Like death, taxes are one of the things that you can’t avoid; you can however avoid getting in trouble with the tax office. Contravention reporting requires SMSF auditors to report Trustee contraventions to the ATO. Over one million Australians use an SMSF to manage their retirement savings and there are thousands more being added every month. Understanding and avoiding the following five traps will help to ensure your retirement nest egg is not at risk of penalties.
1. Loan to member/financial assistance
Topping the list at 22% of reported contraventions reported to the ATO for the 2013/14 financial year was Trustees ‘accidentally’ dipping into their retirement savings or to put it another way, accessing their super early.
“One of the most common mistakes people make with their SMSF is mistakenly treating their SMSF bank account savings as funds that they can access whenever they wish” says Karen Hellwig from CPA Australia. While many of these breaches may be purposeful transactions such as paying HECs bills, providing additional cash flow for their business or buying a holiday home, CPA Australia has also heard of instances where trustees have inadvertently withdrawn cash from their SMSF account while using online banking on their mobile phone. Karen’s advice is to trustees is to “take particular care to ensure their SMSF and its assets are kept separate from their personal assets and savings to avoid temptation and unwitting mistakes”.
Evolv Super’s Audit Manager, Brendan Frawley, points to section 65 of the Superannuation Industry Supervision Act (SISA) that strictly prohibits any form of financial assistance to members. Financial assistance he points out is made clear in SMSF ruling 2008/1 as “any arrangement or transaction whereby the assets of the SMSF are converted into other assets, diverted, or there is a prejudice to the financial position of the SMSF”.
Members need to ensure that all transactions that are in some way related to them are done on an arm’s length basis and if you’re not sure, speak to an SMSF specialists, and read our article discussing the ATO rules to SMSF borrowing.
2. In-house Assets
Coming in second place at 19% of reported contraventions are Trustees that hold more than 5% of their assets in investments related to the member. For example, if John runs his own company and has an SMSF, he may choose to invest in his own company which would then be considered an in-house asset. Similarly, if the fund and related parties own more than 50% of an entity, that entity may be deemed an in-house asset. In-house assets can only account for 5% of the total value of assets within his SMSF at the time of audit.
There are a limited number of exceptions to this rule, the most common of which is commercial real estate leased to the members’ business. From the above example, if John’s SMSF owned a commercial property, his company is able to lease the property from his SMSF provided the arrangement is legally binding and done at arm’s length.
Complications can arise after the initial purchase if underlying ownership structures are changed, causing a breach. “Once in breach, we find that Trustees are unaware of their obligations and processes to be followed for correction. Commonly these types of investments are illiquid in nature placing further time pressures on trustees,” said Director of TriSuper Auditors, Joel Curry.
“In our experience, the ATO will be lenient with Trustees who take reasonable steps to correct breaches as soon as practically possible”.
3. Separation of assets
Separating bank accounts is not only a good way to avoid inadvertent loans to members it might also help you avoid the third most common trustee mistake – separation of assets. When an SMSF has individual trustees (as opposed to corporate trustee) it needs to be clear that the SMSF is the beneficial owner of assets held in the name of the trustee for the purpose of the SMSF. This contravention is not only the third largest at 13% but by value is the second largest contravention at 25%.
Evolv Super’s Brendan Frawley says that “shares and bank accounts held in the members personal name with no evidence of beneficial ownership by the fund, could be in breach of section 52B(2)(d) and SISR 4.09A”. One of the easiest ways to avoid this contravention, he suggests, is to have a Corporate Trustee.
Michal Bodi, Partner at Sydney Financial Planning, explains that “many mistakes are committed by SMSF trustees daily, simply because running a super fund is hard work… it’s like running a small business on the side”. For this reason, trustees need to have a disciplined approach to structuring their accounts and asset holdings to avoid being pinged for separation of assets.
4. Administrative type contraventions
Not many of us enjoy paperwork but if you’ve taken the step to manage your own superannuation fund then being on top of the administration of your fund one of the many obligations that comes with that. Unfortunately, only some of that can be outsourced to accountants and specialists. Administrative type contraventions account for 10% of all reported contraventions.
Two common ways this type of contravention occurs according to Brendan Frawley is in Trustees failing to return paperwork within the required amount of time as determined by the relevant SISA rules.
“On some occasions we are required to obtain documents from Trustees in relation to the audit of an SMSF. If the Trustees fail to provide the documents within 14 days we are obliged to report this to the ATO as per section 35C(2) of SISA,” he says.
Similarly, “if there is a change of Trustee during the year the Trustees are required to sign an ATO Trustee Declaration within 21 days of becoming a trustee. If this is not provided then we are obligated to report this to the ATO as per section 104A of SISA”.
Both of these mistakes and other administration errors can be avoided by working closely with your SMSF specialists to understanding your administrative obligations as a trustee.
5. Sole Purpose
It may be surprising that one of the most talked about SMSF obligation has only managed to get into 5th place in the most common Trustee mistakes. Sole purpose test contraventions account for 8% of those reported and just 4.5% by value. In order to access superannuation funds a member must meet a number of criteria such as age and working status. Sole Purpose rule breaches essentially happen whenever a member of a fund receives a benefit from their superannuation prior to being eligible. The classic example of this would be buying a holiday house that the member spends a few months a year at without paying rent.
Benefit goes beyond just personal benefit though and could speak to the way in which a deal is structured. Joel Curry gives a clear cut example of a sole purpose breach being where a commercial property (owned by the SMSF) is leased to a related party of that SMSF at a rate below the market. In the holiday house example above the same contravention would exist if the member gave themselves a large discount on the rental rate of their SMSF-owned property.
This role doesn’t just apply to property though, if an SMSF purchases artwork it must be for the sole purpose of the fund and not include any benefit for the members (prior to eligible age). Therefore, it cannot be hung in the private residence of a related party as this, the ATO argues, would give a benefit to the member. The Cooper Review recommended that SMSF should not be allowed to invest in these types of asset and suggested a 5 year horizon for existing SMSF’s to dispose of such assets. Instead, the government of the day allowed SMSF’s to continue to purchase and hold collectibles and personal use assets but have put much tighter controls on the conditions that need to be met to hold these. For example, artwork needs to be insured in the name of the SMSF even if the gallery has its own insurance and if that insurance is not in place within 7 days of the purchase of the artwork it will be considered a breach. For collectible cars, not only can they not be stored at the residence of a related party but they can’t be driven by a related party for any reason, including maintenance.
Navigating these rules can become quite technical so if you’re inclined to invest in collectibles then it’s important to get a clear understanding of the conditions of having that asset. The bad news is that the liquid in that wine collection is the property of the SMSF too, not just the bottles.
It’s easy to see how these sorts of contraventions can arise in an SMSF and shows how important it is to not take on the responsibility of running your own superannuation fund lightly. Most of the breaches above can be avoided by simply having a clear delineation between your personal assets and the assets of the SMSF. While slightly less convenient, using different banks for each purpose would overcome some of the accidental breaches and remove the temptation for purposeful breaches. Like Michal Bodi from Sydney Financial Planning suggests, “it’s like running a small business on the side” and so if someone doesn’t want to take on the extra obligations, rules and duties associated with running their own superannuation fund then they shouldn’t get into it.
About Josh Callaghan
Josh Callaghan is the former General Manager of Wealth at Canstar and co-founder of Fintech Queensland. In his role at Canstar, Josh was responsible for the strategic direction, operations and commercial outcomes of the Wealth division, which includes Superannuation and Investments. He has over 19 years of experience in product management, strategy, technology and marketing in the financial services industry.