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If the industry was pleased about the draft ruling on limited recourse borrowing arrangements (LRBA), the final ruling, SMSFR 2012/1 has done nothing to wipe the smiles off trustee & industry faces. The ATO has taken a practical approach in this ruling to key concepts including:
- What is an ‘acquirable asset’ and a ‘single acquirable asset’
- ‘maintaining’ or ‘repairing’ the acquirable asset as distinguished for ‘improving it’; and
- When a single acquirable asset is changed to such an extent that it is a different (replacement) asset
Much of the industry feedback for the final ruling was to add further clarity and practicality to assist trustees and professionals alike to understand these key concepts. Broadly, I think this ruling has achieved a more than satisfactory outcome for the specific issues. There does however remain a range of outstanding issues that further clarification, including in-house assets, the concept of the holding trust vs. bare trust amongst others.
I have provided below a summary of my views from the final ruling, SMSFR 2012/1: Limited Recourse Borrowing Arrangements – application of key concepts:
Single Acquirable Asset
The final ruling has expanded on its initial views regarding the need to consider both the legal form and substance of the acquired asset, having regard to both the proprietary rights (ownership) and the object of those rights. It explains that it may be possible to for an asset to meet the single acquirable asset definition, notwithstanding that the object of property comprises of separate bundles of proprietary rights (e.g. two or more blocks of land).
The final ruling further outlines factors relevant in determining if it is reasonable to conclude that what is being acquired is a single object of property. These include:
- the existence of a unifying physical object, such as a permanent fixture attached to land, which is significant in value relative to the overall asset value; or
- whether a State or Territory law requires the two assets to be dealt together.
Where the physical object situated across two or more titles:
- is not significant in value relative to the value of the land; or
- is temporary in nature or otherwise able to be relocated or removed relatively easily; or
- a business is being conducted on two or more titles; or
- the assets are being acquired under a single contract because, for example, the vendors wish to ‘package’ the assets
will mean that these assets will remain as being distinctly identifiable and not be identified as a single object of property.
Repairs, maintaining and improvements
The most pleasing aspect of reading the final ruling was the removal of any references to TR97/23, which from a tax perspective deals with repairs vs. improvements. Importantly, in distinguishing between repairs, maintaining and improving, the Commissioner applies their ordinary meaning having regard to the context in which they appear within s67A & s67B of the SIS Act.
The ruling provides a variety of practical illustrations that demonstrate what is a repair or maintenance (where borrowings can be applied) versus what would amount to an improvement (where borrowings can not apply, however the fund or member’s own resources can be applied for any improvement). In particular, the Commissioner has clearly indicated that restoration or replacement using modern materials will not amount to an improvement. The lines may be blurred somewhat if superior materials or appliances are used, how it would be a question of degree as to whether the changes significantly improve the state or function of the asset as a whole.
This distinction of repairs, maintaining and improving is critical because we must remember that borrowed funds can only be used for prescribed purposes – being the acquisition of a single acquirable asset, including expenses incurred in connection with the borrowing or acquisition, or in maintaining or repairing the acquirable asset. Where improvements are made with borrowed funds, this is a breach of not only the s67A exception, but then any maintenance of a borrowing beyond this becomes a breach of s67(1) (general borrowing prohibition).
In general terms, any improvements made to property where the single acquirable asset was for example the residential house and land is allowed whilst carrying a limited recourse loan, but only to the extent that it doesn’t become a different asset. For example, the addition of a pool, garage, shed, granny flat, additional bedroom, or second story are all allowable improvements without changing the character of the asset where it becomes a different asset (breaching the replacement asset rules in s67B).
Different (replacement) asset
It is important that the single acquirable asset is not replaced in its entirety with a different asset (unless covered under s67B). When considering the object and proprietary rights of the asset, any alterations or additions that fundamentally changes the character of that asset will result in a different asset being held on trust under the LRBA.
The ruling provides a range of examples as to when an asset become a different asset including through subdivision, a residential house built on land, and change of zoning (residential to commercial). There are however various examples that demonstrates that where such improvements don’t create a different asset, including:
- one bedroom of house converted to home office
- house burnt down in a fire and rebuilt (regardless of size) using insurance proceeds and SMSF funds
- compulsory acquisition by government on part of property; and
- granny flat added to back of property
When it comes to the use of a LRBA for the development of property, the ruling provides clarity around the importance of the terms of the contract of purchase as to what will constitute the single acquirable asset. For an off-the-plan purchase (as was stated in the draft ruling), if a contract was entered into and under the contract a deposit was payable with the balance payable on settlement after being built and strata-titled, this is allowable under a LRBA (as the strata-titled unit is the single acquirable asset). It is noted that a separate car park or furniture package will not meet likely be packaged into the single acquirable asset and require a separate (or multiple) LRBA.
The Commissioner has expanded his views further in the final ruling that a similar outcome occurs if the contract entered into is for the purchase of a single title vacant block of land, along with construction of a house on the land before settlement occurs. Where the deposit is paid upon entering the contract and the balance payable upon settlement is applied for the acquisition, it may be funded by a single LRBA as the single acquirable asset is the land with a completed house on it. Examples 9 and 10 within the ruling outline the important differences how house and land purchases need to be structured to meet the single acquirable asset definition.
In my view, the end result is a positive one for property investors within self managed super funds. The scope available for improvements certainly makes this strategy appealing as well. Fundamentally though, you need to ensure that the investment will stack up being held inside superannuation…
It will be interesting to watch the changing landscape of borrowing in super as the impact of this final ruling and the proposed licensing obligations on these arrangements unfold over the coming months…Read More
With the volatility of investment markets spanning over several year now, we have seen many SMSF trustees take some significant hits on their investment portfolios. With a growing proportion of members moving to pension phase, it is important to not only try to manage the upside, but also the down.
Where all members are in pension phase, the assets of the fund become segregated; that is, no actuarial tax certificate is required for the fund to claim a tax deduction for exempt current pension income (ECPI). Where there are capital gains and losses under a segregated approach, these are simply disregarded.
But what if for the financial year, a client had $100,000 of realised capital losses? Do we simply want these losses lost forever? I wouldn’t have thought so…
A strategy to ensure that these capital losses can be carried forward is to apply an unsegregated approach to the fund’s tax exemption. However, to achieve this you must engage an actuary to determine proportion of total pension liabilities over the fund’s total super liabilities. To have an unsegregated approach you would need to have either:
- part or all of a member in accumulation phase; or
- fund reserves
When applying the unsegregated approach, capital losses can be carried forward as the tax exemption percentage from the actuary is applied to the net capital gain of the fund (see s.102-5, ITAA 1997).
To understand this further, let’s look at the following example:
Fred and Wilma are both retired and drawing account based pensions from their SMSF. During the 2011/12 financial year, they have realised several assets which have resulted in a net $100,000 of capital losses. As all assets of the fund are being used to support the pensions, the fund is segregated and as such, all capital gains and losses are disregarded. However, if Fred decided to commute $1 of his pension back to accumulation phase, the fund would be required to obtain an actuary certificate for the financial year as the assets of the fund are now unsegregated. As a result of this change in method in determining the fund’s tax exemption, the $100,000 of capital losses can now be carried forward and applied at some point in the future against capital gains.
Why is this important?
In light of the Commissioner’s views expressed within draft ruling, TR 2011/D3: when a pension commences and ceases, carried forward capital losses can be valuable when a pension ceases, either at death, commutation or when a member may have failed to comply with the pension standards (i.e. not taken the minimum pension).
This time of year is important to think about the impact of any capital gains and losses position and the methodology that may be applied to exemption income for the financial year.Read More
A recent case of Mason and the Commissioner of Taxation has highlighted the importance of how and when a member can access their superannuation benefits.
Benefits since 1 July 1999 are typically preserved (not accessible) until a member meets a condition of release. Where the trustee(s) are satisfied that a member has met a condition of release with a nil cashing restriction, the member’s preserved benefits and restricted non-preserved benefits in the fund become unpreserved (accessible).
Conditions of release are the events that a member needs to satisfy to withdraw benefits from their super fund. The conditions of release are also subject to the governing rules of the fund. It may be possible that a benefit may be payable under the super laws, but can’t be paid under the rules of your SMSF.
Examples of conditions of release with a ‘nil’ cashing restriction:
- Retirement on or after preservation age
- Attaining age 65
- Permanent incapacity
- Termination of gainful employment (restricted non-preserved benefits)
- Terminal medical condition
- Termination of gainful employment with a standard employer-sponsor of the regulated super fund on or after 1 July 1997 where the member’s preserved amounts in the fund at the time of the termination are less than $200; and
- Being a lost member who is found, and the value of whose benefit in the fund when released, is less than $200
It is important to note that transition to retirement (TRIS) once a member has reached preservation age (currently 55), is a condition of release. However, it still imposes a ‘cashing restriction’ and therefore the member’s superannuation components will remain unchanged (e.g. stay preserved).
The Mason case outlines the fund member (Mr. Mason) being of the belief that attaining age 55 was a condition of release that allowed him to access his super to withdraw lump sum amounts. Whilst age 55 can be a condition of release when a member starts a Transition to Retirement Income Stream (TRIS), it still has imposed cashing restrictions until such a time as Mr. Mason had retired. This was not the case at the time of either of these lump sum withdrawals, as he continued to work within his bookkeeping business. He did however declare the amounts as lump sums within his personal tax return against his low rate cap amount. The Commissioner after conducting an audit of the fund (after the auditor issued an Auditor Contravention Report) was found that the two lump sum amounts withdrawn during the 2008/09 and 2009/10 financial years were in fact illegal early access amounts.
The tribunal in its findings stated that Mr Mason …should have been aware that “retirement” was a “condition of release” if the MTSF was to pay superannuation benefits in a lump sum or sums and, further, that “cashing restrictions” would apply to the “attaining the preservation age” condition of release;
As a result the Tribunal affirmed the Commissioner’s decision to include the amount in question as assessable income within his personal tax return to be taxed at his marginal tax rates (not as a lump sum against his low rate cap amount). It was fortunate for Mr Mason that the Commissioner used his discretion under section 42A of SISA to allow the fund to remain a complying fund.
With preservation progressively raising to age 60 for those born after 1 July 1964, it is an important to understand the rules and regulations about when you can access superannuation benefits. The courts have shown that as a trustee/member, you are responsible for the actions taken in the fund and the penalties that will apply for non-compliance.Read More
The strategy involves a process of withdrawing benefits from a member’s superannuation account and then making a non-concessional contribution (NCC) of the same money back into the fund.
The primary objective of this popular strategy is to convert all or part of a member’s taxable component into tax-free component. In order to undertake a recontribution strategy, the member must:
- have first met a condition of release (with a nil cashing condition) to withdraw benefits (or already have unrestricted non-preserved benefits), plus
- be eligible to contribute into superannuation.
There are a number of reasons why fund members may wish to undertake a recontribution strategy, including:
- improving the tax-effectiveness of a superannuation income stream paid up to age 60;
- reducing the tax impost on death benefits paid to non-dependant beneficiaries; and
- hedging against legislative risk (transferring benefits to a spouse)
Improving the tax-effectiveness of a superannuation income stream paid up to age 60
A recontribution strategy can be effective for a member receiving an income stream prior to age 60, as any pension is assessable income to the recipient. Where a member has satisfied a condition or release, they have the ability to withdraw a lump sum and recontribute this amount to improve the tax-free component of the income stream. From a strategy viewpoint, this taxable component withdrawal is typically taken up to the low rate cap amount ($165,000 for 2011/12), taken in proportion with any tax-free component.
Where an income stream is started after the recontribution, the proportions of the tax-free and taxable components are ‘locked in’ at the commencement date. These proportions are then used to determine all future income payments and commutations that the member receives. Subject to the member’s personal tax position and pension amounts to be taken, the recontribution amount may be more effective to operate as a separate interest. That is, establish two separate pensions, one made up entirely of tax-free component. Reducing the tax impost on death benefits paid to non-dependant beneficiaries.
Since 1 July 2007, benefits received in the form of a lump sum or income stream from age 60 are tax-free in the hands of the recipient. As a result, the primary driver for a recontribution strategy post age 60 is to improve the tax position of death benefits paid to non-dependent beneficiaries, whether directly or via an estate. Where a non-dependant beneficiary (i.e. adult kids) receives a lump sum death benefit, they will be taxed on the taxable component at 16.5%. Therefore, the use of a recontribution strategy can provide a tax saving of up to 16.5 cents in every dollar that is recycled. For a fund member aged 60 – 64 (having met a condition of release), they could effectively withdraw up to $450,000 of their benefits tax-free and recontribute this amount back into the fund, providing an estate planning benefit of up to $74,250. Again, it may be beneficial for the member to run a multiple pension strategy as the recontribution will be made up of entirely tax-free component.
Recontribution to a spouse
Prior to the introduction of Simpler Super (pre 1 July 2007), a recontribution from the member to a spouse account was an effective income-splitting strategy. With the tax-free status of benefits post age 60, this strategy has been somewhat diminished. It does however have limited application for members where one spouse may be significantly older than the other, for example where one member is under 60 and one member is over 60 years of age. Centrelink may also be a consideration here with individuals who may qualify for an age pension. Consideration of the spouse’s age and eligibility to accept the contribution must be considered as part of any recontribution strategy.
The issue of changing government policy is always at the back of people’s minds when it comes to superannuation. Whilst a withdrawal post 60 as a lump sum or pension is currently tax-free, is it always going to be the case? A recontribution to a spouse can be used to ‘hedge’ against future legislative risk.
Practically how it must work
To undertake a recontribution strategy, this money must be physically withdrawn from the fund, paid to the member and then deposited back into the fund as a contribution. An accounting entry is not sufficient; there must be a debit and corresponding credit within the fund’s bank account.
A recontribution strategy can be undertaken when the member is either in accumulation or pension phase. The tax treatment of any benefits taken need to be considered when determining whether the withdrawal as a lump sum or pension (i.e. under age 60). Where there is insufficient cashflow to undertake a recontribution, this strategy could be undertaken as an in-specie lump sum (not as in-specie pension payments, unless done as a partial commutation according to TR 2011/D3). Any recontribution of assets is subject to the exceptions outlined in section 66 of the SIS Act (acquisition of assets from a related party). Where the lump sum or pension withdrawal is taken by a member under age 60, the appropriate statutory reporting to the Australian Taxation Office will apply, including reporting of benefits on the Fund’s Activity Statement, preparation of PAYG payment summaries, etc.
Tax Office’s view on recontribution strategies
The ATO’s view of recontribution strategies dates back to August 2004, where they issued a media release that stated various straightforward recontribution strategies would not attract the general anti-avoidance provisions (Part IVA) of tax law.
Since the introduction of Simpler Super on 1 July 2007, the ATO’s position on recontribution strategies has been addressed through an industry stakeholder Q&A document, that outlines that where a “…recontribution strategy that is carried out to minimise the tax that might be payable on a death benefit paid to a non-dependant, the Commissioner is very unlikely to apply Part IVA to such an arrangement”. It is important to note that this view is not legal binding on the ATO and that they would assess each scenario on a case-by-case basis.
Recontribution vs. Anti-detriment payment
An alternative prior to undertaking a recontribution strategy, is to consider whether the beneficiaries would otherwise be eligible to receive an anti-detriment payment (refund of tax paid on contributions). This is important because a spouse or child or any age (including non-dependent kids) are generally eligible for an anti-detriment payment when a death benefit is paid as a lump sum. However, as the anti-detriment payment is only paid on the taxable component, using a recontribution strategy to recycle taxable component to tax-free component will reduce or eliminate any anti-detriment entitlement of a deceased member.
Everybody will adopt one of two strategies when it comes to superannuation:
- the SKI model (spend the kid’s inheritance) or
- inter-generational wealth transfer
With many people who have built wealth within superannuation now looking for an orderly of transfer of wealth to the next generation, the recontribution strategy can be a valuable tool to maximise the amount that is passed on to future generations.Read More
The latest quarterly SMSF statistics released by the Australian Taxation Office for the December 2011 quarter show some slowing in the growth of the self managed super fund market. The question must be asked:
- is this a result of SMSFs reaching saturation point; or
- is it a result of the lack of Government direction and loss of consumer confidence in retirement savings policy?
The latter issue around loss of confidence in superannuation and investment markets was a key theme addressed in the SPAA/Russell research conducted, which produced the annual “2012 Intimate with SMSFs” report.
New establishments for the December quarter were 5,915, the lowest number of setups since statistics have been published on the ATO website (back to June 2008). On an annualised basis, the 2011 calendar year saw 33,114 new funds established, more than 5% more than the previous year. When looking at net establishments, this percentage is significantly higher (67% net growth) as we have seen 2,769 funds wound up during 2011.
Total fund assets is again around the $400 billion mark, with growth in both cash held by SMSF trustees and listed shares – the growth in shares may have been a combination of ASX movement and some trustees seeing ‘value’ in the market, both from a growth and yield perspective.
Not surprisingly, we are seeing the most growth in assets in Western Australia, 10.4% of total assets – up from 8.8% back in June 2004. It doesn’t seem like much, but when the industry was $127 billion in 2004, this represented $11 billion, today this amount is more than $41.6 billion.
The data on younger entrants was still fairly strong for the quarter, 35.1% of new members were under the age of 45. As I have previously raised in my both presentation at the SPAA conference and also on my blog, many advisers will need to re-think how to deliver education and advice to a younger, more engaged, and web-savvy group of SMSF members. The scaled advice opportunity in my view presents an exciting time ahead for the SMSF industry.
Details of the December 2011 quarter SMSF statistics can be found here, http://www.ato.gov.au/superfunds/content.aspx?menuid=0&doc=/content/00309172.htm&page=1&H1
These latest growth statistics may just be a ‘blip’ on the radar, so we will continue to watch these SMSF statistics with great interest.
I would be interested in your thoughts whether you think these statistics are a result of SMSFs having peaked or a consumer confidence dropping due to Government using superannuation as a political football?Read More
As we move closer to the implementation of industry reforms regarding the provision of financial advice, Treasury last week has added to the pile with the re-issuing of draft Corporations Amendment Regulations to provide that limited recourse borrowing arrangements as allowed under superannuation law are financial products.
These reforms were previously announced back in March 2010, with industry consultation in June of that year. In light of the submissions previously made, Treasury has substantially revised these draft Regulations. However, it remains a clear policy objective of Government to move these type of borrowing arrangements into the financial consumer protection framework as there continues to be concerns of targeted activity and inappropriate advice to acquire property using borrowings.
Under these Corporations Act 2001, those providing advice in respect to the limited recourse borrowing arrangement established in accordance with s67A and s67B will be required to have an Australian Financial Services License (AFSL). For those simply providing credit facilities, they are not caught by these regulations.
To be able to provide advice in this area, an AFSL that allows for advice on derivatives or securities meets the requirements to also cover limited recourse borrowing arrangements. This poses an interesting question for many accountants considering their licensing options with the proposed ‘conditional license’ to be implemented to allow for advice likely to be under a ‘class-of-product’. All of the current limited licence solutions won’t provide for them to deal in securities unless they met additional competency requirements of the AFSL holder (and paid the additional licensing cost as well).
Who issues the financial product?
A previous confusion of the regulations related to the issuer of the limited recourse borrowing arrangement. As a borrowing arrangement involves numerous parties, it is difficult to determine which party is the “issuer”, or when the product is “issued”. These concerns posed difficulties for Government and the industry in determining which party, if any, is obliged to disclose information required under the corporations legislation.
These changes now clarify that the limited recourse borrowing arrangement is “issued” when a person enters into a legal relationship that sets up the arrangement and that each party to the arrangement is an “issuer” of the product. It is unclear from these regulations whether related party lenders get caught under these arrangements as an issuer of a financial product?
When do these changes commence?
These proposed regulations would take effect three months after the legislative instrument was exercised by Government.
As we close in on the two-year review period proposed by the Cooper Review with limited recourse borrowings, in my view the Government can only start the clock ticking once these laws take effect. With:
- changes to the definition of limited recourse borrowing arrangements from 7 July 2010,
- details of the final ruling SMSFR 2011/D1 expected in May 2012, and
- changes to make these arrangements financial products
surely the Government’s assessment to date would be baseless? or maybe… just maybe once resolved, consumers and advisers alike will have a framework in which to work with moving forward!! Let’s hope so.Read More
Depending on who you are listening to and what financial services news you read each day, you can easily get confused whether the Future of Financial Advice (FOFA) reforms are going to decrease or increase the number of financial advisers.
Whilst we may see the exit of many advisers who will find it simply too hard and too late in their professional lives to re-wire their businesses, we are going to see an influx of SMSF strategic advisers via the accounting profession. With the details of the accountant’s exemption replacement due very soon (possibly as early as next week), it is my understanding that we could see up to 20,000 public practitioners entering the proposed conditional licensing regime to be able to provide advice (non-investment) to SMSF clients. As always, the ’devil will be in the detail’, which we eagerly await to see.
In my view, with these sort of numbers potentially moving into the advice space, we are going to see some ‘jousting’ for the key adviser seat. With many self-directed SMSF trustees simply looking for strategic guidance around life events (i.e. what is being proposed through the scaled advice reforms) rather than wholistic advice, it will be fascinating to see how this plays out as moving forward this advice will most likely be available through either a financial planner or licensed accountant. Regardless of the whether it is predominantly the adviser or accountant sitting in the key adviser seat, this is ultimately a positive outcome for SMSF trustees as professional competency improves in this area. (advisers becoming SMSF specialists).
With the SMSF industry expected to grow to more than $2 trillion dollars by 2030 (see Deloitte Actuarial Report - Dynamics of the Australian Superannuation System, The next 20 years: 2011–2030), the opportunities within the sector will continue to grow as it matures further. Remember, the SMSF as an industry (under the ATO umbrella) has only been around since 2000. It is staggering to see the grow achieved by the section in such a short period of time.
I expect FOFA will deliver on its promise to increase competency in the area of SMSFs. For those wanting to get involved or take a more active role with their business in the sector, you need to ask yourself are you ready for the future of the SMSF industry?Read More
There’s been a lot of media in recent times about the growth in younger entrants to the Self Managed Super Fund market. Much of this discussion has come from the recently updated SMSF statistical summary published by the Australian Taxation Office.
Is this simply a ‘spike’ in the statistics or is it a genuine trend in younger people being attracted to SMSFs? Let’s have a look at some of these quarterly statistics issued by the ATO since June 2009:
Under 45 years of age
|30 June 2009||
|30 June 2010||
|30 September 2010||
|31 December 2010||
|31 March 2011||
|30 June 2011||
|30 September 2011||
As you can see from the table, we are seeing a sustained trend in new SMSF entrants under age 45 years of age.
What do you think are the reasons behind this trend?
- Is it greater control? or
- Are people taking a greater interest in their super at a younger age? or
- Have people changed because they are not satisfied with their previous fund (e.g. performance and/or fees)? or
- Greater investment opportunities, such as limited recourse borrowing to acquire property? or
- All of the above!!
Are you a younger SMSF entrant? or are you advising younger SMSF entrants? I would love to hear stories why individuals are being attracted to SMSFs at a younger age?
PS. I’ll be presenting on the topic of attracting SMSF business your way at the 2012 SPAA National Conference in Sydney, 15-17 February. Join me for this session as we explore some of these changing trends and how you can leverage new ideas to build your SMSF business…Read More