Self-Managed Superannuation Funds (SMSFs) are the fastest growing sector of the superannuation industry, spiking by 33% between 2008 and 2012, putting them in the sights of both the super industry and the Australian Taxation Office.
From July the ATO will be able to levy individual fines of up to A$10,200 on fund trustees who breach superannuation law, a step up from the previous environment where breaches could only result in making a fund “non-compliant”, or a referral to a court for penalties.
But many superannuation industry representatives want more regulation of self-managed super funds, with calls to the current financial system inquiry ranging from regulating the funds as a financial product, to forcing fund trustees to use a financial planner when the fund borrows money to invest in property.
The current benefits of SMSFs
SMSFs are perceived as giving tax advantages to their members, but they are taxed at the same (concessional) rates as other superannuation funds, and must comply with similar regulatory requirements: the main technical differences are in the administration of the fund, and the control that the member/trustees of an SMSF have in devising an investment strategy. The tax advantages that members of SMSFs do obtain are largely through the characteristics of the structure and the profile of SMSF members.
However there are some regulations that apply specifically to SMSFs; and others that in practice are more relevant to SMSFs than other types of superannuation funds.
A SMSF is a superannuation fund that has fewer than five members, and these members are also the trustees of the fund. This gives the member/trustees the flexibility to devise and control an investment strategy that meets the needs of its members, as required.
One of the key reasons that many members of SMSFs give for choosing an SMSF as an investment vehicle is the level of control it gives them over their investments. However this places a high level of obligation on the trustees, and also exposes the members of the SMSF to risk which the trustees must manage.
SMSFs are not eligible for financial assistance where the fund has suffered loss due to fraud or theft, and do not have access to the Superannuation Complaints Tribunal to resolve disputes.
Funds must already pass the sole purpose test
All superannuation funds are required to meet the sole purpose test, which requires that the purpose of a superannuation fund must be to provide benefits to members in retirement and, in the event of their death, their dependants. The regulatory framework for all superannuation funds is designed to support this core purpose, but SMSFs are particularly impacted: for example the law prohibits a fund from intentionally acquiring an asset from a related party, or loans or other financial assistance to the members of a fund.
But there is room for bias…
There are long-standing exclusions from the non arms-length rules that allow a SMSF to pay market value to purchase business real property from or lease it to a related party. This allows a person establishing a SMSF to transfer business premises to their superannuation fund and lease the property back from the superannuation fund, a strategy frequently used by business owners to provide an income stream to the fund.
One of the issues around SMSFs is ensuring that the trustee/members properly recognise the separation of superannuation assets from assets that are personally owned and controlled, and the regulations are designed to preserve that separation of assets. For example, from 2011 investments by SMSFs in certain collectibles, including artwork, wine, antiques or memorabilia were subject to regulations regarding these investments that regulate the use of certain collectible assets by members so that they cannot be used by or stored in a member’s residence.
The other exclusion that has gained much coverage during the recent property boom is the rule which overrides the prohibition on borrowing. In principle the trustees of a superannuation fund are not permitted to place members’ retirement funds at risk, thus the power to borrow is restricted. This restriction was eased in 2010 to allow borrowing by any regulated superannuation fund where the borrowing is linked to a specific asset. The provision is particularly relevant to SMSFs due to the structures used to comply with the requirements and the relative scale of the funds held by SMSFs.
This is where the flexibility and investment strategies of SMSFs become relevant. If the members have a bias toward investing in real property, then they may devise an investment strategy incorporating borrowings; whereas other investments with lower capital requirements, such as property trusts, could be funded without borrowing.
However the biggest tax advantage that SMSF members obtain flows from the profile of the SMSF investor. Members of SMSFs typically have higher income levels than members of other superannuation funds across all age groups, and their account balances are correspondingly higher. Further, the nature of the fund makes it attractive to investors who take an active interest in their superannuation strategies, despite the risks.
In the meantime the rapid growth in the sector, combined with the level of control that trustees have over the assets of the fund, raises the risk that trustees will make poor decisions: either through not being sufficiently informed in respect of an investment or through pushing the boundaries of the SMSF structure.
There seems to be something inconsistent in a system that mandates savings but then allows those savings to be put at risk through insufficient regulation. It is time for the sector to be examined more closely.