Courts to date with the result that a number of different views of the operation of these laws can be found amongst lawyers practising in this area and with ASIC, the financial services regulator. This article examines the nature of the wholesale client eligibility tests with particular emphasis on the application of the individual wealth tests in the SMSF context. It is in 4 parts: Part A covers the wholesale/retail client distinction generally. Part B looks specifically at the use of "accountant's certificates". Part C looks at the other eligibility tests. Part D provides answers to frequently asked questions. Part A: The wholesale/retail client distinction generally 1. The distinction between wholesale and retail clients 1.1 The distinction between wholesale and retail clients has been a fundamental part of the financial services laws since the 2004 Financial Services Reform legislation. Under those laws a person is either a wholesale client or a retail client in relation to a particular financial product or service 1. As will be seen below, a person can be both at the same time in relation to different products and services. 1.2 The main effects of the distinction are as follows: certain financial products may only be open to investment by wholesale clients 2 ; only a retail client is required to be given a Financial Services Guide 3, a Statement of Advice 4 or a Product Disclosure Statement 5 ; (c) to determine whether a managed investment scheme needs to be registered or not 6 ; (d) as a limitation on the authorisations of particular licensees under their AFSLs 7 ; (e) dispute resolution 8, cooling-off rights 9 and compensation arrangements 10 only apply to retail clients; (f) ASIC's mandated training obligations only apply to advisers of retail clients 11 ; (g) the FOFA requirements concerning best interests obligations 12, charging ongoing fees 13 and conflicted remuneration 14 only apply to retail clients. charteredaccountantsanz.com Chartered Accountants Australia and New Zealand ABN 50 084 642 571 (CA ANZ). Formed in Australia. Liability limited by a scheme approved under Professional Standards Legislation. Members of CA ANZ are not liable for the debts and liabilities of CA ANZ.
1.3 Similar rules also apply to the need to issue a disclosure document (such as a prospectus) for the issue of corporate securities 15. Although the eligibility for nondisclosure under those rules is largely the same as under the financial services laws, the terminology of "wholesale" and "retail" is not used. In the subsequent discussions of the classes of wholesale eligibility below the corresponding exemption for prospectus disclosure will also be indicated. 2. When is it permissible to treat an SMSF client as wholesale? 2.1 A client is required to be treated as a retail client unless the financial services legislation allows otherwise 16. 2.2 An SMSF must have one of two trustee structures 17 : corporate trustee - each member must be a director of the trustee. A single member SMSF may have either one or two directors the second director being either a relative or person who is not an employer of the member; or individual trustee for a multiple member SMSF each member must be an individual trustee. For a single member SMSF there must be 2 individual trustees the second trustee being either a relative or person who is not an employer of the member. 2.3 At law, the trust fund itself is not a legal entity and the status of the fund's trustee(s) as a wholesale client needs to be looked at rather than the trust itself. 2.4 Where the SMSF has a corporate trustee then the company is the client and it is the status of the company that needs to be considered. 2.5 Where the SMSF has individual trustees then the client is the joint individual trustees. It is crucial in this regard to keep in mind that individual trustees must be considered as a joint entity and not as the sum of their individual circumstances: "Inherent in the basic system of trusts is the principle that trustees must act unanimously. They do not hold several offices they hold a single, joint, inseparable office." 18 3. Distinguishing the members from the trustees 3.1 With individual trustees there is also a need to distinguish between advising the trustee(s) of the SMSF as distinct from the members of the SMSF. In this regard, two overriding rules must be kept in mind 19 : A superannuation product is always provided to a client as a retail client regardless of their eligibility to be a wholesale client. If any other type of financial service (such as financial product advice) is provided to a person which "relates to a superannuation product" then the client must (except for some large superannuation funds) always be treated as a retail client regardless of their eligibility to be a wholesale client. 3.2 What is clear from this is that advice to a person concerning matters such as: (c) (d) setting up an SMSF; joining an existing SMSF; contributing to an SMSF; or the decision to receive a pension from an SMSF, charteredaccountantsanz.com 2
must all be made to the client as a retail client as they involve the provision of an interest in a superannuation product (that is, the SMSF) or the provision of a financial service (such as advice) which clearly relates to such a superannuation product. 3.3 However, advising the individual trustees of an existing SMSF in relation to a nonsuperannuation financial product (for example, an interest in a managed investment scheme) or a product that is not a financial product (for example, residential property) does not "relate to a superannuation product". Rather, it relates to that particular product being advised on. The result is that the individual trustees of the SMSF can potentially qualify as a wholesale client in relation to non-superannuation product advice. 3.4 This does not mean that the individual trustees of the SMSF are automatically wholesale clients. Rather, it means that they can be treated as wholesale clients if they meet one of the eligibility tests. There is also nothing to stop a client who is eligible to be a wholesale client from being treated as a retail client if the service provider wishes to do so. PART B: ACCOUNTANT'S CERTIFICATES 4. The individual wealth tests 4.1 The legislation creates 5 main classes of eligibility to be a wholesale client. This section will focus on the individual wealth tests as they require certification by accountants. The other tests are set out in Part C. 4.2 The individual wealth tests are frequently used by financial advisers as they are relatively straightforward tests and the adviser can rely on the certification provided by the accountant. While many SMSFs will have the necessary level of assets or income within the fund, the control test also offers scope to include assets or income held outside of the SMSF. 4.3 As noted above, it is crucial in this regard to keep in mind that individual trustees must be considered as a joint entity and not as the sum of their individual circumstances. Therefore, it is only assets or income that the individual trustees jointly own that can be counted towards the individual wealth tests. 4.4 For example, a husband and wife who were individual trustees of an SMSF could also include the value of the family home if they owned it jointly. Similarly, if they were joint trustees of a family trust. However, if the wife owned an investment property in her own name then this could not be included. 5. Individual Wealth 5.1 The individual wealth tests require a person to have either: a) net assets of at least $2.5 million; or b ) gross income for each of the last 2 financial years of at least $250,000, as certified by an accountant 20. 5.2 The accountant's certificate lasts for 2 years before requiring renewal 21. There is no form specified for the certificate. However, ASIC issued a template certificate in 2006 which is available at the following link: http://download.asic.gov.au/media/1322725/cert_pro_forma_accountant.pdf. charteredaccountantsanz.com 3
6. The inclusion of controlled entities 6.1 The individual wealth tests have an extended operation in relation to controlled entities such that: In determining the net assets or gross income of a person the net assets or gross income of a company or trust controlled by that person can be included 22. This has obvious application in relation to an SMSF given that such funds are established as trusts. If a person is eligible to be a wholesale client (under any of the eligibility tests) then a company or trust controlled by that person is also a wholesale client 23. 6.2 Control is defined as the capacity of one entity to determine the outcome of decisions about another entity's financial and operating policies 24. 7. Who can control an SMSF? 7.1 The trustee(s) of an SMSF clearly control the assets of the SMSF which means that the income and assets of the fund can, therefore, be included for the purposes of whether the trustee(s) themselves meet the individual wealth test. 7.2 Control is defined as the capacity of one entity to determine the outcome of decisions about another entity's financial and operating policies 25. It is possible that more than one person or entity may meet the legal meaning of control in relation to a subject entity at the one time. 8. Who can control an SMSF? 8.1 The trustee(s) of an SMSF clearly control the assets of the SMSF which means that the income and assets of the fund can, therefore, be included for the purposes of whether the trustee(s) themselves meet the individual wealth test. 8.2 However, can an SMSF be also controlled by a person other than the trustee(s)? If so, and that person is themselves a wholesale client, then the trustee(s) of the SMSF will also be a wholesale client (as trustee(s) of a controlled trust). 8.3 Due to the nature of the superannuation rules it is unlikely that such control could be shown other than in limited circumstances. For example, an individual trustee of an SMSF would be unlikely to control the SMSF as there must always be another individual trustee of the SMSF. As the individual trustees must act unanimously none of them would have individual control of the SMSF (they would always require the other trustees to agree to any course of action that was proposed in relation to the SMSF). 8.4 A similar lack of control would exist between the multiple directors of the corporate trustee of an SMSF. 8.5 However, it is possible to have a single director trustee company. Therefore: (c) A single member SMSF with a corporate trustee that had that member as sole director and shareholder would be controlled by the member. If the member was a wholesale client in their own right then the corporate trustee of the SMSF would be a wholesale client as well. Alternatively, the single member could add his or her personal assets or income to that of the SMSF with a view to exceeding the individual wealth thresholds on a combined basis. If so, then the member personally and the corporate trustee of the SMSF would be wholesale clients. charteredaccountantsanz.com 4
PART C: THE OTHER ELIGIBILITY TESTS 9. Product Value 9.1 If the product being invested in or advised on has a value exceeding $500,000 26. It also applies to a portfolio of similar products with a total value exceeding $500,000 that are purchased as part of the same transaction 27. 9.2 If a person meets this test in relation to a product then they can be treated as a wholesale client in relation to that product for as long as they hold it 28. 9.3 However, the test does not apply to the extent that investment funds are sourced from a superannuation fund 29. It has been suggested that this exclusion means that the trustee(s) of an SMSF may not take advantage of the product value test. 9.4 However, in our view, the exclusion applies to an investment made by a member or other beneficiary of a superannuation fund and not the trustee(s). Therefore, the exclusion applies to a member's superannuation benefit that: will shortly be paid to the member or other beneficiary by the superannuation fund (for example, on the member attaining age 65); or was paid to the member or other beneficiary by the superannuation fund within the previous 6 months. Therefore, the exclusion does not apply to an investment of the assets of an SMSF being made by the trustee(s) of the SMSF. 9.5 Practical considerations - Although this is a simple, objective test it is product specific and it is not often that a SMSF will have $500,000 to make a one-off investment in a single product or portfolio of products. 10. Professional Investors 10.1 A range of investors with one of the following specific attributes 30 : an AFSL holder; a body regulated by APRA other than a trustee of a superannuation product; (c) a body registered under the Financial Corporations Act 1974; (d) a trustee of a superannuation product with more than $10 million in assets; (e) a person having or controlling more than $10 million in gross assets (including moneys held by an associate or on trust); (f) a listed entity and its related body corporates; (g) an exempt public authority; (h) a person that carries on an investment business that is offered to the public; (i) a foreign entity that would meet one of these requirements had it been established in Australia. 10.2 Given the nature of an SMSF it is not possible for it to be considered as "a person that is carrying on an investment business that is offered to the public". 10.3 Practical considerations this exemption basically covers large institutional and specialised investment organisations. It is objective in operation and relatively easy to apply in practice. It is largely irrelevant to SMSFs as it only applies to large (over $10 million in net assets) superannuation funds and, therefore, will apply only to a limited number of SMSFs. charteredaccountantsanz.com 5
11. Large Businesses 11.1 Where the product is to be used in connection with a business that is not a small business. A small business is one that has less than 20 employees or less than 100 employees if the business is or includes the manufacture of goods 31. 11.2 Practical considerations of no relevance to the trustee(s) of an SMSF. 12. Sophisticated Investor 12.1 Persons that an AFSL holder (only a licensee may make the assessment - it cannot be done by a representative of the licensee) has determined to be experienced in using financial services 32. The test consists of 5 elements which can be summarised as follows: (c) (d) (e) the product is not a general insurance product, a superannuation product (see paragraph 3.3 above on this point) or an RSA product; the product or financial service is not used in connection with a business; the AFSL holder is satisfied on reasonable grounds that the client has previous experience in using financial services and investing in financial products that permits the client to assess a range of specified factors; the AFSL holder gives to the client a written statement of its reasons for being so satisfied; and the client signs a written acknowledgement in relation to certain matters. 12.2 Practical considerations while this exemption appears, on its face, to offer a fair degree of flexibility to classify as a wholesale client an experienced investor who does not meet another eligibility test, it does not seem to be commonly used in practice. The main downsides are: (c) (d) it cannot be used for general insurance or superannuation products; it cannot be used for financial products used in connection with a business; the need to go through the formal requirements; and the subjective (and, to some extent, self-serving) nature of the assessment which can make it subject to later challenge by either ASIC or a disgruntled client. 12.3 In most cases, a person with the potential to be classified under this test is probably likely to meet one of the other criteria anyway. For those that do not, an AFSL holder should carefully consider whether they can (or should) classify an investor as a wholesale client under this test. charteredaccountantsanz.com 6
PART D: FREQUENTLY ASKED QUESTIONS Question 1: How are assets within the SMSF allocated to the trustees? If there are 2 trustees e.g. husband and wife, is it 50/50%? There is no allocation of assets. The individual trustees are treated by law as a "single, joint. inseparable office". Question 2: Whose assets and income can be taken into account in addition to the SMSF assets and income e.g. trustees and other entities the trustees control. The SMSF assets can be taken into account as they are controlled by the trustees. Other assets can be included only if they are controlled by the trustee e.g. assets of other trusts which it is trustee of and property held by the trustee non-beneficially. Note that for individual trustees the other property needs to be held jointly by the trustees and not individually. Question 3: Name to appear on certificate: Is the certificate to be issued in the name of the trustee in their own capacity or should it state as trustee for the SMSF? Technically, it is in their own capacity as their wholesale client status applies generally and not just in relation to their trusteeship of the SMSF. However, it would be prudent to acknowledge somewhere on the certificate that they are trustee(s) of a particular SMSF if that is the context in which the certificate was requested. Question 4: Is a separate certificate to be issued to each trustee if there is more than one trustee or is it to be issued to the trustees jointly? For individual trustees it must be a joint certificate. Question 5: Net asset test: Are the 'net assets' of the SMSF counted when determining if the criteria for issuing a certificate has been satisfied? Yes, as those assets are controlled by the trustee(s). Question 6: Are the 'net assets' of the trustees (e.g. if they are individuals) that are separate to the SMSF counted and added to the assets of the SMSF? Only if those assets are held or controlled jointly by the individual trustees. Question 7: If we assume that an individual has personal 'net assets' of $2.7m and the same individual is one of the trustees of an SMSF that has $1.5m 'net assets', what is the total 'net assets' for the purpose of considering to issue a certificate to the trustee? Only the $1.5m of superannuation fund net assets. charteredaccountantsanz.com 7
Question 8: Gross income test: Is the 'gross income' of the SMSF counted when determining if the criteria for issuing a certificate is satisfied? Yes, as that income is controlled by the trustee(s). Question 9: Is the 'gross income' of the trustees (e.g. if they are individuals) that is separate to the SMSF counted and added to the income of the SMSF? Only if that income is received or controlled jointly by the individual trustees. Question 10: If we assume that an individual had personal income of $500,000 and that same individual is one of the trustees of an SMSF that has $300,000 gross income (including $60,000 contributions received from the same individual as a member), what is the total gross income for the purpose of considering to issue a certificate to the trustee? The gross income would be $240,000 on the basis that the contribution was on capital account (despite the fact that contributions are treated as assessable income for taxation purposes). Also, bear in mind that the gross income test has to be met for each of the previous 2 financial years. HNLaw Pty Ltd (ACN 068 367 046), trading as Compact - Compliance & Training, and Holley Nethercote Commercial & Financial Services Lawyers developed this document in collaboration with Chartered Accountants Australia and New Zealand. HNLaw Pty Ltd is the owner of copyright in this document, first published in Australia in November 2015, and licences Chartered Accountants Australia and New Zealand to use the material for the benefit of its members. The contents of this document does not constitute legal, financial or commercial advice, or a recommendation of any services or products. You should consider obtaining independent advice before making any investment, financial or legal decision. charteredaccountantsanz.com 8
References 1 Section 761G(4) of the Corporations Act 2001. 2 Product issuers often impose such a restriction in order that their product does not need to be registered with ASIC or have to meet the "retail" regulatory requirements. 3 Sections 941A(1) and 941B(1) of the Corporations Act 2001. 4 Section 944A of the Corporations Act 2001. 5 Sections 1012A(3)(c), 1012B(3) and 1012C(3) of the Corporations Act 2001. 6 Section 601FC(2) of the Corporations Act 2001. 7 Section 914A(1) of the Corporations Act 2001. 8 Section 912A(1)(g) of the Corporations Act 2001. 9 Section 1019A of the Corporations Act 2001. 10 Section 912B(1) of the Corporations Act 2001. 11 Compliance with training obligations under Regulatory Guide 146 is imposed by ASIC as a licence condition. In relation to the exclusion of wholesale clients see RG146.21. 12 Section 961(1) of the Corporations Act 2001. 13 Section 962A(1) of the Corporations Act 2001. 14 Sections 963A(1) and 964B of the Corporations Act 2001. 15 The corresponding exemptions are contained in section 708 of the Corporations Act 2001. That section also includes some additional exceptions which it is beyond the scope of this article to consider. 16 Section 761G(1) of the Corporations Act 2001. 17 Section 17A of the Superannuation Industry (Supervision) Act 1993. 18 Sky v Body (1970) 92 WN (NSW) 934 per Street J. 19 Section 761G(6) of the Corporations Act 2001. 20 Section 761G(7)(c) of the Corporations Act 2001 compared with section 708(8)(c). 21 Section 761G(7)(c) of the Corporations Act 2001 as modified by regulation 7.6.02AF of the Corporations Regulations 2001. 22 Sections 761G(7A) and (7B) of the Corporations Act 2001 [inserted by regulation 7.6.02AC of the Corporations Regulations 2001] compared with section 708(9B) and (9C). 23 Section 761G(7)(ca) of the Corporations Act 2001 [inserted by regulation 7.6.02AB of the Corporations Regulations 2001] compared with section 708(8)(d). 24 Section 50AA of the Corporations Act 2001. 25 Section 50AA of the Corporations Act 2001. 26 Section 761G(7) of the Corporations Act 2001 compared with sections 708(8) and. The dollar limit is variously prescribed under regulations 7.1.18 to 7.1.24 of the Corporations Regulations 2001. 27 Regulation 7.1.29(5) of the Corporations Regulations 2001. An example would be advice to purchase a portfolio of ASX200 stocks with a value of over $500,000. 28 Regulation 7.1.27 of the Corporations Regulations 2001. 29 Regulation 7.1.26 of the Corporations Regulations 2001. 30 Section 761G(7)(d) of the Corporations Act 2001 and the definition of "professional investor" in section 9 [as modified by regulation 7.6.02AE of the Corporations Regulations 2001] compared with section 708(11). 31 Sections 761G(7) and (12) of the Corporations Act 2001. There is no corresponding exemption under section 708. 32 Section 761GA of the Corporations Act 2001 compared with section 708(10). charteredaccountantsanz.com 9