Jeff Song

There are circumstances where a former spouse could be considered a related party of the fund. Any transactions would be subject to the sole purpose test and the investment strategy requirement. Trustees should not assume that a member’s ex-spouse or other non-relatives such as distant family members or friends are not related parties of the fund but should seek professional advice when considering any transactions with any of them.

A question we get from time to time is whether the trustee(s) of an SMSF can enter into transactions such as a loan, lease or another type with a fund member’s former spouse. In this article, we will consider a number of compliance issues with SMSF transactions involving a former spouse. You will note that some of the compliance considerations would be relevant in situations where the transacting party is a distant relative (i.e. cousin) or a friend who isn’t included in the definition of ‘relative’ under the Superannuation Industry (Supervision) Act 1993 (Cth) (“the SIS Act”).

Definition of relative and general prohibition on lending money of the fund or otherwise giving financial assistance to a member’s relative

The SIS Act contains two slightly different definitions of a ‘relative’ – one in s10 and the other in s17A. The definition in s17A adopts a wider definition which includes ‘former spouse’ (and cousins) as a relative, but this definition is not relevant for the purpose of determining if there is any prohibited loan or financial assistance to a member’s relative under s65 of the SIS Act.

The relevant definition is in s10, and it doesn’t include a former spouse as a relative of the member. On the face of it then, there is no general prohibition on the fund trustee from lending money or giving financial assistance to the member’s former spouse.

However, care needs to be taken to ensure that the transaction doesn’t give rise to an ‘indirect’ financial assistance to someone who is a relative (i.e. the member’s children). The ATO’s view as expressed in SMSFR 2008/1 is that the s65(2)(b) also encompasses any arrangement where the loan is to a non-relative but indirectly gives financial assistance to a member’s relative. If the arrangement is with mutual understanding that the monies so borrowed from the fund would be used for the benefit of their children (or any other relatives of the member) arguably there is provision of prohibited indirect financial assistance.

This risk could be mitigated by entering into (and adhering to the terms of) an enforceable agreement that is appropriately drafted to restrict the use of loan amount by the borrower and otherwise note reasonable arm’s length terms between the parties.

Part 8 Associate and in house asset issue

Whether a former spouse of a member is a related party of the fund is not necessarily a simple question. SIS Act adopts a broad definition of related party and can quite easily capture a member’s ex-spouse as a related party.

An example is where the member’s superannuation interest is subject to a payment split in favour of their former spouse pursuant to a Family Law consent order. Even where the former spouse has never had a membership interest themself (and regardless of what the trust deed or the member register of the fund says) the SIS Act and the regulations extend the definition of a member for SMSFs and deem the former spouse themselves as a member of the fund from the operative time of the splitting order.

To avoid this situation, it is necessary to convert the former spouse’s ‘entitlement’ under the court order (or financial agreement) into a ‘superannuation interest’ for the former spouse in another superannuation fund (rollover) or cashing out the benefits to the former spouse if he/she has met an unrestricted condition of release. This example highlights the importance of seeking the appropriate advice and to carefully complete the super splitting process right to the end. A Family Court order is a powerful document and it might offer a false sense of comfort that the process is over.

Another example is where the former spouse is considered a related party due to being a partner of a partnership with the member. The SIS Act has adopted the tax law definition of partnership for IHA purposes which is broader than the general law definition of a partnership. This broader definition includes arrangements whereby two or more individuals or entities are simply in receipt of income jointly. Likely the Family Law consent order would have considered and dealt with any joint investment. However, it’s again important to ensure that the parties have actually implemented the orders and no longer hold any joint investment. For example, if an order required a jointly owned investment property to be transferred to one of them, the transfer should be effected with a conveyancer to ensure they are not considered as related parties by reason of jointly receiving investment income.

There are of course many other circumstances where a former spouse could be considered a related party of the fund including via general law partnership, or involvement in the same company or a trust. Any transactions would of course be subject to the sole purpose test and the investment strategy requirement. Trustees should not assume that a member’s ex-spouse or other non-relatives such as distant family members or friends are not related parties of the fund but should seek professional advice when considering any transactions with any of them.

The post SMSFs transacting with former spouse, cousins or friends appeared first on AdviserVoice.

Jeff Song

A question we get from time to time is whether the trustee(s) of an SMSF can enter into transactions with a fund member’s former spouse whether the transaction is a loan, lease or another type.

In this article, we will consider a number of compliance issues with SMSF transactions involving a former spouse. You will note that some of the compliance considerations would be relevant in situations where the transacting party is a distant relative (i.e. cousin) or a friend who isn’t include in the definition of ‘relative’ under the Superannuation Industry (Supervision) Act 1993 (Cth) (“the SIS Act”).

Definition of relative and general prohibition on lending money of the fund or otherwise giving financial assistance to a member’s relative

The SIS Act contains two slightly different definitions of a ‘relative’ – one in s10 and the other in s17A. The definition in s17A adopts a wider definition which includes ‘former spouse’ (and cousins) as a relative, but this definition is not relevant for the purpose of determining if there is any prohibited loan or financial assistance to a member’s relative under s65 of the SIS Act.

The relevant definition is in s10, and it doesn’t include a former spouse as a relative of the member. On the face of it then, there is no general prohibition on the fund trustee from lending money or giving financial assistance to the member’s former spouse.

However, care needs to be taken to ensure that the transaction doesn’t give rise to an ‘indirect’ financial assistance to someone who is a relative (i.e. the member’s children). The ATO’s view as expressed in SMSFR 2008/1 is that the s65(2)(b) also encompasses any arrangement where the loan is to a non-relative but indirectly gives financial assistance to a member’s relative. If the arrangement is with mutual understanding that the monies so borrowed from the fund would be used for the benefit of their children (or any other relatives of the member) arguably there is provision of prohibited indirect financial assistance.

This risk could be mitigated by entering into (and adhering to the terms of) an enforceable agreement that is appropriately drafted to restrict the use of loan amount by the borrower and otherwise note reasonable arm’s length terms between the parties.

Part 8 Associate and in house asset issue

Whether a former spouse of a member is a related party of the fund is not necessarily a simple question. SIS Act adopts a broad definition of related party and can quite easily capture a member’s ex-spouse as a related party.

An example is where the member’s superannuation interest is subject to a payment split in favour of their former spouse pursuant to a Family Law consent order. Even where the former spouse has never had a membership interest themself (and regardless of what the trust deed or the member register of the fund says) the SIS Act and the regulations extend the definition of a member for SMSFs and deem the former spouse themselves as a member of the fund from the operative time of the splitting order.  To avoid this situation, it is necessary to convert the former spouse’s ‘entitlement’ under the court order (or financial agreement) into a ‘superannuation interest’ for the former spouse in another superannuation fund (rollover) or cashing out the benefits to the former spouse if he/she has met an unrestricted condition of release. This example highlights the importance of seeking the appropriate advice and to carefully complete the super splitting process right to the end. A Family Court order is a powerful document and it might offer a false sense of comfort that the process is over.

Another example is where the former spouse is considered a related party due to being a partner of a partnership with the member. The SIS Act has adopted the tax law definition of partnership for IHA purposes which is broader than the general law definition of a partnership. This broader definition includes arrangements whereby two or more individuals or entities are simply in receipt of income jointly. Likely the Family Law consent order would have considered and dealt with any joint investment. However, it’s again important to ensure that the parties have actually implemented the orders and no longer hold any joint investment. For example, if an order required a jointly owned investment property to be transferred to one of them, the transfer should be effected with a conveyancer to ensure they are not considered as related parties by reason of jointly receiving investment income.

There are of course many other circumstances where a former spouse could be considered a related party of the fund including via general law partnership, or involvement in the same company or a trust. Any transactions would of course be subject to the sole purpose test and the investment strategy requirement. Trustees should not assume that a member’s ex-spouse or other non-relatives such as distant family members or friends are not related parties of the fund but should seek professional advice when considering any transactions with any of them.

By Jeff Song, Managing Solicitor – Superannuation Online Services Division

The post SMSFs transacting with former spouse, cousins or friends appeared first on AdviserVoice.

Jeff Song

The superannuation environment may offer great tax efficiency in passing a member’s death benefits to their dependents, however there is a rider – the member will not have full control over how the benefits will be used by the beneficiary.

One of the beauties of SMSFs is that members can be flexible with their directions to the trustee through their binding death benefit nominations. Subject to the SMSF’s governing rules, members can go beyond simply nominating which of their dependents will receive benefits.

Because of s59 of the SIS Act and the binding death benefit rules in SISR 6.17A, which apply to APRA funds but not SMSFs, binding death benefit nominations (‘BDBNs’) used by APRA funds are often not afforded the same level of flexibility.

With APRA funds, the member’s decision in most cases would only extend to who will receive their death benefits, and other decisions such as the form of the death benefit payment (i.e. lump sum or beneficiary pension) are ultimately at the trustee’s discretion or at least require the trustee’s consent.

Even with the benefit of greater flexibility for SMSFs, how the superannuation death benefits will be used by the beneficiaries is generally beyond the control of the member making the binding death benefit nomination, due to the mandatory cashing out requirements and the pension rules.

For example, if the death benefits are to be paid in a lump sum, the compulsory cashing of death benefits requirement under regulation 6.21 mandates the death benefits be cashed in a single lump sum or an interim lump sum and a final lump sum. Once in the hand of the nominated beneficiary, there is no effective control over how the money is spent by the beneficiary.

The member could try to have control over the use of the death benefit by specifying terms and conditions the beneficiary must agree to before receiving the death benefit. However, there will be no practical way of enforcing the beneficiary’s adherence to the terms and conditions once the beneficiary receives the benefit money or property.

If death benefits are paid as an account-based pension, which is the most popular type of SMSF pension, generally there is no limit on maximum amount of pension the beneficiary can take in any year and also the beneficiary may choose to commute the pension for lump sum payment at any time.

Arguably, one could specify in their binding death benefit nomination that the pension must not be commuted by the beneficiary and also set maximum annual pension payment limits.

If the member’s child is the beneficiary, there is a mandatory commutation requirement under SISR which must override any such additional rules set by the member (i.e. the pension must be commuted and the resulting sum must be cashed out when the child turns 18 or, for a financially dependent child, 25, unless the child has a disability).

If the deceased’s spouse is the beneficiary, there is no mandatory commutation requirement for a beneficiary pension in the form of an account-based pension.

If the governing rules and the pension documents are appropriately drafted, such pension may still qualify as a complying pension. However, the effectiveness of this strategy has not been tested in court and there is some uncertainty as to whether or not the beneficiary with the sole beneficial interest in the pension can successfully challenge the limitations and access the benefits at will.

If the member’s major concern is having control over the death benefits after the member’s passing, there are other options for consideration including a BDBN directing the death benefits to be paid to the executor of their estate with a testamentary trust set up in their Will.

Of course, this option would come at its own costs such as loss in tax efficiency and potential risk of the estate being challenged. Members and trustees should seek both legal and tax advice when considering different options.

The post SMSFs and binding death benefit nominations – where is your limit? appeared first on AdviserVoice.

Jeff Song

• The maximum number of members in an SMSF is expected to increase from 4 to 6 in near future.
• With economies of scale/pooling of resources, this could open doors to new SMSF opportunities.
• On the other hand, having more members in the same fund will increase the likelihood of disputes.
• If there is an unfortunate falling out, can a member with majority interest in SMSF expel another member?

Let’s assume the new law for 6 member SMSFs has come into effect and consider an example of the White Castle Family Fund of which Castle Pty Ltd is the corporate trustee. John and Mary and their two daughters, Jessica and Melanie, were the initial members of the fund and Melanie’s husband, Harold, has been admitted as the 5th member of the fund after the limit increased to 6.

With the pooled resources, the fund then bought a commercial property and leased it to their family business run by John and Mary. Harold then had a major falling out with John. John has the majority balance in the fund, with his member balance accounting for $3m out of the total $5m in the fund. John wishes to remove Harold as a member of the fund but Harold is simply ignoring John’s wishes.

Trust Deed of the fund and the constitution of the corporate trustee

The current trust deed might provide a mechanism for removing a member by giving the trustee or the member(s) with the majority balance the power to remove a member.

If John has that power, as the member with the majority interest, he can follow the applicable governing rules to exercise his power to remove Harold as a member. If the power is in the trustee, the constitution of the corporate trustee needs to be checked to see how the directors can validly make decisions for the company.

If the constitution requires unanimous agreement of all directors, then it seems unlikely in our example that Harold will agree to the decision to remove himself as a member of the fund.

If on the other hand, the constitution provides for decision by majority votes, where each director’s voting power is simply one vote or is proportionate to their member balance in the fund, then John may have the control over the trustee’s exercise of the removal power either because he and Mary and their other daughter vote to remove Harold, even though Harold and Melanie vote against, or because John and Mary control the voting power through the value of their interests in the fund.

It’s also worth considering the shareholding structure of the company. It is not a requirement for all members to be shareholders of the fund’s corporate trustee. If John is the sole shareholder of the corporate trustee which needs unanimous agreement of the directors for making decisions, he can remove Harold as a director of the corporate trustee who is unlikely to cooperate.

The fund would then be non-compliant (all members have to be directors) but John could then swiftly move to remove Harold as a member thereby returning the fund to compliance within the ATO time guidelines for such rectification.

However, exercise of the removal power by the member(s) or the trustee is not the end of the story and there are other and perhaps more difficult hurdles in getting Harold’s member balance out of the fund.

Rollover of exiting member’s balance

In order to implement the decision to remove Harold as a member, the trustee must be able to pay his benefits out of the Fund. Assuming he hasn’t met an unrestricted condition of release, his benefits must be rolled over to another regulated superannuation fund. SIS regulations expressly state that a member’s benefits in a fund must not be rolled over from the fund without the member’s consent to the rollover. This means the fund is unable to give effect to its decision to remove Harold as a member if Harold doesn’t consent to his balance being rolled over to another fund.

Arguably, there is an implied consent from Harold upon his admission as he would have agreed to be bound by the governing rules in the deed which provide for a mechanism for his removal. However, there is a level of risk in relying on this argument as it can be uncertain whether the governing rules, Harold’s member admission documents and other circumstances giving rise to the implied consent are sufficient to satisfy the ‘consent’ requirement under the regulations.

While the term consent is not defined in the regulations, appropriately drafted governing rules and member admission documents may prove to be effective in satisfying this consent requirement.

Liquidity

If the trustee gets over the consent hurdle, another potential challenge may be in raising sufficient liquidity in the fund to rollover Harold’s benefit. Owning a lumpy asset (i.e. the commercial property), poor return on investments (i.e. temporary COVID rent relief), and minimum pension payment obligations for retirement phase members may exacerbate this issue and in an unfortunate scenario, the fund may be forced to sell investments with unexpected tax consequences.

Issues discussed above are not exhaustive and there is no one-size-fits-all solution to the issues. Trustees considering multi-member funds should consider seeking early advice to prepare their funds for potential disputes. They should also ensure that the draftsman of the fund’s trust deed has considered these possibilities and prepared the deed accordingly.

The post Can an SMSF member with a majority interest in the Fund expel another member?  appeared first on AdviserVoice.

Jeff Song

While the facts of a recent NSW Supreme Court case, G v G (No.2) [2020] NSWSC 818, relate to a financial manager appointed under the NSW Trustee and Guardian Act 2009 (NSW) and retail super funds, the decision that the fiduciary office has no authority to make a binding death benefit nomination seems to raise an interesting question quite relevant for SMSFs; namely, can an attorney under an Enduring Power of Attorney (‘EPOA’) validly make, change or revoke a binding death benefit nomination on behalf of their principal?

BDBN and Trust Law

A superannuation fund is a type of trust and death benefits of a member form part of the trust assets. Accordingly, distribution of death benefits is generally subject to the trustee’s discretion.

A fundamental principle of the trust law is that a trustee cannot delegate the exercise of their powers under the trust, except to the extent permitted under the trust instrument or by virtue of legislation.

In the case of APRA-regulated funds, s59 of the SIS Act provides this exception and expressly permits members to make death benefit nominations that are binding on the trustee. In the case of SMSFs, most modern superannuation trust deeds expressly permit members to make the binding nominations for this purpose.

From a trust law perspective, this practice of divesting the trustee of their discretion in payment of death benefits is valid so long as it is expressly permitted in the trust deed. Accordingly, if the trust deed permits an attorney for the member to make a BDBN for that member, then it is not a breach of the trust law for the attorney to make a BDBN.

Scope of authority of the attorney

Assuming the SMSF’s trust deed permits a BDBN by an attorney, another issue is whether the attorney has valid authority under their EPOA document or the applicable Power of Attorney legislation in the relevant jurisdiction.

Without going into details about the relevant law in each jurisdiction, an attorney’s authority under an enduring power of attorney is terminated upon the death of the principal and quite naturally, an attorney cannot be validly authorised to undertake any testamentary act on behalf of the principal (i.e. make, change or revoke the principal’s will).

In the context of the financial manager of a protected estate, the case of G v G (No 2) has pointed out that “a protected estate manager is charged with management of the protected person’s estate during the lifetime of the protected person, not beyond it” and decided that the protected estate manager’s authority did not extend to making of a binding nomination for payment of a death benefit payable by the trustee of a superannuation fund after the protected person’s death.

If the same analogy is adopted to the situation of an attorney under an EPOA, it would not be proper for the attorney to make BDBNs which affect payment of benefits beyond the lifetime of the principal.

This NSW decision seems to be in contrast with the decisions from a number of QLD cases (i.e. Re Narumon Pty Ltd [2018] QSC 185 and Re SB; Ex Parte AC [2020]) where the Courts have held that making a BDBN is a financial matter, not a testamentary act and therefore could be delegated to an attorney.

The current prevailing view in Australia is also that making a BDBN is not a testamentary act as it’s an exercise of the member’s contractual right (i.e. the member’s right to make BDBNs under the governing rules of the fund).

We note that the Court’s decision does not dispute this prevailing view. The decision rather seems to be in line with the policy recommendation of the Law Council of Australia and Australian Law Reform Commission that while making a BDBN is not a testamentary act, it should be treated as such.

The extract of the recommendation from the ALRC report 131 – Elder Abuse – A National Legal Response, is reproduced below:

“The Law Council of Australia agreed with the ALRC that the main issue concerning BDBNs is that there is currently no clear policy position on whether a nomination should be considered similar to a will or simply a lifetime instruction in relation to a person’s assets. The Council also agreed with the ALRC’s analysis that nominations are will-like in nature and they should be treated in policy terms ‘similarly to wills’.”

Whether or not the same analogy used in G v G (No.2) will be adopted by Courts of different jurisdictions in the context of attorneys making BDBNs is uncertain. Given the current uncertainty in this area of law, we generally do not recommend attorneys make BDBNs on behalf of their principal/member.

If the member still has capacity, they should make the BDBN in accordance with the applicable trust deed to ensure it is valid on the trustee upon their passing. If a member no longer has capacity and their attorney is concerned about lack of a current BDBN for the member, we strongly recommend seeking expert legal advice.

The post Uncertain future of attorneys making BDBNs for their principals appeared first on AdviserVoice.

Jeff Song

An important reminder that discretionary trusts that have already sold all residential properties before the deadline of 31 December 2020 could still be assessed for foreign surcharge purposes under the new NSW laws even if the trusts have already been wound up.

The retrospective effect of The State Revenue Legislation Further Amendment Act 2020 (NSW) means the surcharge could apply to:

• transactions from 21 June 2016 in relation to surcharge duty; and
• 2017 and subsequent land tax years in relation to surcharge land tax.

The window is still open (but not for too much longer) to review whether your discretionary trust is safe from the new foreign surcharge laws in NSW that has retrospective effect.

The transitional arrangement allows trustees to irrevocably amend trust deeds to exclude foreign beneficiaries by 31 December 2020 to ensure the surcharge doesn’t apply from the above effective dates.

Existing discretionary trust

For an existing discretionary trust, its trust deed should be reviewed and amended to exclude foreign persons if:

• it acquired any residential property in NSW on or after 21 June 2016;
• it has held a residential property in NSW at any time after 21 June 2016 regardless of the timing of its acquisition and whether it’s since been disposed;
• while the 31 December 2020 deadline is in relation to NSW residential properties, review and amendment of the trust deed are still recommended if the trust holds a residential property in other jurisdictions in Australia many of which apply surcharge duty and/or land tax to foreign persons;
• the trust holds substantial interest in an entity which holds (or has held) a residential property as described above (i.e. units in a unit trust or shares in a company)

If your trust deed needs to be reviewed and amended, please provide us instructions urgently by using this link: Exclusion of Foreign Persons in a Discretionary Trust.

Due to overwhelming demand and our goal of ensuring the highest possible quality of service, new instructions received after Wednesday 16 December cannot be guaranteed to be completed by the time of our Christmas closing date of 22 December.

Discretionary trusts that have been wound up and no longer exist

Under the new surcharge laws in NSW, previous stamp duty and/or land tax assessments in relation to trusts while they were still in existence could be reassessed by Revenue NSW for foreign surcharge purposes.

As these trusts have already been wound up, they no longer exist and therefore are not afforded the opportunity to have the deeds amended for foreign surcharge purposes.

While there is no formal public ruling on this issue, Revenue NSW informally advised our firm that an internal decision has been made as follows:

In respect of discretionary trusts that have already been wound up:

• if none of the beneficiaries who received distributions are foreign persons, Revenue NSW will not reassess previous assessments for surcharge
• if any of the beneficiaries who received distributions are foreign persons (even one person/entity) they will reassess if applicable for surcharge

For relevant trusts, it is suggested that the following evidentiary documents are submitted to Revenue NSW as soon as possible:

• evidence that the trust has been wound up;
• date of when the trust was wound up; and
• list of all beneficiaries who received the final distributions from the trust and their foreign status.

By Jeff Song, Senior Solicitor – Division Leader Superannuation Online Services

The post The retrospective effect of The State Revenue Legislation Further Amendment Act 2020 (NSW) on discretionary trusts  appeared first on AdviserVoice.

Jeff Song

What happens where, at the time of death of the pensioner, a reversionary pension fails to revert because the nominated reversionary pensioner (an SIS Act dependant) is not eligible to receive income stream death benefits, for example where the nominated reversionary pensioner is an adult child of the deceased member.

SIS sub-regulation 6.21(2)(b)(ii) and (2A) provides that death benefits in the form of income stream can only be paid to an SIS Act dependant of a member and in the case of a child is less than 18 years of age or being 18 or more years of age, is (i) financially dependant on the member and less than 25 years of age or (ii) has a prescribed disability.  Adult children (not under a disability) can only receive death benefits in the form of lump sums.

A pension ceases as soon as a member in receipt of the pension dies unless a dependant beneficiary is automatically entitled to a reversionary pension (ATO publication: Starting and Stopping a Pension).

An account-based pension has to meet prescribed standards in the SIS Regulations.  One of the standards in SIS sub-regs 1.06 (9A) and (9B) is:

“the pension is transferable to another person only on the death of the beneficiary (primary or reversionary) to an eligible dependant in the form of a pension under para 6.21(2b) or 6.21(2A) or (2B).”  Para 6.21(2b) and 6.21(2A) defines income stream death dependants.

Where the pension is auto reversionary, the continuation of the pension after the death of the member is subject to the nominated reversionary beneficiary being an entitled death benefit income stream (“DBIS”) recipient.

If the nominated beneficiary is not a DBIS recipient and the pension fails to revert, the pension ceases as soon as the member dies.  If this is the case, the reversionary nomination is no longer relevant.

A valid auto-reversionary pension is a carve out as the pension continues and therefore does not form part of the general death benefits of the member.  However, where the nomination is ineffective, the pension ceases immediately at the time of the death of the member.  It is reasonably arguable that accordingly the commutation lump sum from the ceased pension is part of the deceased member’s general death benefit and should be dealt with in accordance with superannuation law and any restrictions in the governing rules of the fund, and not in accordance with the reversionary pension terms.

If this is the case, in the absence of a binding death benefit nomination, the Trustee has absolute discretion to decide which eligible beneficiaries will receive the death benefits and the form and proportion of the death benefits to be paid, subject to the trust deed.

In making the death benefits determination, the Trustee may have regard to the failed “reversionary nomination” but may also decide to allocate the residuary pension benefits and other death benefits to any eligible beneficiaries. The adult child in this discussion may be left empty handed.

Look out for unintended consequences that may arise where a child is the nominated reversionary pensioner and the pension fails to revert because at the time of death of the pensioner, the child has is no longer a DBIS dependant.

By Jeff Song, Managing Solicitor – Superannuation Online Services Division

The post Reversionary pensions that don’t revert appeared first on AdviserVoice.

Jeff Song

An SMSF investing with a related party must be careful not to breach the in-house asset rule.

Donald and Melania are members of the Trumpet Super Fund and directors of the corporate trustee, D & M Pty Ltd. Their son Louis runs a building business and is a sole director and sole shareholder of LT Builders Pty Ltd. They are considering a property development as a joint venture whereby the super fund provides the capital and LT Builders Pty Ltd provides its expertise in actually carrying out the building. They enter into a joint venture agreement and acquire vacant land in the name of the super fund trustee and the building company as tenants in common. Does this arrangement breach the in-house asset rule?

It is not uncommon for SMSF trustees to team up with related parties for an investment. Whether it is a property development project or other types of investment, the main compliance hurdle for SMSFs when related parties are involved is the in-house asset (‘IHA’) rules.

In simple terms, the IHA rules require trustees to ensure that the fund does not have more than 5% of its investment in in-house assets. Broadly, this can be categorised into two parts:

1. ‘prohibition on acquisition’ of new IHAs if the level of IHA is over 5% prior to acquisition or will be over 5% after the acquisition; and
2. ‘requirement to dispose’ of sufficient IHAs if the level is exceeded.

In keeping the level of IHA under the 5% limit, it is important to consider whether your proposed structure will give rise to IHAs. To demonstrate the importance of choosing and properly setting up the right structure from a superannuation law compliance perspective, we will compare the different IHA implications a joint venture structure and partnership structure would have in a property development project of an SMSF and its related parties.

A joint venture has no uniform legal meaning under the superannuation law and generally refers to a commercial arrangement between two or more individuals or entities for the purpose of undertaking a particular business.

On the other hand, the Superannuation Industry (Supervision) Act 1993 has adopted the tax law definition of partnership for IHA purposes which is broader than the general law definition of a partnership. This broader definition includes arrangements whereby two or more individuals or entities are simply in receipt of income jointly.

LT Builders Pty Ltd is a related party of the Trumpet Super Fund (a company that is sufficiently influenced by the members’ son). However the property owned by the SMSF with its related party as tenants in common is not an IHA due to s71(1)(i) of the SIS Act which excludes such property from the definition of that term.

Further, the joint venture is a commercial arrangement between parties and is not by itself a related party of the fund if it is properly set up with necessary features of a joint venture. With this structure, the SMSF would not have an investment ‘in’ a related party and accordingly does not acquire any IHAs by the project.

If however the arrangement is not properly set up as a joint venture and the SMSF and LT Builders Pty Ltd receive income jointly, the arrangement will be deemed as a partnership under the superannuation law for IHA purposes.

Being properly set up means that the agreement between the parties (and all the documents they issue to or enter with third parties) make clear that neither party is liable for any defaults or wrongful acts of the other and each is only entitled to a half share of any profit from the enterprise.

In contrast to a joint venture, a partnership would itself be a related party of the fund and the SMFS’s investment in the partnership would be an in-house asset of the fund, being an investment ‘in’ a related party.

The issues discussed above are not exhaustive and the issues surrounding whether an investment structure is a joint venture or a partnership for IHA purposes are not only complex but are also the subject of some legal uncertainty.

The above is a simplified and general example to highlight the potential IHA implications of different investment structures and a trustee considering a joint investment with related parties should obtain appropriate advice to ensure compliance.

By Jeff Song, Managing Solicitor – Superannuation Online Services Division

The post Choosing an investment structure to meet in-house asset rule appeared first on AdviserVoice.

Jeff Song

SMSF trustees should not give into the siren call of low interest rate refinancing of their Fund’s loan until they have considered these points.

In the current low-interest rate environment, there has been an increased interest in refinancing an existing limited recourse borrowing arrangement (‘LRBA’) with a related party lender.

For this financial year, the minimum interest rate under the ATO’s safe harbour guidelines is 5.10% p.a. which in most cases would be lower than what would have been available to the trustees when they originally acquired the property using an LRBA.

While the refinancing option could mean significant savings in monthly repayments for the SMSF, trustees should carefully consider the SIS Act compliance requirements in refinancing an LRBA with a related party loan, which could be more onerous to comply with than maintaining the LRBA with a bank.

Let’s consider an example of Daniel and Gladys who are members and trustees of their SMSF, Premier Superannuation Fund. They originally borrowed from a bank to acquire a commercial property under an LRBA in 2016 at the interest rate of 6.60% and are now considering refinancing it with a loan from a related private company, Premier Pty Ltd.

The new loan must be a complying LRBA under s67A of the SIS Act

The SIS Act provides for refinancing under limited recourse borrowing arrangements when the borrowed money is applied to refinance a borrowing in relation to the single acquirable asset.

Firstly, this means the new loan from Premier Pty Ltd must be made in relation to the same commercial property and no other acquirable asset. The loan documentation should be drafted accordingly and formally establish a sufficient link between the loan and the property as the only security for the loan.

Secondly, the money so borrowed from Premier Pty Ltd must be applied solely for the purpose of replacing the financing arrangement from the earlier arrangement with the outgoing bank. The amount of the new loan therefore must not exceed the amount required to payout the bank in respect of the original LRBA.

Other than the above, the Daniel and Gladys Superannuation Fund should ensure the usual LRBA conditions are maintained in the new arrangement including the requirement to have the property held on trust (i.e. holding trust) and limiting the recourse of the lender or any other person in the event of default to only the commercial property.

Sole Purpose

The trustees should be able to demonstrate that the refinancing is for the sole purpose of retirement benefits for the members. At the very least this means Premier Pty Ltd should not unreasonably benefit from the refinancing arrangement and all engagement should be on documented arm’s length terms. An example of a possible contravention is where the SMSF trustees decide to refinance with a related party on materially similar (or inferior) terms in order to provide additional income source to a struggling related party.

Arm’s length requirement

The Superannuation Industry Supervision Act 1993 (“SIS Act”) requires SMSF trustees to deal with third parties at arms-length. This is a critical requirement, as it can be a criminal offence to breach the requirement.  Additionally, a breach may result in the income arising from the transaction being taxed at the top marginal rate of income tax (i.e. non-arms’ length income or NALI).

It is strongly advisable that Daniel and Gladys mirror the Practical Compliance Guidelines PCG 2016/5 which sets out ‘Safe Harbour’ terms on which SMSF trustees may structure their LRBAs consistent with an arm’s length dealing. It is not necessarily an immediate breach of the arm’s length requirement if they don’t follow the ATO’s guidelines however, the trustees would need to otherwise demonstrate that the arrangement was entered into and maintained on terms consistent with an arm’s length dealing.

As the lender is a related private company, Division 7A of the Income Tax Assessment Act 1936 may potentially apply to treat the amount advanced as payment of dividends. In order to avoid this, Daniel and Gladys may structure the loan as a Division 7A complying loan and ensure the prescribed minimum interest charge and maximum term requirements for a secured Division 7A loan are also satisfied.

Implications on total superannuation balance

The new measure introduced by Treasury Laws Amendment (2018 Superannuation Measures No 1) Act 2019 would apply to LRBAs where:

(a)    the lender is an associate of the SMSF; or

(b)    the member or members participating in the LRBA have satisfied an unrestricted release condition (such as attained age 65 or being “retired” for superannuation purposes), regardless of whether the member is actually in retirement phase.

As Premier Pty Ltd is an associate lender of the SMSF, the outstanding loan balance each year will need to be proportioned among Daniel and Gladys to be added to their respective total superannuation balance. Once their total superannuation balance reaches $1.6 million, the member is unable to make further non-concessional contributions.

Summary

There are important compliance issues to consider when refinancing an existing LRBA. If you are exploring the potential financial benefits of low interest rate loan from a related party, please seek appropriate advice to ensure compliance.

By Jeff Song, Managing Solicitor – Superannuation Online Services Division

The post Low interest rates prompting LRBA refinancing appeared first on AdviserVoice.

Jeff Song

Investing in derivatives has been one of the popular investment options for savvy investors. As the ATO has been posing the question to some SMSF trustees whether their investments are appropriately diversified, do derivatives provide legitimate diversification opportunities for SMSFs?

In a nutshell, superannuation laws do not prohibit this type of investment, however SMSF trustees should carefully observe the relevant compliance requirements.

Are you investing in derivatives?

Derivatives transactions include a broad assortment of instruments such as options, futures, warrants, swaps or Contracts for Difference (CFDs). A derivative is fundamentally a contract between parties where the value of the contract is ‘derived’ from that of the particular asset(s) the contract is linked to.

In a typical derivatives investment, the investor enters into a contract (which gives rise to certain contractual rights and obligations between the parties) without the investor actually owning the underlying assets that the contract is linked to and derives its value from. The underlying assets can include shares, commodities, currencies and a variety of other asset types.

Note that some Exchange-Traded Funds (ETFs) can also be derivatives. Although many ETFs are not derivatives, some may be considered as such if the assets held in the ETFs are themselves derivatives. If so, the trustee investing in such ETFs should observe the compliance requirements applicable to derivatives investments.

What are the SIS compliance requirements?

Like with any other investment options, investing in derivatives must satisfy the sole purpose test. The fund’s trust deed should also be reviewed to check whether the proposed derivatives investments are permitted by the fund’s trust deed.

The investment strategy of the Fund should also be reviewed to see if the proposed derivatives investment is within its scope. Financial implications of investing in derivatives including the associated risks with such investment should be carefully considered and it would be advisable for trustees to seek appropriate financial advice in this regard. This will also help them discharge their general trustee obligations in relation trust investments (including SMSFs) which obligations are incorporated as overarching covenants in the SIS Act.

Further, if the derivatives give rise to a charge over the assets of the fund, there is an additional requirement to have a formal derivatives risk statement in place. Not all derivatives require the investor to give a charge over its assets as security. If however a SMSF trustee is investing in a derivative which requires the trustee to give a charge over the assets of the fund, the trustee must have in place a formal derivative risk statement and comply with the terms of the statement throughout the investment period.

A derivative risk statement should set out the following:

1. what policies the trustees will adopt in the use of derivatives;
2. how the trustees will analyse and assess the risks associated with the use of derivatives;
3. how the use of derivatives fits in with the investment strategy of the fund;
4. what restrictions and controls the trustee will put in place to regulate the use of derivatives, particularly taking into account the expertise available to the Fund; and
5. the compliance processes to ensure the controls are effective.

SMSF auditors are also expected by the ATO to check and ensure that an appropriate statement is in place and that the relevant derivatives investments (and the charge thereby given) are consistent with the terms of the statement.

The issues discussed above are not exhaustive and a trustee considering such investment should obtain appropriate advice to ensure compliance

By Jeff Song, Managing Solicitor – Superannuation Online Services Division

The post SMSFs and derivatives – a potential diversification option appeared first on AdviserVoice.