Collectables, market value reporting, separation of assets, investment strategies and 30% tax on contributions
In our first two articles on stronger super and SMSFs we set out a time line of the various stronger super and other Government changes that have affected self managed superannuation funds (SMSFs) in the last few years. In this article we look at some of those changes that commenced in the 2011/12 and 2012/13 years in more detail.
New restrictions on investing in collectibles
The new restrictive rules on the trustees of SMSFs investing in collectables (and personal use assets) have been in place for a few years now. The new rules take effect from two dates. First, the rules will immediately apply to all collectables acquired from 1 July 2011. Second, the rules will apply from 1 July 2016 to collectables acquired pre-1 July 2011. Effectively, pre-1 July 2011 collectables must either be disposed of before 1 July 2016 or comply with the new rules by that date.
As can be seen below, the new rules are quite onerous and therefore, SMSF trustees investing in collectables must ensure they are aware of all the requirements before they acquire such an investment.
Regulation 13.18AA(1) of the Superannuation Industry (Supervision) Regulations 1994 (SIS Regs) sets out that the following assets are captured by the new rules:
- artwork (as defined in the Income Tax Assessment Act 1997 as a painting, sculpture, drawing, engraving or photograph; or a reproduction of such items; or a property of a similar description or use);
- coins, medallions or bank notes;
- postage stamps or first day covers;
- rare folios, manuscripts or books;
- wine or spirits;
- motor vehicles;
- recreational boats; and
- memberships of sporting or social clubs.
Investments in these collectables and personal use assets must comply with the following rules.
1. Collectables must not be leased to (or under lease arrangement with) a related party
“Related party”, “lease” and “lease arrangement” are defined under their existing definitions in the Superannuation Industry (Supervision) Act 1993 (SIS Act).
Related party is defined widely and will include members and the relatives of members together with any trusts, partnerships or companies that they control or have more than a 50% interest in. It also includes a “standard employer sponsor” of an SMSF (if any) and its related entities.
A lease arrangement extends to any agreement, arrangement or understanding in the nature of a lease between an SMSF trustee and another person, under which the other person is to use, or control the use of, property owned by the SMSF, whether or not the agreement, arrangement or understanding is enforceable, or intended to be enforceable, by legal proceedings. Therefore, this will extend beyond legal lease arrangements to licence and informal arrangements.
2. Collectables must not be stored in the private residence of the related party
Although private residence is not defined, it is clear from the explanatory statement which introduced these rules that this rule is intended to catch a related party’s home or abode. Therefore, it would catch the main residence or holiday house of an individual but not their business premises or an investment property. It is also clear from the explanatory statement that a private residence also includes associated buildings such as a garage or shed on the same parcel of land as the residence.
This prohibition will not apply to properties of companies and trusts as such entities cannot have private residences.
An SMSF trustee is able to keep collectables in special purpose storage facilities owned by a member, or a related party, provided that the facility is not part of a private dwelling of that member or related party.
3. Decision on storage of the collectable must be documented
An SMSF trustee must record in writing reasons for the decision made with respect to the storage of the collectable. The trustee must keep such written records for at least 10 years.
4. Collectable must be insured in the super fund’s name
An SMSF trustee must insure a collectable (other than a membership of a sporting club or social club) in the name of the SMSF within 7 days of acquiring the collectable. This measure will not be satisfied if insurance is obtained in the name of the SMSF trustee without reference to the SMSF.
Given such a short time period it will be prudent for SMSF trustees to be prepared to insure the collectable before they acquire it.
5. Collectable must not be used by a related party
This is an interesting requirement when considering the prohibition against leasing collectables (in reality it probably makes the leasing prohibition redundant). According to the explanatory statement, the purpose of this requirement is to prevent a related party from obtaining personal enjoyment from the collectable. “Classic examples” of potential uses by related parties include an SMSF’s artwork being displayed in the family home of a member or an SMSF’s classic car being driven by a member.
6. The transfer of a collectable or an interest in a collectable to a related party must be at market price determined by a qualified independent valuer
Unlike other superannuation and tax measures that require dealings to be at market value without requiring a supporting valuation, this measure requires the price to be determined in accordance with a valuation from a qualified independent valuer.
In addition, this measure not only applies to sales of collectables to related parties but would also cover in-specie benefit distributions of collectables and other arrangements where the related party acquires an interest (which could include an indirect interest) in the collectable.
According to the ‘valuation guidelines for self-managed super funds’ published by the Australian Taxation Office (ATO), an acceptable qualified valuer is usually one who holds formal valuation qualifications or is considered to have specific knowledge, experience and judgment by their particular professional community. This is usually demonstrated by being a current member of a relevant professional body or trade association.
As the valuer is required to be independent, that person cannot be a member of the SMSF or a related party of the SMSF.
Market value reporting in financial statements
From 7 August 2012, regulation 8.02B of the SIS Regs imposes an obligation on SMSF trustees to value all assets in the SMSF’s financial statements and accounts at market value. Market value is defined in section 10(1) of the SIS Act as:
the amount a willing buyer of an asset could reasonably be expected to pay to acquire the asset from a willing seller if the following assumptions were made:
- The buyer and seller dealt with each other at arm’s length in relation to the sale;
- The sale occurred after proper marketing of the asset; and
- The buyer and seller acted knowingly and prudentially in relation to the sale.
Unlike the obligation for collectables (as noted above), there is no requirement to obtain an independent valuation or that the price must be determined in accordance with an independent valuation. In relation to what the ATO would be expecting in relation to this obligation, the ATO’s guidelines outline various valuation methodologies and principles for different classes of assets.
Separation of SMSF assets from non-SMSF assets
The obligation on an SMSF trustee to keep the SMSF’s assets separate from the personal assets of the trustee or the assets of a standard employer-sponsor or their associates has always been a requirement contained in the trustee covenants in section 52(2)(d) of the SIS Act. However, from 7 August 2012, this requirement is now an operating standard in the SIS Regs which can be enforced by the ATO against SMSF trustees.
These requirements are strangely limited as they provide that SMSF trustees must keep the money and assets of the fund separate from the money and assets:
- Held by the trustee personally; and
- Held by the standard employer-sponsor or associates of a standard employer sponsor.
On a strict interpretation this would not include assets or money held for, or by, members (who were not trustees) and related parties (that are not standard employer sponsors or their associates) or held by the SMSF trustee in another capacity. Nor is there a requirement to hold assets in the name of the SMSF, just to keep them separate from personal assets.
Interestingly, the explanatory statement gives the impression that this requirement would catch the mixing of the SMSFs assets with those of the members when it states that “[t]he Super System Review panel noted that breaches of the existing covenant occur with some frequency, such as where an SMSF operates using a member’s personal bank account rather than through a separate account established for the SMSF, or where assets are recorded in one or more member’s name personally, rather than in their capacity as trustee of the SMSF.” However, as currently drafted, unless the member was an individual trustee, these examples would not breach the new requirements.
Regularly review the investment strategy and consideration of insurance
The investment strategy requirement imposed on an SMSF trustee is both a trustee covenant (section 52B(2)(f) of the SIS Act) and a prescribed operating standard under regulation 4.09(2) of the SIS Regs.
As of 7 August 2012, the operating standard in relation to an SMSF investment strategy was expanded in two ways:
- to require SMSF trustees to review regularly the investment strategy with regard to relevant circumstances; and
- to consider whether SMSF trustees should hold a contract of insurance that provides insurance cover for one or more members of the SMSF.
1. Regular review of investment strategies
As ‘regularly’ is not defined anywhere in the SIS Act or the SIS Regs, the regularity of reviews is largely dependent on the circumstances of the SMSF and its members. According to the explanatory statement “trustees should conduct a review on a regular basis to take into account factors such as changing circumstances of their SMSFs and its members”.
It would be prudent for SMSF trustees to, at the very least, review the investment strategy annually. In addition, the investment strategy should be reviewed where a significant event occurs, such as where a member starts to receive a pension, where a member dies or a significant asset is sold.
There is no requirement as to how the investment strategy should be reviewed or whether any evidence of such a review is required. Of course it would be prudent to record the occurrence of such a review in order to establish that the SMSF trustee has complied with its obligations. According to the explanatory statement, evidence of this requirement would be satisfied by documenting the decisions in the minutes of SMSF trustee meetings held during the year.
2. Consideration of Insurance
The introduction of regulation 4.09(2)(e) of the SIS Regs, with effect from 7 August 2012, imposes an obligation that, as part of formulating, regularly reviewing and giving effect to an investment strategy, SMSF trustees must have regard to whether contracts of insurance should be held to provide insurance cover for one or more members of the SMSF.
According to the explanatory statement “[T]rustees of SMSFs are expected to be self-reliant in determining the type and level of insurance cover members might require whether within or outside their SMSF. In meeting this requirement, trustees should have regard to the personal circumstances of their members and other legislative requirements such as the sole purpose test in section 62 of the [SIS Act].”
Again, although there is no strict obligation to record such consideration, the explanatory statement provides that evidence of the decision could be documented in the SMSF’s investment strategy or minutes of an SMSF trustee meeting held during the year.
30% contributions tax on individuals earning more than $300K
From 1 July 2012, an additional 15% tax is payable on the amount of concessional contributions that cause an individual’s “income” to exceed their $300K threshold. That is, those contributions will be taxed at an effective tax rate of 30%. This measure has been a bit of a “sleeper” given that it applied from last financial year. We expect this will change when the assessments for the 2012/13 year start being issued in the next few months (after individuals and super funds have lodged their 2012/13 tax returns). There are special rules for individuals with interests in defined benefit funds which will not be discussed in this article.
The $300K “income” threshold includes not only an individual’s salary but also the individual’s:
- Taxable income;
- Reportable fringe benefits;
- Total net investment losses;
- Taxable component of any super lump sums in excess of the low rate cap; and
- “Low tax contributions” (effectively concessional contributions from employers and personal deductible contributions).
The $300K threshold excludes excess concessional contributions not refunded, disregarded or reallocated.
Where the addition of the concessional contributions to an individual’s other income causes the individual to exceed the $300K limit, the additional 15% tax is only assessed against the amount of the concessional contributions that exceed the $300K limit. For example, if an individual’s assessable income was $290K and they had concessional contributions of $25K made on their behalf, it would only be $15K of concessional contributions that would be taxed at the additional rate of 15% (as the first $10K was under the $300K threshold). Whereas, if an individual had $305K of assessable income and $10K of concessional contributions were made on their behalf, then all $10K of concessional contributions would be taxed at the additional 15% (because the individual already exceeded the $300K limit before the concessional contributions were added).
Unlike the “standard” contributions tax which is payable by the super fund trustee, the additional 15% tax is issued against the individual in a process that is similar to the excess contribution tax regime. That process can broadly be summarised as follows:
- The additional 15% tax is assessed against the individual via a notice of assessment.
- The tax is due and payable personally by the individual 21 days after a notice of assessment is issued (late payments will attract general interest charge).
- At the same time of the issuing of the notice of assessment, the Commissioner must also issue to the individual a super release authority which (if provided to the super fund) compels the super fund to release to the individual, or the ATO, an amount of up to the additional 15% tax.
- The individual has up to 120 days to give release authority to their super fund (but is not obliged to).
- Upon receipt of the release, the super fund must release the amount within 30 days.
- The released amounts are non-assessable non-exempt income in the hands of the individual (ie so the amounts are not taxed again as super benefits).
Individuals affected by this measure will therefore broadly have 3 options:
- Pay the additional 15% tax themselves within 21 days and leave the amount of the “tax” in the super fund;
- Pay the additional 15% tax themselves within 21 days and recover the amount of the “tax” from their super fund; or
- Send the release authority to the super fund within 120 days and direct the super fund to pay the amount.
If the second option is chosen, then, in order to avoid general interest charge, the taxpayer may have to first pay the amount to the ATO themselves and then be “reimbursed” by the super fund. This is because the tax is payable within 21 days whereas the super fund does not have to release the amount until 30 days after it receives the request. Alternatively, if an individual wants to use their super benefits to pay the tax, the third option could be used, given that individuals have 120 days to action it (rather than 21 days under the second option). It should be noted however that a payment of the tax by a super fund after the 21 day period under the third option does not mean that general interest charge will not apply on the late payment (although the explanatory memorandum suggests that the late payment by a super fund could be grounds for remission of the general interest charge).
The first option would be preferable for individuals who have the personal funds to pay the tax and would prefer to keep the amount in super.
Download a PDF version of this article: Stronger Super and SMSFS - Part 3
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