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.
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 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
A penalty unit is now worth $210, therefore each violation costs each trustee $12,600. Penalties must be paid individually by the trustee (or on behalf of the corporate trustee), not by the SMSF.
On their website, the ATO provides more details about how they handle non-compliance.
However, there are some loans to related party businesses that can be granted under stringent guidelines and won't violate these strict laws as long as they are properly implemented. One approach to lawfully access super early via an SMSF is to have your SMSF drive a small loan to your business.
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.
A loan of less than 5% of the SMSF's assets is frequently not thought of as being very large. This only amounts to $50,000 for an SMSF with a balance of $1 million, which could not be sufficient for a business owner to sustain a prolonged business disruption.
When the market value of the SMSF's assets declines and the loan amount rises to more than 5% of the fund's assets, one major risk is what will happen. The trustee(s) of the SMSF must implement a written plan to address the excess by the end of the following financial year 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.
For instance, 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, before June 30, 2021, the trustees must reduce the loan amount to under 5% once more, meaning that the $50,000 would need to be reduced to less than $45,000 to prevent the investment from being deemed an in-house asset.
Can an SMSF make investments in private businesses?
Even if you work there, your SMSF may invest in a private or public company. The requirement is that you do not possess a veto power over elections. If you do, your investment will be considered an in-house asset, and its value cannot exceed 5% of your SMSF's overall assets.
For more information on investments in businesses that are regarded as related parties, see ATO Tax Ruling 2009/4. An investment in a company that you own 50% of is deemed to be an in-house asset, according to paragraph 157 of the judgement.
maintaining a share trading business
Is it permissible to trade shares within an SMSF? The quick and easy response is "yes."
Shares are traded by all of the major retail superannuation funds. Buying and selling are also unavoidable when investing in superannuation.
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.
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.
What are the key benefits of SMSF Borrowing Arrangement?
Leverage your retirement funds - A limited recourse borrowing arrangement for SMSFs enables your SMSF to borrow money for investments. By taking out a loan to invest or "gear" your superannuation assets in this way, your fund is able to purchase a beneficiary interest in a property that it otherwise might not be able to afford (it could be a business premise you own or operate your business from).
Although your SMSF does not legally own the asset, it does acquire a beneficial interest in it, which entitles your fund to all income (including rental income) generated by the asset. When the asset is sold, your SMSF is also eligible to collect any capital gains.
Tax concessions – Your SMSF is subject to superannuation taxes at a reduced rate if it receives investment income, including income earned because your fund owns a beneficial interest in property acquired through a limited recourse borrowing agreement.
If your fund is in the accumulation phase, the income from the asset will only be taxed at a maximum rate of 15%. In comparison to owning the asset in your own name, via a business or trust structure, or in your own name, this could lead to your fund paying significantly lower rates of tax on the income received.
Additionally, the income from the acquired asset, including realized capital gains, is tax-free in your fund if it is being used to support the payment of one or more superannuation income streams.
Asset protection – In the case of bankruptcy, superannuation assets are often shielded from creditors. The superannuation fund's beneficial interest in assistance is also covered by this protection. In order to maximize the benefits of asset protection, it may be advantageous to structure the acquisition of an asset under a limited recourse financing agreement.
What are the principal risks of an SMSF borrowing arrangement?
Only particular assets may be purchased - Under a limited recourse borrowing agreement, only assets may be bought that the trustee of the SMSF is not otherwise forbidden from purchasing. This generally means that limited recourse borrowing arrangements cannot be used to acquire assets that you or a related party already own. The ownership of the commercial real estate and listed securities by you or a connected party is subject to several exceptions.
The asset purchased through a limited recourse financing agreement must also be a single asset. This typically refers to equity interests in a single business or real estate that was built on a single traditional title. If there is a physical asset (like a building) or if there is a State or Territory 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 under a limited recourse borrowing arrangement.
The trustees of an SMSF may be obliged to liquidate an asset at a significant loss to the SMSF if it is acquired by the SMSF in violation of the aforementioned regulations. If the superannuation borrowing rules are broken, the SMSF trustees could also face fines and other penalties.
Costs associated with property improvements and changes - In general, assets purchased through a limited recourse borrowing arrangement cannot be changed for another asset. Practically speaking, this means that during the term of the loan, changes cannot be made to a property acquired through a limited recourse borrowing arrangement if they fundamentally alter the asset's nature. For instance, it is prohibited to make changes to a property that would have the effect of converting it from being residential to a commercial property while the loan is still in existence. However, if borrowed money are not used to finance them, alterations or enhancements to the property that has the effect of increasing the asset's functional efficiency but do not impair the asset's character are allowed.
Borrowed money, including a drawdown from the loan used to buy the asset, can be used to pay for maintenance and repair expenses related to the asset that has been acquired.
If the replacement asset regulations are broken, SMSF trustees may be subject to fines and other penalties.
Cost – Buying an asset under a limited recourse loan agreement could incur extra expenses that wouldn't otherwise be the case. For instance, the creation of a separate trust and the writing of distinct legal documents, such as trust deeds and company constitutions, are necessary for an SMSF limited recourse borrowing arrangement (if the trustee of the separate trust is a corporate trustee). Additionally, financial institutions might charge a fee for reviewing the trust deed for your fund, and the loan's limited recourse nature might result in a higher interest rate.
Liquidity – Loan repayments must be withdrawn from your fund in order to maintain liquidity. This implies that your fund must always have enough liquid assets to cover loan repayments. Careful preparation is required to make sure that contributions and investment income from the fund are enough to cover loan repayments and other current and future obligations when they become due. This is crucial if the property cannot be leased for any length of time or if one or more members are in the retirement phase (due to the requirement for the fund to also meet minimum pension payment requirements).
The contribution ceilings place restrictions on the number of contributions that may be made on a concessional tax basis, even for members who are still in the accumulation phase. If non-concessional contributions are needed to pay back the loans because the member's concessional contribution threshold has already been reached, this could reduce the limited recourse borrowing arrangement's tax effectiveness.
It's crucial for SMSF trustees to take into account the necessity for life insurance in the event that one or more fund contributors pass away. To ensure that, in this case, the SMSF trustee may utilize the proceeds of a life insurance policy to repay the debt, the trust deed for the fund must be carefully drafted.
If the trustee of the SMSF defaults on the loan, the lender may seize the asset, sell it, and pay the trustees of the SMSF the proceeds of the sale less the outstanding loan balance. The lender will not be able to use any other assets of the SMSF as collateral if there is a difference between the outstanding loan balance and the sale revenues obtained. However, if there is a guarantor, they can be asked to cover the difference.
Loan documentation and purchase contract – The Australian Taxation Office has learned that some limited recourse borrowing contracts signed by trustees of SMSFs were not properly drafted. Some of these agreements cannot simply be reorganized or corrected, and to end the agreement, the property may need to be sold, which would result in a significant loss to the fund.
The asset bought under the limited recourse borrowing arrangement must be acquired in the Security Trust's name, with the trustee of the SMSF acquiring a beneficial interest in the asset in accordance with the Security Trust Deed, in order to be compliant with the requirements. If the SMSF trustee fails on the loan, the lender will not have access to any fund assets under the conditions of the loan, which must be on a limited recourse basis.
Tax losses and capital gains – Any potential tax losses that may result from an asset's after-tax cost being greater than its income are quarantined in the fund. This means that you cannot utilize the tax losses to reduce your taxable income from sources other than the fund. A property's worth, including any equity it may have accrued over time, cannot be used to buy further properties outside the fund since, similarly, the value of a property acquired under a limited recourse borrowing arrangement cannot be used as collateral for other loans.
Governing rules and other matters - Trustees should constantly think about the caliber of the investment they are making and if a limited recourse borrowing arrangement is consistent with the investment strategy of the fund. Before any limited recourse borrowing arrangement is made, the trustee of the SMSF must be permitted to borrow by the SMSF's governing rules. An action for recovery of loss or damage suffered by a person with a beneficial interest in the fund may be brought if an investment is not in line with the investment strategy of the fund or is not permitted by the rules regulating the fund.