Accounting partners are aware of the Future of Financial Advice (FOFA) legal changes pertaining to providing advice on self-managed super funds (SMSFs) and the loss of the accountant's exemption that permitted them to do so without having an Australian Financial Services Licence (AFSL).
The best course of action must now be chosen by those who want to keep providing SMSF advice to their clients or grow their businesses in this expanding industry.
We have spoken with more than 500 accountants in Australia over the past 12 months, many of whom are business owners of two to six partner firms and members of the three accounting associations. Each of them had a unique perspective on how their industry is changing and had different strategies for dealing with it.
Generally speaking, you are not permitted to operate a business, take out a loan, or buy a vacation home using your SMSF. In-house assets are these investments in "grey areas." To avoid violating the SMSF sole-purpose test, in-house assets can only make up 5% of a Fund's total asset value. The main thing to remember about an SMSF is that all investments must be made exclusively for retirement.
Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.
An SMSF operating a business is typically regarded as a significant indication that the fund has violated the sole-purpose criteria. You may operate a business in an SMSF under certain conditions. However, anyone considering doing so is highly encouraged to read the ATO fact sheet "Carrying on a Business in an SMSF," which was published on May 25, 2010, in its entirety. An SMSF must be managed only to give Fund Members access to retirement benefits. Any investment choices made must be made with the exclusive intent of generating future retirement benefits, not for the purpose of providing present service.
It's a big decision to decide whether to become a self-licensee or an authorized representative of a licensee, and many accountants are confused by their alternatives.
While the majority of partners are primarily worried about the financial effects of change, some are just considering application expenses to obtain a license rather than examining the full scope of costs associated with using and maintaining a licence.
Many people also fail to consider the non-financial factors, which are crucial in deciding the best course of action for the company. This comprises:
- the kind of guidance on SMSFs they want to give their clients;
- the time commitment required to keep a license;
- the difficulty of setting up and operating their business's SMSF advisory capacity;
- the chance cost of delaying until June 2016 or, worse yet, doing nothing at all.
There is little doubt that Melbourne accountants will gain from growing their advisory services division. In fact, the legislative change should be viewed as an opportunity to carefully evaluate the company's long-term growth strategy and succession plan and, if necessary, modify the business plan.
Whatever choice is taken, it's essential to understand the effects on your company and the true cost of licensing. It's a choice that needs to be made in order for the business to stay relevant, participate in the shifting market, and satisfy customers' expectations.
Stuart Abley, the CEO of SMSF Advice Limited, has extensive experience in the financial planning and accounting sectors and how they can effectively collaborate.
Three mindsets can be found in the current market, as we've observed from our interactions with accountants:
- Those who are aware of the prospects but are unsure of how to implement them in their company.
- Those who are delaying licensing decisions because they believe they have enough time to think about their options but are unaware of the amount of time needed to prepare
- Early adopters who are already adapting their business models to benefit from the legal shift.
What exactly is a limited recourse borrowing arrangement for SMSFs?
A typical SMSF limited recourse borrowing agreement entails the fund borrowing money from a connected person, such as a member of the fund, or from a third-party lender. The SMSF then utilizes the loan and its own available cash to buy a single asset, typically a home or business, that is kept in a different trust.
The separate trust's trustee becomes the asset's legal owner, while the trustee of the SMSF gains a beneficial interest in it. By paying one or more payments, the trustee of the SMSF has the right to take legal possession of the asset. If the SMSF defaults on the loan, the lender's rights are restricted to the asset held in the separate trust, and any investment income earned from the asset goes to the SMSF. This indicates that the other assets held by the SMSF are not a source of recourse.
Can My Smsf Give Me a Loan?
No. You and your family members are not eligible for a loan from your SMSF. Making this kind of loan must be avoided because it is not a lawful way for an SMSF to access funds very early.
Superannuation funds, including SMSFs, are not allowed to give money to members or their family members under Section 65 of the SIS Act.
A regulated superannuation fund's (SMSF) trustee or investment manager may not:
- loan funds from the fund to:
- a member of the fund; or
- a relative of a member of the fund; or
- Give any additional financial support using the fund's resources to:
- a member of the fund; or
- a relative of a member of the fund.
A trustee who violates this clause may be subject to a 60-unit administrative fine ($12,600 per trustee), disqualification from serving as a trustee of an SMSF, as well as civil and criminal penalties.
My Smsf Is Able To Loan Money To My Business?
Loans to a business run by a member of an SMSF are generally forbidden and subject to the following administrative penalties:
- Lending to members and relatives – 60 penalty units
- In-house assets – 60 penalty units
One penalty unit is now worth $210, and as a result, each violation results in a cost of $12,600 for each trustee. The trustee personally (or on behalf of the corporate trustee) is responsible for paying any penalties; the SMSF itself is not responsible for doing so.
More information regarding the ATO's approach to dealing with non-compliance may be found on the organization's website.
Nevertheless, there are some loans to related party firms that can be provided under severe guidelines and won't break these restrictive rules as long as they're correctly implemented. These loans are one of the few exceptions to the general rule that prohibits lending to related parties. Have your self-managed super fund (SMSF) provide your company with a modest loan so that you can legally access your retirement savings earlier. This is one method for doing so.
The main limitations are:
- A corporation or trust with a corporate trustee is the recipient of the loan (not to a sole trader business or partnership)
- The loan amount represents less than 5% of the entire fund assets (based on market value)
- The terms of the loan are impartial commercial terms.
- The loan is permitted by the SMSF's trust deed and is a part of the investment plan for the SMSF.
- The sole purpose test is not violated by the loan.
It is common practise to not consider a loan that constitutes less than 5% of the SMSF's assets to be a very substantial loan. This only amounts to $50,000 for an SMSF with a balance of $1 million, which could not be enough for a business owner to weather a protracted disruption in business operations.
One significant threat is what will take place in the event that the market value of the SMSF's assets experiences a fall while at the same time the loan amount increases to more than 5% of the fund's assets. If the cost of the loan to the linked party (i.e., the internal asset) exceeds 5% of the fund's assets at the end of the financial year, the trustee(s) of the SMSF are required to implement a written plan to address the excess by the end of the following financial year. This is the case even if the cost of the loan is less than 5% of the fund's assets.
For example, if a loan of $50,000 is made in April 2020 (based on the market value of all assets in the SMSF totalling $1 million), but the value of all assets falls to $900,000 as of June 30, 2020, prior to June 30, 2021, the trustees must reduce the loan amount to under 5% once more, which means that the $50,000 would need to be reduced to less than $45,000 in order to prevent the investment from being deemed an in-house asset. This is necessary in order to prevent the investment
Can an SMSF make investments in private businesses?
Your SMSF is permitted to make investments in either private or public companies, regardless of whether or not you work for them. It is a prerequisite that you do not have the power to veto elections in any capacity. In that case, your investment will be regarded as an in-house asset, and the total value of your SMSF's in-house assets cannot exceed five percent of the fund's total assets.
Refer to ATO Tax Ruling 2009/4 for more information on investments in businesses that are considered to be related parties. According to paragraph 157 of the judgement, an investment in a company that you control a majority share of is considered to be an in-house asset. [Citation needed]
Keeping up with a stock trading firm.
Within a self-managed super fund (SMSF), is it acceptable to trade shares? The answer, which is "yes," is both speedy and simple to provide.
The most important retail superannuation funds all participate in the trading of shares. When investing in superannuation, it is also impossible to avoid buying and selling investments.
It's a little trickier to respond to the query of what constitutes a reasonable level of share trading. Apart from the fact that your SMSF's Investment Strategy should allow trading, there isn't much advice in this area. Whenever Superannuation Warehouse creates a new SMSF, we give you a template for an investment strategy. You are responsible for making sure that the Investment Strategy captures your plans as Trustees of the Self-managed Superannuation Fund.
Depending on the purpose of the trades, or the reasons why the buys and sells are performed, it is determined case by case whether an SMSF is an active share trader or an investor. In legal proceedings, the following considerations are taken into consideration to determine an SMSF's trading status:
- The nature of the fund's operations, particularly whether they have a profit-making goal
- The activities' frequency, volume, and regularity, as well as how closely they resemble those of other companies in your industry
- preserving records of finances, inventory, licenses, credentials, business addresses, registered business names, and Australian business numbers
- The volume of the operations, and
- The amount of capital employed.
Why is this crucial?
Because you don't want to violate the sole purpose test as Trustees (providing retirement benefits to members). You run the risk of losing the tax breaks offered to SMSFs if you do.
Is share trading etc. "carrying on a business"?
The ATO is also concerned that some SMSF Trustees' investing activities, such as share trading and making specific "tax-effective" investments, may be construed as operating a business. Again, the SMSF may lose its compliance status and the Trustee or SMSF may be subject to penalties if those activities constitute carrying on a business.
The ATO's worries are reflected in the following regulatory requirements, which SMSF Trustees must abide by:
- the sole purpose test, and
- investment rules in general.
It is crucial that Trustees are informed of and follow the SISA's investing guidelines. It's important to keep in mind:
- develop an investment strategy and stick to it, and
- make and keep investments in a fair and impartial manner. Whether a competent person operating with proper consideration for his or her own economic interests would have undertaken such an investment can be evaluated.
Trustees must NOT:
- purchase assets from family members (albeit there are several restrictions); or
- lending to or offering financial support to other SMSF participants or their families.
Extreme example
A Trustee might conclude that betting on red or black while playing roulette would be a smart financial strategy. The trustee is free to follow whatever investing strategy they like. It's allowed. Even though we would never support something so extreme, this example does highlight the trustee's immense authority and obligation to act in the SMSF's best interests.
Which advantages of an SMSF Borrowing Arrangement stand out the most?
Leverage your retirement assets. Your self-managed super fund (SMSF) has the ability to borrow money for investments if it has a limited recourse borrowing arrangement in place. Your superannuation fund is in a position to purchase a beneficiary interest in a property that it otherwise might not be able to afford if it did not take out a loan to invest or "gear" its assets in this manner and do so instead (it could be a business premise you own or operate your business from).
Even though your SMSF does not technically own the asset, it does gain a beneficial interest in it. This gives your fund the right to receive all income that is generated by the asset, including rental revenue. Your SMSF may be able to receive any capital gains when the asset in question is eventually sold.
Tax concessions – If your SMSF earns income from investments, including income that is earned because your fund owns a beneficial interest in property that was acquired through a limited recourse borrowing agreement, then your SMSF is subject to superannuation taxes, but at a rate that is lower than the standard rate.
If your fund is still in the accumulation period, the highest possible tax rate that could be applied to the income generated by the asset is 15%. This could result in your fund paying much lower tax rates on the income that is received as compared to the situation in which you owned the asset in your own name, via a business or trust structure, or in your own name.
Additionally, if the acquired asset is being used to support the payment of one or more superannuation income streams, then the income from the acquired asset, including any realised capital gains, is exempt from taxation in your fund.
Asset protection – When an individual declares bankruptcy, their superannuation assets are frequently protected from their creditors. This protection extends to include the beneficial interest that the superannuation fund has in receiving help as well. It is possible that it would be beneficial to organise the purchase of an asset within the context of a limited recourse finance agreement in order to optimise the benefits that come with asset protection.
What are the main dangers of a borrowing agreement for an SMSF?
To comply with the terms of a limited recourse borrowing arrangement, the trustee of the SMSF may only purchase specific assets. These assets must be ones that the trustee is not prohibited from purchasing under any other circumstances. Because of this, it is generally impossible to employ limited recourse borrowing arrangements to acquire assets that either you or a connected party already hold. There are a few exceptions to the rule that says you or a related party cannot own listed stocks or commercial real estate unless you meet certain criteria.
A limited recourse finance agreement must also involve the purchase of a single asset as the collateral for the loan. Typically, this refers to equity interests in a single company or piece of property that was constructed on a single traditional title. If there is a physical asset (like a building), or if there is a law that prohibits the sale of the separate legal tiles separately, properties constructed across one or more legal titles may occasionally still be considered a single asset in the context of a limited recourse borrowing arrangement. Examples of such laws and regulations include state and territorial prohibitions on the sale of individual legal tiles.
If a Self-Managed Superannuation Fund (SMSF) acquires an asset in a manner that is contrary to the restrictions described above, the trustees of the SMSF may be required to sell the asset at a large loss to the fund. If the laws of borrowing from superannuation are broken, the trustees of SMSFs could be subject to fines and other penalties as well.
Expenses connected with making alterations and enhancements to the property - In general, assets purchased with funds obtained under a limited recourse borrowing agreement are unable to be exchanged for a different asset. In a nutshell, this signifies that during the life of the loan, modifications to a property that was purchased with funds obtained through a limited recourse borrowing arrangement are not permitted if they would result in a fundamental change to the character of the asset. It is against the law, for instance, to make alterations to a property during the time that the loan is still in effect if those alterations would have the effect of changing the property from a residential property to a commercial property. Alterations or enhancements to the property that have the effect of boosting the asset's functional efficiency but do not degrade the asset's character may be permitted, but only if borrowed money is not used to finance them.
Money that has been borrowed, including a drawdown from the loan that was used to buy the asset, may be put towards the payment of expenses connected to the newly acquired asset that are relevant to its maintenance and repair.
SMSF trustees run the risk of being fined and subjected to additional penalties if they violate the restrictions regarding replacement assets.
Cost – When purchasing an item with a limited recourse loan arrangement, it is possible that additional costs will arise that would not be the case under normal circumstances. For an SMSF limited recourse borrowing arrangement, for example, the establishment of a separate trust and the drafting of unique legal documents, such as trust deeds and company constitutions, are both required in order to meet the requirements of the law (if the trustee of the separate trust is a corporate trustee). In addition, financial institutions may assess a fee for analysing the trust deed associated with your fund, and the fact that the loan has limited recourse may result in a higher interest rate being charged on the loan.
Liquidity – In order to keep your fund liquid, it is necessary to deduct money from it to cover loan obligations. This suggests that your fund must always have sufficient liquid assets to meet the repayment of any loans it has taken out. It is necessary to undertake careful preparations in order to guarantee that the fund's contributions and investment income will be sufficient to meet all of the fund's current and future commitments, including loan repayments, when they come up for payment. This is absolutely necessary in the event that the property is unable to be rented out for any period of time, as well as in the event that one or more of the members have entered the retirement phase (due to the requirement for the fund to also meet minimum pension payment requirements).
Even for members who are still in the accumulation phase, the contribution ceilings set constraints on the number of contributions that can be made on a concessional tax basis. These restrictions apply to the amount of money that can be contributed. It is possible that the tax efficacy of the limited recourse borrowing arrangement will be diminished if the member's concessional contribution threshold is already met, so making it necessary for the member to make non-concessional contributions in order to repay the loans.
It is absolutely necessary for trustees of SMSFs to take into consideration the requirement for life insurance in the event that one or more donors to the fund pass away. It is imperative that the trust deed for the fund be meticulously structured in order to guarantee that the SMSF trustee will be able to make use of the proceeds from a life insurance policy in order to settle the debt.
In the event that the trustee of the SMSF fails to make payments on the loan, the lender has the right to seize the asset, sell it, and then pay the trustees of the SMSF the proceeds of the sale, less the amount still owed on the loan. If there is a discrepancy between the outstanding loan balance and the sale profits that were acquired, the lender will not be allowed to use any other assets that are held by the SMSF as collateral to secure the loan. However, if there is a guarantor, one might request that they pay the difference between the two amounts.
Loan documentation and purchase contract – It has come to the attention of the Australian Taxation Office that certain limited recourse borrowing arrangements that were signed by trustees of SMSFs were not drafted in the correct manner. Some of these agreements cannot simply be reformed or corrected, and in order to terminate the agreement, the property may need to be sold, which would result in a considerable loss for the fund. Several of these agreements cannot be easily reorganised or amended.
In order to be in compliance with the requirements, the asset that was purchased using the limited recourse borrowing arrangement needs to be acquired in the name of the Security Trust. Additionally, the trustee of the SMSF needs to acquire a beneficial interest in the asset in accordance with the terms of the Security Trust Deed. In the event that the SMSF trustee is unable to repay the loan, the terms of the loan, which must be structured on a limited recourse basis, stipulate that the lender will not have access to any of the fund's assets.
Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.
Tax losses and capital gains – Any potential tax losses that may arise as a consequence of the after-tax cost of an asset being higher than the revenue it generates are isolated within the fund for safekeeping. This indicates that you are unable to use the tax losses to reduce the amount of income that is subject to taxation that comes from sources other than the fund. Due to the fact that the value of a property that has been acquired through a limited recourse borrowing arrangement cannot be used as collateral for other loans, the value of a property, including any equity that it may have accumulated over the course of time, cannot be used to purchase additional properties that are not part of the fund.
Governing rules and other matters - The trustees of a fund need to keep their minds continuously on the quality of the investments they are making and on the question of whether or not a limited recourse borrowing arrangement is compatible with the fund's overall investment strategy. The trustee of the SMSF must first be granted permission to borrow by the governing rules of the SMSF before any arrangement for limited recourse borrowing can be made. If an investment is not in keeping with the investment plan of the fund or is not permitted by the regulations regulating the fund, a person who has a beneficial interest in the fund may bring an action to recover loss or damage sustained by that person as a result of the investment.