2 major changes affecting SMSFs
The SMSF market is facing two important changes: AFSL requirements for accountants who advise SMSF clients and the ATO closing a loophole on interest-free loans provided to SMSFs by its members.
Two issues that are currently working their way through the SMSF market could have a profound impact on the way the market operates.
The first involves the way that the largest profession servicing this market, accountants, operates. The second involves an aggressive tax play used by SMSFs.
Let’s start with a reminder of how the SMSF market is regulated.
What’s happening to accountants?
While becoming a member of an SMSF technically is a dealing in a ‘financial product’, which would normally require the adviser to be licensed under the Corporations Act, accountants are, until 1 July 2016, exempt from those rules when advising on setting up or winding down an SMSF.
Now things are changing and accountants need, from that date, either a full financial services licence or a limited financial services licence, if they want to advise a client on setting up an SMSF and dealing with their existing superannuation interest.
The most obvious client example where this would be relevant would be an individual coming up to retirement having, say, $700,000 in a retail or industry super fund, who wants to manage it themselves using an SMSF, as they will now have more time on their hands. Usually, they would seek guidance from their trusted accountant, but what will happen in future?
If the accountant goes down the licencing route, either as a licensee or an authorised representative of a licensee, their world changes significantly as the business will differ greatly from an accounting practice. At a macro conceptual level, licensees and authorised representatives work on a ‘disclosure basis’, in that the potential investor has to have all the risks associated with a potential investment disclosed and then they decide whether to invest or not.
At a legal relationship level, there are a whole range of rules for managing conflicts of interest by licensees and authorised reps, such as acting in the best interest of the client and not being remunerated by commission.
At a practical level there is also the paper work. Licensees and authorised reps must tell clients what they can do in terms of financial services (a Financial Services Guide) and, more importantly, they must document their recommendations and reasons for them (a Statement of Advice).
Compare this formal and stylistic way of working with that of an accountant, which is largely the reverse, where clients rely on and trust decisions and recommendations made by accountants. Ultimately, clients rely on the membership of an accounting body subject to its ethical and professional conduct restraints.
(Note, there are a few alternatives for accountants who do not want to go the licensing option, such as providing execution-only services or co-venturing with a licensed financial adviser who does all the activity requiring a licence).
ATO closing a contributions loophole
The other issue that will affect the SMSF market involves income tax. To limit the amount of tax benefits anyone can get out of using a SMSF, there are limits on how much they can contribute, both concessionally-taxed and after-tax. These are called the contribution caps.
It was different prior to 2007, when you could put as much into a SMSF as you wanted (not all of which would be deductible of course), but if you took out more that was considered reasonable, you paid extra tax. These were called the Reasonable Benefit Limits. From 2007, the tax system reverted to the way that it had operated before 1997, when there were limits on the amount that could be contributed to a SMSF. Which is what we have now with the caps.
If instead of contributing to a SMSF and being limited by the contribution caps, you could lend all your wealth interest free, well, you have just driven a Mack truck through some pretty important integrity measures in the system, being those contribution caps.
As you are both the borrower, being a member of your SMSF, and the lender, why pay yourself interest? Indeed, that is what has been happening.
The ATO is now actively trying to resolve this serious integrity breach by reclassifying the income that the SMSF receives from the investment that it acquires with the funds that have been borrowed at zero interest from the member as “Non Arm’s Length Income”- NALI, in the trade (an unfortunate acronym for those involved). That type of income is taxed at the highest marginal tax rate and not the preferential super tax rates of 15% or 0% if in pension mode.
After a couple of false starts, the ATO has now put the SMSF market on notice of the risk of tax at 47% on related party non-commercial loans.
The SMSF advising market seems to have got the message and are now saying that all loans to SMSFs, including from related parties, should be on full commercial terms. Not just with respect to the interest charged, but also in terms of LVRs and payment schedules.
About the author
Gordon Mackenzie is a Senior Lecturer in taxation and business law at the Australian School of Business, University of New South Wales.
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