Six-member fund ideal asset holding structure

The federal government has promoted six-member funds as a retirement income planning tool for families, but this overlooks the investment and borrowing opportunities they can create as asset holding structures for non-related members, an SMSF legal firm has noted.

Townsends Business and Corporate Lawyers said the creation of six-member SMSFs, which is awaiting the passing of legislation to increase the maximum number of members from four, would allow them to be used as asset holding structures as well as a family superannuation vehicle.

“The six-member fund may see more people view the SMSF as an appropriate structure for a wide range of investments, particularly those involving a group of people hoping to pool their resources,” the legal firm said in an update on its website.

“For example, an SMSF may be the structure business buddies use to purchase an asset, rather than being restricted to being a structure only for jumbo families. Provided there is no breach of the sole purpose test, such an approach could result in material benefits.”

Additionally, six-member SMSFs would also have advantages in regards to borrowing and tax that were unavailable to equivalent structures outside the superannuation environment, Townsends added.

“The limited ability to resource the SMSF due to contribution limits can be overcome by borrowing. The SMSF may enhance its capital base through limited recourse borrowing subject to appropriateness, the investment strategy and the LRBA (limited recourse borrowing arrangement) rules,” it said.

“This can provide the SMSF with greater flexibility to invest in more substantial projects or further diversify investments. Loan interest and borrowing expenses are generally tax deductible to the SMSF.

“The SMSF has immense advantages over other commercial structures when it comes to tax, both in terms of the applicable rate of tax and the use of franking credits. The lower tax rate potentially accentuates the compounding effect of earnings reinvestment in the fund.”

The firm noted that while the government first announced plans to create six-member funds in April 2018, claiming it would allow greater flexibility, it had provided little explanation as to how that would occur.

“The enthusiastic Explanatory Memorandum for the [Treasury Laws Amendment (Self-Managed Superannuation Funds)] Bill couldn’t point to any significant need or request for reform. Just 7 per cent of SMSFs in Australia have more than two members,” the legal firm noted, adding that despite the low level of government commentary, SMSF trustees should prepare for the change.

Townsends noted the benefits of a six-member fund would include reduced costs due to shared compliance and administration costs, higher contribution inflows from five or six members, and the sheltering of small super guarantee contributions for younger members from high public offer account fees.

At the same time, six-members SMSFs would have to handle the issues related to more member trustees, children knowing more about their parents’ financial affairs and vice versa, the creation and implementation of different investment strategies for different age groups, and who had control within the fund.

Source: smsmagazine.com.au

Pandemic puts investors in charge

In the three months to September 30 last year, the number of self managed superannuation funds increased 5530 as 5607 people decided they wanted to take direct control of their super. 

Last financial year tells a similar story. Although the numbers were slightly negative for the June quarter ( minus 398) – reflecting a historical norm where this quarter sees most wind-ups to coincide with the end of the financial year – the March (3922), December (3733) and September (5578) quarters took SMSF growth back to nearly 13,000 for the 2019-2020 financial year after slowing markedly in the previous two years.

It seems remarkable that two quarters of this growth occurred during a global pandemic when market volatility, job losses, business closures and social upheaval were the order of the day. But it fits a historical pattern; it also happened after the global financial crisis. Economic crises, it seems, push people to want greater control over their financial affairs.

And it was not just those nearing or in retirement who were setting up SMSFs. There is a growing cohort of younger people who are being attracted to SMSFs. Based on Australian Taxation Office statistics, the number of people under 50 years with an SMSF make up nearly 25 per cent of the nearly 1.1 million Australians who opt to manage their own superannuation. Of this number, 3.5 per cent are below 35. (As would be expected, the 50-75 age bracket remains dominant with 62.3 per cent of all SMSF members.)

For those opting for an SMSF, a recent report by the actuarial firm Rice Warner on costs would have been reassuring. Using data from more than 100,000 SMSFs, it found that funds with balances of $200,000 or more are cost-competitive with industry and retail superannuation funds and those with balances of $500,000 or more are typically the cheapest. Even balances between $100,000 and $150,000 are cost-competitive, provided a cheaper service provider is used or trustees do some of their own administration. Only below $100,000 do SMSFs stop being cost-competitive.

This is not surprising. As the report points out, over the past seven years SMSF costs have fallen (in large part due to technology), while the costs of APRA-regulated funds have increased. Most SMSF investors’ personal experiences did not reflect the costs attributed to SMSFs by the 2018 Productivity Commission report ($500,000 to be cost-effective) or the now-expired November 2019 ASIC flyer, titled Self-managed superannuation funds: Are they for you?, that included inflated SMSF annual running costs.

But setting up an SMSF has never been just about costs. Or investment performance for that matter. Of course, both costs and investment performance play a part in the decision-making process, but they are not top of mind, as a recent SMSF Association survey of 800 SMSF investors highlighted. What the survey revealed was the thinking process involved in setting up an SMSF is far more nuanced than simply looking at costs and investment performance – and it helps to explain why they are appealing to a growing number of Australians.

In a nutshell, what motivates many investors is the control an SMSF gives them. When that is teased out, it comes down to being able to make flexible investment choices, dissatisfaction with their existing fund, and tax and estate planning.

With this mindset, it helps explain why some younger SMSF investors with lower balances that are not cost-competitive with APRA-regulated funds still opt to set up a SMSF. It also explains why they are not deterred by lower average investment returns because, while an SMSF’s investment performance correlates to fund size, the actual investment performance of an individual SMSF will be driven by the investment strategy chosen for that SMSF.

As shown in the Rice Warner research, in 2017 and 2018, an average SMSF balance of between $100,000 and $200,000 had returns 4.56 per cent and 3.86 per cent, respectively, lower than APRA-regulated funds. But once an SMSF passes the $200,000 barrier, the difference starts to narrow. SMSFs with balances between $200,000 and $500,000 returned 7.07 per cent in 2017 and 6.02 per cent in 2018, not far behind APRA funds, and at $500,000 the difference is negligible.

Some of those SMSFs will have very conservative investment strategies because they are in pension phase and are very focused on capital preservation. Others will have more aggressive investment strategies and achieve higher than average investment returns. We are planning further research this year into better understanding the drivers of investment performance for smaller SMSFs.

So, when an SMSF reaches $500,000 (and, remember, 63 per cent of SMSFs had balances exceeding $500,000 and only 15 per cent had balances below $200,000 in 2019), they have more opportunities to diversify their investment portfolios, which can bring higher returns. By contrast, funds with lower balances are typically weighted towards cash and term deposits, reflecting more conservative investment strategies.

Many younger investors who want to take the time, effort and money to oversee their retirement income strategies also appreciate it’s a marathon, not a sprint. They know higher returns will come as their balances grow. And many grow quickly, as the Rice Warner research shows. Of 8043 funds with balances of less than $200,000 in 2017, 3208, or 40 per cent, had broken through this barrier by 2019, with 24 per cent doing so in the first year.

For many younger Australians, an SMSF will never appeal – far better to leave it to a large super fund to do the heavy lifting. But for those who embrace taking control of their retirement income strategy, the rewards are clearly there, whether it’s measured in terms of costs or investment returns.

Written by John Maroney, CEO, SMSF Association


SMSFs and 50/50 unit trusts

There is an increasing number of SMSFs that invest in 50/50 unit trusts. That is, an SMSF has a 50 per cent interest in a unit trust, with another unitholder holding the remaining 50 per cent interest, which invariably is an unrelated SMSF.

Our experience over the years has uncovered weaknesses in how many of these have been implemented, operated or documented.

We examine below some key risks that should be considered and strategies for successfully navigating this trust structure.

Is the trust a related trust?

Where there are two unrelated SMSFs each holding 50 per cent of the units in a unit trust, this “arrangement” has generally been considered not to give rise to a related trust for in-house asset purposes under s 70E(2)(a) of the Superannuation Industry (Supervision) Act 1993 (Cth) (SISA).

However, there are several other tests that can easily give rise to a related trust relationship and related follow on consequences as discussed below.

The primary consequence of the related trust relationship is that once this relationship arises, the in-house asset rules limit each fund’s investment to no more than 5 per cent of the market value of each fund.

ATO materials regarding 50/50 unit trusts

The ATO in March 2013 confirmed in its ATO National Tax Liaison Group – Superannuation Sub Committee Minutes of 5 March 2013 (ATO NTLG Minutes) that an SMSF holding a 50 per cent interest does not, by itself, amount to control of a unit trust. These non-binding ATO comments have been relied on by many without realising that the ATO did not rule out the other tests in s 70E(2) such as s 70E(2)(b) and (c).

Section 70E(2) provides three limbs to test whether a unit trust is a related trust.

(2) For the purposes of sections 70B, 70C and 70D, an entity controls a trust if: 

  • a group in relation to the entity has a fixed entitlement to more than 50 per cent of the capital or income of the trust; or 
  • the trustee of the trust, or a majority of the trustees of the trust, is accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of a group in relation to the entity (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts); or 
  • a group in relation to the entity is able to remove or appoint the trustee, or a majority of the trustees, of the trust.

More than 50 per cent of units

The test in s 70E(2)(a) relies on whether a group (e.g. the member and the member’s related parties) has a fixed entitlement to more than 50 per cent of the capital or income of the trust.

This requires more than a 50 per cent holding of units. Therefore, a 50 per cent or lesser holding does not give rise to a related trust relationship under s 70E(2)(a). This test is generally relatively easy to establish from the unit trust documentation and related records if all units are of the same class of units.

In reviewing a trust deed, however, you need to carefully review the provisions of each deed in detail and should not make any assumptions on what, for instance, you might expect to find in the document. As noted by the High Court in CPT Custodian Pty Ltd v Commissioner of State Revenue (2005) 224 CLR 98 at [15]:

In taking those steps, a priori assumptions as to the nature of unit trusts under the general law and principles of equity would not assist and would be apt to mislead. All depends, as Tamberlin and Hely JJ put it in Kent v SS “Maria Luisa” (No 2), upon the terms of the particular trust. The term “unit trust” is the subject of much exegesis by commentators.

However, “unit trust”, like “discretionary trust”, in the absence of an applicable statutory definition, does not have a constant, fixed normative meaning which can dictate the application to particular facts of the definition in s 3(a) of the act.

If there are different classes of units, for instance, a detailed analysis would need to be undertaken to see which unitholder may exert more influence or control.

Sufficient influence

The second test in s 70E(2)(b) that can result in a related trust relationship is what is broadly known as the “sufficient influence” test. The ATO comments on the 50/50 unit trust question in the 2013 NTLG Minutes were qualified s 70E(2)(b) stating that:

… the trustee of the trust … might reasonably be expected, to act in accordance with the directions, instructions or wishes of a group in relation to the entity …

Until recently, there has been little guidance on the sufficient influence test in s 70E(2)(b). SMSF trustees involved in 50/50 unit trusts have generally tried to minimise any “related trust” risk. Some instances that may indicate some influence might include:

  • The unit trust deed provides one unitholder a discretion, power or advantage over the other unitholder.
  • The constitution of the corporate trustee to the unit trust provides one director/shareholder with power or advantage over the other director/shareholder, e.g. the chair of a directors or shareholders meeting has a casting vote.
  • One unitholder and/or a related entity, for example:
    • is actively involved in managing and controlling the unit trust’s affairs and the other is relatively passive; or
    • provides loans to the unit trust and has influence via the loan agreements or mortgage or security arrangements in relation to the unit trust.

Recent developments in case law and ATO materials now, however, provide better guidance on what is meant by sufficient influence.

The BHP Billiton Limited v FCT [2020] HCA 5 decision considered “sufficient influence” for the purposes of identifying “associates” of a company under s 318 of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936). The High Court held that BHP Billiton Limited sufficiently influenced BHP Billiton Plc (and vice versa). Further, BHP Marketing AG (the group’s Swiss marketing entity owned 58 per cent by BHP Billiton Limited and 42 per cent by BHP Billiton Plc) was sufficiently influenced by BHP Billiton Plc and BHP Billiton Limited.

Similar wording is used in s 318(6)(b) of the ITAA 1936 to that in s 70E(2)(b) that relevantly provides:

(6) For the purposes of this section:

  • … 
  • a company is sufficiently influenced by an entity or entities if the company, or its directors, are accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the entity or entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts); …

The BHP decision held that for a company to be “sufficiently influenced” by another entity under s 318(6)(b), it was not necessary to show “effective control” or a causal link between the entity’s “directions, instructions or wishes” and the company’s actions (as BHP had contended).

The court held that the test could be satisfied if the facts provided a basis upon which to conclude a “requisite degree of contribution” between such directions and actions. The BHP facts broadly involved, among other things, a dual-listed UK-Australian company arrangement where directors had to generally vote in a consistent manner.

While the BHP decision related to a different legislative test in relation to a company and its associates for tax purposes to the test in s 70E(2)(b) of the SISA that relates to a unit trust, the decision is relevant as it provides meaning to the similar legislative text/test. As you will glean from the above legislative extracts, both tests (i.e. s 318 of the ITAA 1936 and s 70E(2)(b) of SISA) largely include similar wording including “directions, instructions or wishes … communicated directly or through interposed companies, partnerships or trusts .

There have also been other recent developments where a company has been taken to be controlled by a person who was not formally appointed as a director. Therefore, the fact that a person is not formally appointed does not preclude that person being in a position of control or sufficient influence.

The power to hire or fire the trustee

For completeness, the third test in s 70E(2)(b) is reliant on who can remove or appoint the trustee, or a majority of the trustees, of the trust. As with the more than 50 per cent of units test in s 70E(2)(a), this test is generally relatively easy to determine by a review of the unit trust’s documentation and related records.

As noted above in relation to the High Court’s comments in the CPT Custodian decision, there is no constant, fixed normative meaning of what a unit trust is, as it depends on the terms in the deed being considered.

In this regard, there are various drafting methods used in relation to who has the power to remove or appoint the trustee, or, in the case of individual trustees, a majority of the trustees, of the trust. Several popular methods that we encounter include:

  • A certain majority of unitholders, e.g. 75 per cent can vote to remove or appoint a trustee.
  • An appointor/guardian/founder or similar person or entity is given the power to remove or appoint a trustee.
  • The current trustee may be given the power to resign, remove or appoint a trustee.

The multi-pronged related trust test

As you will see from the above outline, there are a number of important considerations to review to determine whether a related trust relationship exists in s 70E(2) of the SISA.

There are also a number of less well-known provisions that might prove a trap for young players.

Does the ATO discretion to deem an asset to be an in-house asset?

In short, yes. For example, the ATO has a broad discretionary power to deem an asset (that is not an in-house under the usual tests) to be one under s 71(4) of the SISA.

The ATO relied on this deeming power in Aussiegolfa Pty Ltd as trustee of the Benson Family Superannuation Fund and Commissioner of Taxation [2017] AATA 3013. While the ATO lost in the Administrative Appeals Tribunal, the ATO does have a broad discretion to deem an asset to be an in-house asset.

The ATO actually won a separate case in the Full Federal Court, namely Aussiegolfa v Commissioner of Taxation [2018] FCAFC 122, that resulted in the units in the unit trust in question being held to be an in-house asset. The Full Federal Court decision effectively removed the ability of the Administrative Appeals Tribunal to deem the asset to be an in-house asset, as the Full Federal Court had already determined the asset’s status.

Understanding the risks

Thus, as you will appreciate from the above outline, a 50/50 unit trust faces a number of possible risks. If there is any doubt, timely expert legal advice should be obtained especially as a contravention of the in-house asset provisions can result in serious adverse consequences. For example, a contravention can potentially result in, among other things:

  • significant administrative penalties;
  • an SMSF being rendered non-complying with a significant tax liability; or
  • being imposed and potentially the SMSF directors/trustees being rendered disqualified from ever being SMSF trustees/directors again.

By Daniel Butler ([email protected]), director, DBA Lawyers
Source: SMSF Adviser


Reform aims to cut costs and simplify SMSFs

Trustees frustrated by excessive paperwork and expensive advice frameworks will be watching two government initiatives with great interest.

There is growing momentum for financial services reform that could see the cost of administering a self-managed super fund fall, with federal Treasury and the Australian Securities and Investments Commission issuing independent consultation papers that could cut red tape and complexity.

Treasury has called for submissions to its consultation paper, Modernising Business Communications, which has the goal of “cutting business costs (including superannuation) and better reflecting the way Australians want to engage and communicate digitally”.

Running parallel to this is ASIC’s consultative paper 332 – Promoting Access to Affordable Advice for Consumers – that has asked the financial advice industry and other stakeholders to outline what impedes the delivery of good-quality, affordable personal advice.

The SMSF sector has benefited from coronavirus-induced relief measures that cut red tape, and the federal government’s stated aim is to build on this to improve efficiencies and further cut fees.

Research by actuarial firm Rice Warner shows the cost of operating an SMSF can range from $1,189 a year for SMSFs (with just accumulation members receiving a base level of compliance and administration services) to $3,359 a year (for SMSFs that have one or more members in the pension phase and are receiving a full range of administrative and compliance services). These costs exclude the cost of advice.

If the initiatives by Treasury and ASIC come to fruition, these figures could drop further.

The Treasury consultation paper wants to identify business communications that will benefit from technology neutrality changes (i.e., that different technologies offering essentially similar services will be regulated in similar ways), particularly those that lower compliance costs.

It identifies superannuation as one area for improvement, noting that much of the legislation is exempted from the Electronic Transactions Act 1999 that allows information to be recorded or retained in electronic form. This needs to change.

The administrative reality for SMSF trustees – whether establishing a fund or in ongoing financial reporting processes – is that a significant number of signatures, resolutions and record-keeping details are required that could be reduced by any efficiencies emerging from recommendations out of the Modernising Business Communications report.

Trustees know only too well the legislative demands to keep physical documents. One example is that trustees are required to retain physical written records of decisions made about the storage of collectables such as artwork, antiques, jewellery and similar items and to retain them for 10 years.

Trustees are also required to prepare a written rectification plan in situations where the fund breaches the 5 per cent in-house asset rules.

New trustees are also required to sign a physical trustee declaration to declare they understand their obligations and responsibilities. Completed declarations must be kept not only for the life of an SMSF but for at least 10 years after it is wound up.

All this paperwork is time-consuming. And costly. Some of it is also unnecessary – especially in a physical form. Allowing these records to be stored by any means as long as the information is readily accessible, in a format that can be easily reused and where the integrity of the information is maintained can only save trustees time and money.

The ASIC paper is looking for ways to make financial advice, including SMSF advice, more affordable. As COVID-19 highlighted, there is a pressing need for a more efficient regulatory framework for financial advisory services, with trustee feedback to the SMSF Association revealing that they find the advice process lengthy, costly and prioritises compliance and the needs of Australian Financial Services Licences over them.

The system also prevents them obtaining limited SMSF advice they might require – a real source of frustration.

Many trustees only want specific strategic advice but instead often find themselves having to sign up for a comprehensive advice package that is simply too price-prohibitive for the actual information they seek.

Allowing advisers to offer limited strategic advice could be the foundation stone on which an SMSF trustee-focused advice framework is built, allowing well-educated advisers who are registered with a single disciplinary body to provide strategic advice on specific areas such as superannuation and cashflow without specific reference to financial products.

It would also have the side benefit of increasing their ability to provide strategic advice without conflicts of interest.

None of this push to simplify the system and cut costs should come at the expense of the integrity of the system or safeguarding the financial interests of every trustee.

Adequate and reasonable protections are needed so that trustees are not at risk from either poorly or illegally executed corporate documents or deficient financial advice. In any reform, the right balance must be struck.

SMSFs got a fillip late last year when the Rice Warner report found that they were cost competitive with APRA-regulated funds above $200,000 and the cheapest superannuation option above $500,000.

It was only below $100,000 that SMSFs were at a competitive disadvantage. If concrete reforms that drive SMSF costs lower eventuate from these two papers, it cannot help but make this superannuation model even more enticing.

Written by John Maroney, CEO, SMSF Association