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COVID-19 rent deferral IHA relief

Sun, 30 Aug 2020 21:35:03 +0000

The ATO has issued draft SPR 2020/D2 which when registered will exempt SMSFs that allow a rent deferral to a related party tenant from the in-house assets (“IHA”) provisions in the following situations. The transitional measure applies to the 2019-20 and 2020-21 financial years.

The moratorium

A deferral of rental income under an arm’s length terms lease amounting to a loan to a related party tenant impacted by COVID-19 will not result in an IHA of the SMSF.

The exemption will also apply to SMSFs that hold an interest in a SIS regulation 13.22B or regulation 13.22C related entity (company or unit trust) that provides rent deferral to a tenant of an arm’s length lease under COVID-19 circumstances. The related trust or company will not lose its IHA exempt status.

What is the IHA?

In the absence of the moratorium, the rent deferred is a loan which is an IHA under Section 71(1) of the SIS Act 1993.

Section 10(1) of the SIS Act defines loan to “include provision of credit and any other financial accommodation whether or not enforceable by legal proceedings.” The definition is inclusive and can include arrangements where an amount is deferred and ultimately payable (SMSFR 2009/4). The rent deferred is a financial accommodation of the amount deferred.

Section 71(1) of the SIS Act provides that an in-house asset includes an asset of the fund that is a loan to, or an investment in, a related party or a related trust of the fund. It also includes a lease or lease arrangement with a related party, except business real property. In the absence of the moratorium, the IHA is the loan. If the rent deferral is non-arm’s length, the SMSF will also have NALI and other SIS Act implications including IHA in relation to the leased asset.

Where the lease is provided by an interposed Regulation 13.22B or 13.22C company or unit trust, the loan (deferred rent) will cause the company or trust to breach Regulation 13.22D borrowing prohibition and the related company or trust will lose its IHA exemption under Div. 13.3A of the SIS Regulations. Without the moratorium, the IHA in this instance will be the related company or trust.

The ratio of the fund’s IHA cannot exceed 5% of the market value of the fund.

Conditions for the moratorium

The conditions are set out in the ATO Explanatory Statement.

“The exclusion will only apply to situations where the SMSF trustee or interposed entity has acted in good faith and, as a result of the financial impact of the coronavirus known as COVID-19, has offered the tenant a deferral of rental income under a lease (on arm’s length terms) during the 2019-20 and 2020-21 financial years in order to ease the financial hardship caused by COVID-19. There should be contemporaneous documentation drafted reflecting the revised rental terms agreed to by the SMSF trustee or company or unit trust covered by regulation 13.22B or 13.22C and the tenant to ensure the parties continue to deal with each other at arm’s length and the lease remains enforceable.”

How about Section 65 of the SIS Act?

As the rent deferred is a loan within the meaning of Section 10(1), the rent deferral will also potentially contravene Section 65 of the SIS Act which prohibits a trustee of a regulated superannuation fund from lending money or providing financial assistance using the fund’s resources to a member or a relative of a member of the fund.

The ATO Addendum to Auditor Contravention reporting instructions specific for 2019-20 and 2020-21 financial years due to COVID-19 provides guidance in this regard.

The ATO will not take compliance action for breach of the following SIS standards where the requirements set out in the moratorium conditions section above have been met for the two transitional years. The relevant sections of the SIS Act are:

Section 65 – rental relief offered o a member or relative of a member either directly or indirectly that can amount to providing financial assistance
Section 84 – rental deferral to a related party amounting to a loan by the SMSF
Section 62 – rental relief not a breach of the sole purpose test
Section 109 – rental relief does not meet arm’s length terms

It is also expected the ATO will extend the contemporaneous moratorium to Section 65 in relation to the IHA exemption.

By Maria Siu, Special Counsel – Superannuation

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Superannuation proceeds trust: excepted income changes

Tue, 21 Jul 2020 21:55:40 +0000

The recent Tax Act amendment on excepted income of testamentary trust distributions may potentially affect superannuation proceeds trusts (“SPT”) that are structured as testamentary trusts. The amendment is an integrity measure to prevent assets unrelated to the estate being injected into the testamentary trust for the purpose of generating concessionally taxed excepted income. Importantly, the SPT will not be affected if it is appropriately structured and implemented.

SPTs have been gaining momentum in super planning as SPTs have distinct advantages over child death benefit pensions which are limited by the modified transfer balance cap and the pension vesting requirement at age 25, except for disability pensions.

Most SPTs are structured as testamentary trusts under sub-section 102AG(2)(a)(i) of the ITAA 1936. This type of SPT provides certainty of succession and proper documentation is essential to ensure super death benefits will be paid to the deceased member’s estate, with the dependants as the ultimate SPT beneficiaries.

In addition, there are also SPTs formed after the death of the fund member by deed under subsection 102AG(2)(c)(v). These benefits devolve outside the Will and are subject to certain restrictions. The latter option is often used as a “catch-up” measure where on death of the member, no testamentary trust provision is in place and the beneficiaries of the benefits are minors.

In both scenarios, the beneficiaries of the SPT will be Tax Act dependants (“TA dependants) of the deceased fund member. Super death benefits distributed to the estate with TA dependants as beneficiaries are tax free. This preserves the tax-free status of the distributions as if they were made directly to TA dependants. In addition, SPT income distribution to minors, subject to applicable rules, will qualify as excepted income taxable at the adult’s marginal tax rates and not the penalty rates of children.

The Amendment

The recent “excepted income” amendments apply to distributions under sub-section 102AG(a)(i) i.e. testamentary trusts. A new subsection (2AA) has been inserted. To qualify as excepted income, the assessable income of the testamentary trust has to be derived by the trustee for the benefit of the beneficiary out of “property transferred to the trust from the estate of the deceased person” as a result of the Will, codicil, intestacy or a court order. Accumulations of income or capital from such property and conversion of such property from one type to another will also meet this requirement.

This means only assets unrelated to the property of the deceased estate injected to the trust will be caught by the new provision, as stated below by the ATO.

“Your income from a testamentary trust is not excepted income if it is generated from assets:

acquired by or transferred to the trustee of the trust on or after 1 July 2019 and
that were unrelated to property of the deceased estate.”

Where a super fund pays death benefits to the deceased member’s LPR (the Executor or Administrator of the estate), the super death benefits will devolve in accordance with the Will of the deceased member. In the case of the SPT, the property (which includes money) transferred to the testamentary trust under the Will will be made directly from the estate. The transfer is not of unrelated estate property and the requirements of subsection 102AG(2AA) will be met.

Example

The following example is from the ATO publication “Work out if you receive excepted income”.

Lavender Trust is a testamentary trust established under a Will of which Alex is a beneficiary. Alex is 14 years old. As a result of the Will, $100,000 is transferred on 17 July 2019 to the trustee of Lavender Trust from the deceased estate. Shortly after, the trustee of a family trust makes a capital distribution of $1M to the trustee of Lavender Trust. The trustee of Lavender Trust invested the entire amount of $1.1M in listed shares.

In the 2019-20 income year, the trustee of Lavender Trust derives $110,000 of dividend income from the investment in the listed shares. The net income of Lavender Trust for that year is $110,000. Alex is made presently entitled to 50% of that amount, which is $55,000.

Alex’s excepted income is $5,000. This amount is the extent to which the $55,000 income resulted from the $100,000 transferred from the deceased estate. The remaining income $50,000 is unrelated to the estate and is not excepted income.

How about SPT outside the Will?

Subsection 102AG(2)(c)(v) makes provision for excepted income of SPTs that are not testamentary trusts. It contains a requirement that the assessable income of the trust must be derived from investment of property transferred “directly as a result of the death of a person” and in addition, out of a provident, benefit, superannuation or retirement fund.

This precludes injection of any asset unrelated to the death of a deceased person.

SPT outside the Will has the following additional restrictions.

Under this arrangement, the minor beneficiaries must under the terms of the trust benefit from the trust capital at the end (subsection 102AG(2A)).
The death benefits must be paid directly from the super fund to the trustee of the SPT and such payment must be permitted by the governing rules of the super fund.
The trustee of the super fund can potentially refuse to pay the death benefits directly to the SPT as being not in the best interest of the beneficiary, subject to the circumstances.

For all SPTs, the income distributed is only excepted income if the trust investments are made on arm’s length terms (sub-section 102AG(3)).

Documentation

Where STPs are involved, the testamentary trust arrangement is the better option. It is also necessary to consider this option together with other super death benefit options available to minor beneficiaries.

Implementing testamentary objectives and outcomes require expert planning and documentations.

Our views expressed in this article are our opinions based on sound legal reasoning rather than a statement of established ATO policy or practice.

By Maria Siu, Special Counsel – Superannuation

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ATO concerns with SMSF property development

Wed, 10 Jun 2020 21:55:27 +0000

The ATO has issued SMSFRB 2020/1 (“SMSFR”) to highlight its main concerns in relation to SMSF property development. It is comprehensive and traverses structuring, investment rules, NALI and the anti-avoidance provisions. SMSF trustees that enter into property development projects must understand the complexity of such ventures and implement all the applicable rules from start to completion in a manner consistent with retirement income objectives. All transactions should be carefully documented.

The ATO strongly encourages SMSF trustees considering property development to seek professional advice and to approach the ATO for advice if necessary.

This article explains the main ATO concerns.

1. In-house assets

An ungeared unit trust or company that meets the requirements of SIS Regulation 13.22C is excluded from being an in-house asset (“IHA”). The reg. 13.22C related unit trust is often used as an interposed entity in SMSF property development. The SMSF maintains the borrowing to invest in the ungeared unit trust which carries out the property development. The exemption in Regulation 13.22C however ceases if the unit trust or company fails to meet any of the conditions in Regulation 13.22D.

The ATO is concerned that the unit trust may not meet all the conditions and therefore fail the IHA exception. In addition, the ATO highlighted the hefty consequences of such contravention.

1.1 Regulations 13.22C and 13.22D requirements

The Reg. 13.22D additional conditions are:

the trustee or company must not conduct a business.
all transactions of the unit trust or company have to be conducted on an arm’s length basis.

The basic Reg 13.22C requirements are recapped below. The unit trust or company must not:

hold an interest in another entity including units in another trust;
lease property to a related party of the fund or enter into a lease arrangement with a related party of the fund except for a legally binding lease over business real property (“BRP”);
make a loan to another entity;
borrow money or allow a charge over an asset of the entity;
acquire an asset from a related party of the fund or an asset that has been owned by a related party of the fund within the previous three years (unless the asset is BRP).

The ATO reiterates it is critical that the unit trust or company complies with both the above regulations at the time the investment is acquired and at all times when the investment is held. Failure to comply at any time is catastrophic because if any of these conditions are not met, “all investments held by the SMSF in that related company or trust including future investments in it will be in-house assets.”

1.2 Asset no longer exempt IHA

A breach of the IHA exception can never be fully rectified. The repercussions are severe. The following is an extract from the SMSFR. “The asset can never be returned to its former excluded state, even if the trustee fixes the issue that caused the asset to cease meeting the relevant conditions. The fund will be required to dispose of the shares or units it holds in excess of the 5% limit within 12 months. In many cases this requires the sale of underlying property or a significant restructure that could be costly to both the development and the SMSF.” Will this lead to funds intentionally becoming non-compliant because they know that the development can be finished within the 12 month period and then sold so no effective breach is recorded?

1.3 The ATO is also concerned that some lease arrangements under the Reg. 13.22C

BRP exception may not be established or renewed through a formal written process leading to the finding there is no valid binding lease. (For full details, please refer to SUPERCentral article SMSF: Dealing at arm’s length.)

2. The use of limited recourse borrowing arrangements (“LRBA”)

In SMSF property development, an LRBA is often used either

to fund the purchase of the real property to be developed by the SMSF; or
to acquire the shares or units in the reg 13.22C property development entity.

In the former situation, the real property to be developed is the acquirable asset. In the latter situation, the shares or units is the acquirable asset.

The ATO has expressed concerns in relation to significant aspects of these arrangements.

2.1 SMSF purchase the real property to be developed

Under an LRBA, the borrowed funds cannot be used to pay expenses incurred to improve the acquirable asset (subsection 67 (1)(a)(i) SIS act). Where the SMSF borrows to purchase the property to be developed and then uses its own funds to develop the property it will not contravene the above prohibition.

The issue of concern relates to the acquirable asset. While the SMSF may use its own funds to develop the property, the ATO considers that property development generally changes the character of the property and it will cease to be the same acquirable asset and the SMSF will not meet the LRBA requirements. (SMSFR 2012/1).

However, this does not prevent the SMSF from acquiring a property with an LRBA and additionally use the funds to maintain or repair the acquirable asset as an investment. This is distinguished from property development, which will change the character of the acquirable asset.

2.2 SMSF acquires shares or units in the property development entity

Where the SMSF borrows under LRBA to invest in a related reg 13.22C or an unrelated trust or company which undertakes the property development, the single acquirable asset is the shares or the units. The SMSF trustee will not have to be concerned about whether the borrowed funds have been used to improve the asset or generally change the character of the property.

The ATO’s concern in this situation is the “arm’s length dealing” aspect of the LRBA. The SMSF is borrowing to acquire the Reg 13.22C units or shares, and not the underlying property which is held by the unit trust or company. The lender of the LRBA is usually a related party, given the unique nature of the single acquirable asset.

The SMSFRB specifies that in such circumstances the ATO safe harbour terms in PCG2016/5 cannot be relied on to show that the terms are consistent with an arm’s length dealing. These safe harbour terms only apply to borrowings over real property or listed shares and investments/units.

Where the acquirable asset is private company shares or units the SMSF “would need to demonstrate that their terms reflect an arm’s length dealing, for example, by showing that they replicate terms of a commercial loan available under the same circumstances.”

The ATO also cautioned that it may be difficult to identify an arm’s length lender that would provide finance for this kind of transaction as the lender can only be provided with a security over the units and not the underlying real property.

Given the importance of the arm’s length requirement and the lack of market data in relation to comparable loans, it may be worthwhile for SMSF trustees to consider this aspect in depth through market research, commercial valuation or failing to match the terms, consult the ATO before proceeding with such arrangement.

2.3 Example

An SMSF entered into a property development project using the related ungeared unit trust structure. The initial investment by the SMSF in the unit trust was $400,000. The unit trust used this amount to purchase land to be developed. To fund the development of the property, the SMSF subscribed for additional $300,000 of the units using an LRBA. The Lender asked for security over the land which is granted by the unit trust. As the unit trust has allowed a charge over the asset of the trust, a 13.22D event arises. This will cause the investment in the units of the related geared unit trust by the SMSF to be considered an IHA of the Fund. Apart from this, the SMSF will also have to substantiate the arm’s length terms of the LRBA under both regulation 13.22D and NALI.

3. NALI

Full details of NALI are provided in the following SUPERCentral articles.

NALI – Non arm’s length income new rules and implications

SMSF: Dealing at arm’s length

Generally, where parties to the SMSF transaction are related, the inference is that they will not be dealing at arm’s length but this inference can be reversed. Proper documentation, procedures and records are integral to this process.

In relation to land development in an SMSF, both the overall structure as well as specific transactions would need to be conducted on an arm’s length basis. SMSFRB provides examples of such transactions.

Purchase of land and other assets.
Terms (including use of personal or related party guarantees) of LRBA or other entities involved in the development.
Where a related party is engaged to provide services in their professional capacity (e.g. building construction), whether they are charged for these services or paid less than the arm’s length rate.
The return on investment and income or capital entitlements.

4. Joint Venture Arrangements

A joint venture may be carried out in the form of a partnership, company, trust or other arrangement.

Care must be taken by the SMSF trustees to ensure that the arrangement, particularly with a related party is a true joint venture. The ATO has expressed concern that in exceptional situations (e.g. SMSF has provided a capital outlay with no rights other than a return on final investment), the investment may in some circumstances be construed as a loan or an investment in the other party and an IHA of the fund.

5. Providing financial assistance to members (Section 65 SIS Act)

The following situations would cause ATO concerns in relation to financial assistance to members.

The SMSF becomes an investor in the property development carried out by the related party because otherwise there would be insufficient funds to complete the property development.
A related party is engaged to provide services as a means of providing them with work or where they are paid more than market value.
SMSF funds are used to finance elements of the property development on non-arm’s length terms or where the SMSF receives little or no consideration.

6. Record keeping

It is important the SMSF keep the necessary records to establish and maintain it has met the applicable requirements. All transactions should be documented to ensure:

there is proof of arm’s length dealings
the arrangements put in place reflect the legal status
the parties intend, and they are permitted by the SMSF deed and investment strategy, to undertake the property development.

It is also important to maintain good record keeping procedures to ensure payments relate to the expenses of the property development.

7. Sole Purpose Test

The SMSF trustee would need to demonstrate that the property development decision is solely to pursue the retirement goals of the members and not influenced by the goals of the business or other entities.

Using an example in the SMSFRB, where an SMSF trustee ceased to pay its members a pension so that the SMSF could use its cash reserves to make additional capital contribution to a struggling property development venture, may indicate that the SMSF has been used for the purpose of ensuring the property development’s success above the retirement needs of the members. This may cause a contravention of the sole purpose test.

8. Other concerns

Some other areas of concern include:

use of the arrangement to manipulate the member’s transfer balance accounts by deliberately undervaluing an asset when it enters retirement phase for the transfer balance cap;
poorly implemented LRBAs and/or funding arrangements resulting in breach of the SIS and Tax Act provisions.
non-arm’s length property development arrangements which may potentially attract the application of Part IVA of the ITAA 1936 and/or Division 165 of the GST Act 1999.

Conclusion

Given the complexity of property development projects, the general necessity of SMSFs to borrow to fund such development, the SIS investment standards, LRBA specific requirements, NALI and other measures, it is imperative that SMSF trustees seek competent professional advice before entering into a property development venture which is also subject to the investment strategy.

On the other hand, LRBAs can potentially augment retirement benefits if they are part of an integral investment strategy that meets the SIS requirements.

By Maria Siu, Special Counsel – Superannuation

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COVID-19: Summary on early release of superannuation

Thu, 02 Apr 2020 20:45:07 +0000

The Coronavirus Economic Response Package Omnibus Act 2020 (“the Act”) received assent on 24 March 2020. Schedule 13 of the Act amends the SIS regulations to make provision for COVID-19 temporarily early release of superannuation. Application for this early release must be made within the period of 6 months starting on the day the new regulation commences.

New condition of release

A new “Coronavirus compassionate ground” condition of release was introduced (sub-regulation 6.19B SIS Regulations). Individuals affected adversely by the economic effect of Coronavirus are permitted to obtain early release of preserved and restricted non-preserved benefits from their superannuation up to $20,000, in two applications of up to $10,000 for each application as follows:

one application in the financial year ending 30 June 2020; and
one application in the financial year ending 30 June 2021.

The amount of superannuation released under this measure is not subject to tax (not assessable income and not exempt income).

Criteria of eligibility

Application can be made to the Regulator (the ATO) on the ground that the amount is required to assist the person to deal with the adverse economic effects of Coronavirus and the person must satisfy any one of the following requirements:

the person is unemployed; or
the person is eligible to receive any of the following social security payments
jobseeker payment;
parenting payment;
special benefit;
youth allowance (other than on the basis of undertaking full-time study or is a new apprentice); or
the person is eligible to receive a household allowance; or
on or after 1 January 2020 the person was made redundant, or their working hours were reduced by 20% or more (including to zero); or
for a person who is a sole trader – on or after 1 January 2020, the person’s business was suspended or suffered a reduction in turnover of 20% or more.

Test for reduction in work hours or turnover

The requirements about reductions in a person’s working hours or in their turnover as a sole trader are determined by reference to changes that have occurred since 1 January 2020. This requires a comparison of a person’s working hours or turnover at the time they make the application and their usual hours prior to 1 January 2020. For example, a person would be eligible to apply for a determination if they had a 20% or more reduction in their usual working hours or turnover relative to the second half of 2019. For applications in the 2020-21 financial year, the same test applies.

Self assessment

It is expected that individuals will self-assess their eligibility to apply for the determination. The requirement about a person’s eligibility to receive the various social security support payments can be satisfied if the person is receiving such a payment or if they are eligible to receive such a payment. This allows a person to apply for the determination in a timely fashion.

Application

Individuals are restricted to a single application (of up to $10,000) in 2019-20 and another one in 2020-21.

A person who requests an amount of less than $10,000 in their application for a financial year cannot make a subsequent application in the same financial year to release the difference. A person with multiple accounts who has less than $10,000 in any one of the accounts can nominate more than one account and the amounts to be released from each account.

How to apply?

Application for a determination will be made on-line through www.my.gov.au using the ATO’s online services. It is expected that application will open mid-April but meanwhile there is a link on myGov for individuals affected by coronavirus to register for this benefit.

ATO determination

The Commissioner must determine that a person is eligible to have an amount (or amounts) released on the Coronavirus compassionate ground upon satisfaction that such determination has not already been made for the applicant during the relevant financial year.

The determination must specify the amount (or amounts) to be released and the superannuation entity (or entities) from which the amount is to be released. The total amount that the Commissioner may determine cannot exceed $10,000.

The Commissioner must also provide a copy of the determination to the applicant and the superannuation entity (entities) covered by the determination.

Trustee responsibility

The trustee must pay the benefits to the member as soon as practicable after the trustee receives the determination, without requiring any additional application from the member. This provision in sub-regulation 6.17D (3) is an operating standard, to ensure that there will be no delay in the release of the benefits.

SMSFs

In the instance of SMSFs, the member applicant would also be a trustee or director of a corporate trustee of their own fund, in different capacities. The ATO has issued the following caution:

“As an SMSF trustee, you are responsible for your and your members’ retirement savings. Please make sure you are eligible for early release of super before you release any funds from your SMSF.”

For SMSFs, a trustee resolution of the ATO determination, the action taken and the benefits released as a result of the determination would complete the records.

By Maria Siu, Special Counsel – Superannuation

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Maria Siu joins Townsends Lawyers and SuperCentral as Special Counsel

Thu, 14 Nov 2019 20:45:57 +0000

Townsends Lawyers and its associate SuperCentral Pty Limited are pleased to announce the appointment of Ms Maria Siu LL.B. (Hons), Dip Fin Serv, Cert Adv Tax to the position of Special Counsel – Superannuation.

Maria will provide superannuation research and advice across both Townsends and SuperCentral legal staff and their clients.

Ms Siu brings a depth of knowledge and experience, having worked in senior compliance, technical services and strategic product development roles with major companies including Standard Chartered Bank, APRA, Deutsche Bank, Colonial Financial Planning, Godfrey Pembroke and BT Portfolio Services.

This experience combined with her keen skills and excellent qualifications in law, tax and financial advice will further strengthen the services offered by Townsends and SuperCentral.

“We are delighted to welcome Maria to the firm. She will be an invaluable addition to our team with the remit of focussing on the promotion and delivery of our technical advice and compliance services at the highest quality level.

“The financial services sector has faced a crisis of confidence and trust by many parts of the industry, the regulators and the public, but we know that accountants and financial planners working in the self-managed superannuation space are committed to providing the highest possible service levels. Our support team is focussed on helping Advisors with the professional legal expertise and advice they need as the sector changes in the face of new regulations and public expectations,” said Townsends Lawyers Principal and SuperCentral Managing Director, Peter Townsend.

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