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Franking credit proposals prompt spate of buy-backs, dividends

The proposed changes to franking credits are predicted to trigger a wave of buy-back announcements and other shareholder returns over the next few weeks, providing a boost for SMSFs and other retirees, says an investment manager.

AMP Capital portfolio manager, equity income, Dermot Ryan said that, over the next four weeks, many of Australia’s biggest companies will report their half-year results and the combination of strong balance sheets and cash flows, late-cycle business strategies and the prospect of Labor’s franking credit changes is expected to see boards hand back money to investors in a tax-efficient way.

Mining, utilities, energy and consumer companies are the sectors most likely to announce buy-back schemes or other shareholder returns, he said, “providing a bountiful one-off boost for many self-funded investors and retirees”.

“These sectors are in robust health from a cash flow and balance sheet perspective. Some have been bolstered by the sale of non-core assets. They have excess capital over and above what they need to invest in their businesses,” he said.

“Many companies from these sectors have paid large amounts of tax in Australia, generating precious franking credits for investors.”

Within the mining sector, management are looking to maintain current production levels at lower unit costs rather than expanding production.

“[This] means the cash flows from current projects can be returned to shareholders rather than used to fund new projects,” he said.

Mr Ryan said that company boards are aware that the value of franking credits amassed on balance sheets may be at risk if Labor wins the upcoming election.

In terms of returning the money to shareholders, companies have a few options, including increasing interim and final dividends, paying a one-off special dividend, or launching a share buy-back program.

“In an off-market buy-back, the company offers to buy shares back from willing sellers at a discount to the trading price, plus pay a special dividend to make up the difference. These dividends come with franking credits which are attractive to many investors,” he said.

An on-market buy-back, on the other hand, is where the company buys back its shares on a first-come, first-serve basis at the market price, without a special dividend.

“Buy-backs are most attractive to shareholders on low marginal tax rates who can offset excess franking credits against other income or take the excess credits in cash. This is particularly attractive to retirees who pay no tax in the pension phase of their investing,” he explained.

Source: https://www.smsfadviser.com/news/17341-franking-credit-proposals-prompt-spate-of-buy-backs-dividends

 

New auditor tool launched for title searches, ASIC extracts

Audit software firm Cloudoffis has announced a new integration with a technology company that will allow auditors to automatically access title searches, ASIC extracts, corporate trustee searches and background checks.

Cloudoffis has integrated with technology firm InfoTrack, allowing SMSF auditors to request corporate trustee ASIC searches through the Cloudoffis platform, which are then automatically stored for quick access.

They will also be able to instantly order ASIC extracts and attach them directly to the audit.

The integration will also enable users to access title searches, background checks and know your customer checks. Searches can be performed directly through Cloudoffis with the results and related costs returned to Cloudoffis and added to the auditor’s subscription.

Cloudoffis has also improved its integration with BGL so that users no longer need to manually upload operating statements, financial statements and investment summaries.

Source: https://www.smsfadviser.com/news/17337-new-auditor-tool-launched-for-title-searches-asic-extracts

The new event-based reporting regime is set to commence from 1 July 2018.

The new event-based reporting regime is set to commence from 1 July 2018. What preparations do firms need to make and what are some of the overlooked traps?

Transfer balance account reporting has been one of the most contentious and divisive issues for the industry in the past year. The ATO initially proposed that all SMSFs would report credit and debit amounts for the transfer balance cap no more than 10 days after the month in which they occurred, and the commencement of income streams no more than 28 days after the end of the quarter in which they were commenced.

These proposals were soon met with intense criticism and lobbying from parts of the SMSF industry, with many firms ill-equipped to deal with the frequency of the proposed time frames.

Following the negative reaction from industry, the ATO revised its position, adjusting the reporting time frame for all events to a quarterly basis, and limiting the new reporting requirements to members with account balances of at least $1 million only.

This means that from 1 July 2018, SMSFs that have members with a total superannuation balance of $1 million or more will be required to report events impacting a member’s transfer balance cap within 28 days after the end of the quarter in which the event occurs.

At time of writing, the ATO has suggested that the $1 million threshold amount will be based on the total superannuation balance of the member on the 30 June immediately prior to the commencement of that income stream. ATO assistant commissioner Kasey Macfarlane says the ATO is also proposing that in situations where one SMSF member has a total super balance greater than $1 million and others in the fund have a total super balance less than $1 million, “the SMSF will report all events for all members 28 days after the end of the relevant quarter”.

“We think its appropriate to apply it at the fund level like that, to avoid administrative complexities of SMSFs and their advisers having to work out different methods and different reporting time frames,” explains Ms Macfarlane. She also stresses that where a member’s superannuation balance falls below the $1 million threshold during a financial year and they were previously above it, they will not be able to switch to annual reporting in that year.

“That approach is being taken to avoid administrative complexity of people going in and out of annual and quarterly reporting, creating difficulty for advisers and administrators,” she says.

IMPLICATIONS OF THE NEW REPORTING

The TBAR reporting regime will affect some SMSFs significantly depending on the size of member balances and the strategies employed, while other SMSFs will see very little impact at all. Despite the extension to the time frames in which funds need to report, quarterly reporting still represents a significant transition from the current rules, where transactions can be reported nearly two years after they occur.

The introduction of the superannuation reforms is likely to lead to an increase in SMSF pensioners who draw more than their required minimum performing additional commutations to maintain room under their $1.6 million cap for extra contributions. Class chief executive Kevin Bungard explains that these additional commutations would of course be reportable events for those members with balances exceeding $1 million. This is likely to become a popular strategy, he says, because it enables clients to add more space back onto their transfer balance cap.

“If it’s a material amount [above the minimum pension], you would look to make sure that you get the credit back onto your cap, so that the client has that additional cap space later on,” he says.

Analysis by Class indicates that around 39 per cent of pensioners drew down at least $5,000 more than the minimum on their pensions during the 2016 financial year.

SMSF Academy director Aaron Dunn agrees that this will be an important strategy from 1 July, but says SMSF practitioners will need to contemplate the timing of when information about these commutations needs to be reported to the ATO.

Another strategy which could attract a higher rate of reportable events is rebalancing the balances between different members in a fund, explains Mr Bungard.

“SMSF members may choose to even up the balances between different members in a fund by taking money out and re-contributing it to the other member and then restarting the pension,” he explains.

“That’s a strategy that’s going to require a level of reporting, especially when you consider that given the caps, it would potentially take someone a number of years to execute that kind of strategy to try and even out the balances.”

One of the other main implications of event-based reporting is that it’s going to be much more difficult to backdate strategies and documents, warns BGL Corporate Solutions managing director Ron Lesh.

“In the past, SMSF practitioners might have backdated the commencement of pensions by 12 months and if they didn’t have to pull any cash out, then that wasn’t a problem,” Mr Lesh explains.

“So they’ll now need to make those types of decisions earlier. So, instead of sitting down at the end of the year, and saying ‘okay, we should have started a pension at the beginning of July, so let’s do that’, they’ll have to report it for the quarter that they started the pension.”

Colonial First State executive manager Craig Day says this inability to backdate documents as a result of the reporting needs to be carefully considered where SMSF practitioners are executing strategies that involve commuting amounts that were paid above the pension minimum.

“You need to actively commute an amount out of your income stream. So you won’t be able to wait until the end of the financial year, and then look at the total amount you had withdrawn from your income stream and then decide that any amounts over and above the minimum will be treated as lump sums,” he cautions.

“You need to be proactive about that and decide that was what you were going to do at the beginning of year.”

If SMSF advisers do decide to recommend a commutation, he says, then they need to get the paperwork and documentation for it sorted upfront.

“It’s not something that should be done in retrospect at the end of the financial year.”

GEARING UP FOR THE REPORTING

For some SMSF firms, particularly those that are still processing client funds manually  preparing for the event-based reporting regime may require moving to new SMSF administration software systems and updating their technology.

Mr Lesh says SMSF firms will need to automate the process of collecting SMSF data.

“Those that are using web-based software will find complying with the requirements a lot easier, those that are not using web-based software will find it a lot harder, and those using no software will find it impossible,” Mr Lesh warns.

A large chunk of SMSF firms, he says, are still only using desktop software rather than cloud-based software, which means they don’t have access to up-to-date information on investments and account balances for their client. He also estimates there could be as many as 100,000 SMSFs that still aren’t using any software at all.

SuperConcepts general manager of technical services and education Peter Burgess says there are already software tools out there that support event-based reporting. These tools generate data files on events for multiple members, which can be uploaded to either the business portal or the tax agent portal.

“So there is an automated solution to this and it’s within the reach of SMSF trustees.”

“Practitioners should look at the automated solutions which are now available because it does make the reporting so much easier,” says Mr Burgess.

One of the most important preparations for the new reporting requirements is educating clients on the details, according to the SMSF Academy’s Aaron Dunn. SMSF firms, he says, either need to put the information about the fund into the hands of the member through cloud-based technology, for example, or there needs to be a communication system in place between the client and the practitioner around when certain money is being moved.

“Those communication pieces are going to become critical, otherwise it does put the member or fund at risk of not reporting within the prescribed time frames,” he says.

The new reporting requirements will also place greater emphasis on client segmentation. Mr Dunn recommends splitting clients into three separate groups; clients with balances above $1 million, those with balances close to $1 million and those that are well below $1 million.

“For the clients above the $1 million, practitioners may need to be more strategy-focused in terms of how those benefits may be taken out if they’re contemplating partial commutations and so forth, versus those under the $1 million.”

SMSF practitioners should then look at clients in the threshold risk area.

“It’s going to be based on the total superannuation balance each year so these clients may slide in and out of the system so you’re going to need to be active in terms of the management of those [funds],” he explains.

The third group, he says, will comprise of the lower risk clients who are unlikely to ever reach the $1 million. SMSF practitioners, he stresses, will still need to think about the fact that these clients may exceed the threshold for quarterly reporting upon receiving a death benefit, however.

TRAPS TO WATCH OUT FOR

While the ATO’s revised position on event-based reporting may have been a welcome relief to the industry, it also means that SMSFs are now out of step with the rest of the superannuation sector. This misalignment means there is the potential for excess transfer balance determinations to be issued by the ATO, warns Mr Burgess.

“So whenever an SMSF member that’s in the pension phase commutes that pension, rolls it over and starts a pension in an APRA regulated fund, there is the likelihood of an incorrect excess transfer balance determination being issued by the ATO,” he cautions.

“That’s because the pension balance at 1 July 2017 would be a credit to the member’s transfer balance account for that amount, and then they transfer it to the APRA fund and the APRA fund has to report the commencement of that pension 10 business days after the end of the month.”

The client would therefore end up with two credits for the pension in their transfer balance account which could then result in an excess pension amount and a determination being issued, he says, because the commutation has not yet been reported by the SMSF.

“Now once that determination has been issued by the ATO, the clock is ticking, and if the member doesn’t act on that determination in a timely manner, the APRA fund will be compelled to commute that excess, even though there isn’t really an excess, and so that can create some legwork and extra stress for the client,” he says.

At a minimum, he recommends that SMSF practitioners report any full commutations 10 business days after the end of the month like APRA funds do, in order to avoid this issue arising.

Mr Day says SMSF practitioners should ideally be recording pension commencements and commutations for their clients on an ongoing basis. ATO data can potentially be out-of-date by 22-and-a-half months for clients reporting on an annual basis so it won’t be reliable, he warns. Advisers who aren’t recording this information could therefore be caught off guard where a client receives a death benefit for example.

If a client dies, their spouse may need to commute and roll back an amount of their own pension to accumulation phase, in order to create additional cap space and allow them to receive more of the original member’s death benefit as an income stream, he explains.

“Unless separate records have been maintained, it may be difficult to quickly calculate the value of the commutation required, especially where the client has been commuting additional lump sums from their own pension, which could delay the payment of a death benefit and increase the risk of exceeding their TBC,” says Mr Day.

In these types of scenarios, SMSF practitioners won’t be able to wait the potential 22-and-a-half months for all the reporting to wash through and know how much to commute, he cautions.

“The adviser would actually need to do that relatively quickly so they’d have to go back in and look at the fund’s records, look at all the transactions and figure out which of those withdrawals are pension payments, which were commutations, and then calculate what the actual transfer balance cap for the survivor is, which would then tell them how much to commute,” he says.

“So it could actually get reasonably complicated for a financial adviser, and there is also a time frame in relation to the payment of death benefits which they need to keep in mind as well, so all that work needs to be done reasonably quickly.”

Given that the commencement of a pension is a reportable event, Mr Bungard says practitioners will also need to monitor balances for clients that are at an age where they could potentially start a pension, even if they are still in accumulation phase.

“[So] if the client is at an age where they could start a pension this year, you will need to know what their total super balance was at the beginning of the year,” he says.

Analysis from Class suggests that around 60 per cent of SMSFs have at least one member who is age 60 or older. Class also estimates that approximately 20 per cent of SMSFs have at least one member who is age 60 or over and a member with a balance over $1 million. Mr Bungard notes that the member aged 60 or over may not be the same member with a balance of $1 million or more.

This point was also raised by Ms Macfarlane in November when she stated that it’s not just SMSF members in retirement phase who will be tested against the $1 million threshold.

“All members’ total super balances are tested against the $1 million threshold and are relevant to determine the reporting time frames that apply,” she says.

“The reason for that is it’s not just about money already in the retirement phase, it’s also about money that people hold in super which could potentially be transferred into the retirement phase in the future, and cause an inadvertent or accidental trip over the transfer balance cap.

Source: https://www.smsfadviser.com/latest-issue/feature-articles/16639-time-warp

How much do you need to set up a self-managed superannuation fund?

This is a common question for anyone considering setting up their own superannuation fund.

It is important to note that there is no mandated minimum amount required to establish a Self-Managed Superannuation Fund (“SMSF”). However, the Australian Securities and Investment Commission (“ASIC”) has issued guidelines to financial advisers on this matter which includes the following points:

  • It is important to consider if a client’s likely balance in an SMSF makes it “cost-effective”. If it is not cost-effective, an SMSF is unlikely to be in the client’s best interest,
  • Establishing an SMSF with a balance of less than $200,000 is not likely to be cost-effective – this is based on a 2013 study by Rice Warner which indicated that the average cost of a superannuation account in Australia was just over 1%,
  • There may be circumstances where starting a fund with less than $200,000 would be in the client’s best interest – for example, where the trustees are prepared to take on as much of the administrative work as possible or when members plan to roll in additional funds in the short term from say another fund or sale of a business.

All savings/investment plans have to start somewhere. Costs are not the only consideration as investment returns are likely to have a much greater effect on fund balances over time. The particular circumstances and plans of the individual/s concerned will be critical to the decision to set up an SMSF and are a far more important consideration than any arbitrary dollar balance.

Take for example the following cases:

Case 1

Bill has operated a very successful small business for many years and has considerable cash reserves but only a modest superannuation balance of $60,000. After taking appropriate advice and undertaking some financial planning, he decides to establish an SMSF. He rolls his existing $60,000 into the SMSF to start it off and then has a plan to make maximum contributions to the fund over the following years i.e. currently $125,000 per annum. He has very particular views on how his retirement savings should be invested. Even though Bill would not make the $200,000 “threshold” for at least a couple of years, the establishment of an SMSF is clearly justifiable based on Bill’s requirements and future plans.
Case 2

Ann has operated a beef cattle business with her husband for more than 30 years and tragically lost her husband in a farming accident. They have no superannuation and after taking advice, Ann decides to establish an SMSF with an initial small cash amount and then prepare the farm for sale with the aim of making a maximum Capital Gains Tax contribution from the sale proceeds. The sale is expected to be at least a couple of years away but Ann wants to get everything in place while she has the help of her only daughter who is due to go back to her overseas employment in the next few months. Again, not meeting the initial $200,000 threshold can be seen as irrelevant to Ann’s longer term interests.
Case 3

Ben and Josie have just been given some of the family farmland to start their own sheep and cattle business. In conjunction with their accountant and financial planner, they have mapped out a medium-term financial plan which includes significant superannuation contributions. They are likely to have variable incomes but aim to be consistent with their contributions and to make significant additional contributions in the better years. They are keen to be involved in the running of the fund and take a close interest in the performance of their investments.
Whilst there is no hard and fast rule for a minimum amount required to justify setting up an SMSF, it is important that the personal circumstances and plans of the individuals concerned be carefully considered and professional advice sought from experienced and licensed professionals.

For any adviser to recommend the establishment of an SMSF to a client, it should be clear that such an action is demonstrably in the client’s best interest. This applies regardless of the amount of the planned initial investment in the fund.


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Don’t Forget Your (Superannuation) Cap

My coat stand at home has a lot of caps on it; baseball caps, old school caps, cricket caps, a memento of the Sydney Harbour Bridge Climb and the list goes on! There are also a lot of “caps” for superannuation funds, but they are not the sort you wear on your head.

In the context of superannuation, a “cap” is an upper annual limit or a ceiling that is permitted within the superannuation laws. The more important caps include:

  1. Concessional Contributions Cap – this is the maximum “concessional” type contribution allowable for each member in a financial year. This cap is currently $25,000. Concessional contributions are taxable at 15% in the fund as the contributor has claimed a tax benefit and this type of contribution can include; employer contributions, salary sacrifice, self-employed and personal contributions. Note that as from 1/7/2018 there will be an option available to carry forward unused concessional contribution limits for individuals who have less than $500,000 in superannuation. There is also an option available to those with Self Managed Superannuation Funds to claim 2 years contributions in the one financial year.
  1. Non-concessional Contribution Cap – this is the maximum “non-concessional” type contribution that can be contributed personally by each member. These contributions types are not claimed for tax purposes and the fund does not have to pay any 15% contribution tax on the amounts received. The current cap is $100,000 pa but there is an option to “bring forward” up to 3 years contributions in one year (i.e. $300,000) for those individuals who are under 65 years of age.
  1. Total Superannuation Balance Cap. As from 1/7/2017 each member has a total superannuation balance cap of $1.6 Million. This refers to the total amount that a person has in all superannuation accounts. Once that cap is exceeded, no further non-concessional contributions are allowed for that individual unless this cap falls below the $1.6M (as measured at the start of each financial year). Note that concessional contributions can continue regardless of the total superannuation balance.
  2. Transfer Balance Cap. This is the maximum amount that an individual can transfer to retirement phase pension accounts and is currently also $1.6 Million. The income and capital gains derived from assets supporting retirement phase pension accounts are exempt from income tax and capital gains tax. This contrasts with other superannuation assets in “accumulation accounts” which are taxed at the rate of 15% on income and 10% on capital gains. The Transfer Balance Cap should not be confused with the Total Superannuation Balance Cap as it does not restrict the amount you can contribute to superannuation but rather how much of your superannuation you can move to the tax free retirement phase. To determine where an individual is relative to their Transfer Balance Cap, an account will be maintained that tracks all the relevant transactions that affect this balance. This account is referred to as the Transfer Balance Account (“TBA”). As an example, let’s say Fred has an accumulated superannuation balance of $2 Million and upon retirement at age 65, decides to move the maximum $1.6 Million into a retirement phase pension account and leave the other $400,000 in an accumulation account. The following table illustrates the effects of various transactions over the following years: As Fred’s TBA has been reduced to $1.1 million, he could transfer up to a further $500,000 into retirement phase pension. He could therefore transfer the full balance of his accumulation account ($485,000) into pension mode and his total superannuation balance of $1.75 million would then be entirely in pension phase and the fund would pay no income tax or capital gains tax thereafter. Note how many of the transactions that affect the superannuation account balance, such as income earned and pension withdrawals, do not affect the TBA. Also, if Fred had simply withdrawn the $500,000 he wanted to make the family gift as additional pension payments (rather than commuting back to accumulation and then paying the $500,000 from there), he would still have a TBA of $1.6 even though his pension account balance is only $1.265 million. He would then be stuck with having to leave the $485,000 in accumulation mode and the fund would pay tax on the income and capital gains generated from that account.
  1. Division 293 Cap. This is calculated as the personal income of a taxpayer plus concessional superannuation for that individual for a financial year. If this figure exceeds $250,000, the tax rate payable on the contributions if increased from the usual 15% to a penalty rate of 30%.
  2. CGT Concession Cap. This refers to an additional contribution amount that is allowed from the sale of a small business. This cap is currently $1.445 Million per person and is in addition to the other contribution caps and is not constrained by the Total Superannuation Balance Cap.
  3. Low Rate Cap. This is an amount up to which superannuation lump sum payments paid to individuals over preservation age but below 60, are not subject to tax. Lump sums above this cap paid to such individuals, attract a rate of 17% tax. The current low rate cap is $200,000.
  4. Pension Withdrawal Cap. This refers to the maximum annual amount that can be withdrawn from a Transition to Retirement Pension Account. This is currently 10% of the balance of the account at the start of the financial year (or at pension commencement). Note that this should not be confused with the minimum pension withdrawal requirements which apply to all types of superannuation pension accounts.

    The following table summarises the caps referred to above – current for 2017/18 financial year:

Exceeding a superannuation cap can have serious consequences. This would generally include paying extra tax and charges and can be as high as 47% of the relevant amounts depending on the circumstances.

It is also important to effectively manage your superannuation caps. As an example of this, assume you start a retirement phase pension with $1.6 Million and start by withdrawing just the minimum required pension of $64,000 pa. A few years down the track, you decide to help out a family member with a loan of $250,000 and provide this by simply drawing an additional pension amount. A year later, the loan is paid back and you go to contribute it back into your retirement phase superannuation account but to your horror, discover that this is not possible as your TBA is still at the cap amount of $1.6 Million! This could have been avoided by covering the $250,000 with a commutation of your pension account (back to accumulation phase and then paid as a lump sum amount) which would have reduced your TBA to $1.35 Million, thus allowing the $250,000 to be transferred back to pension phase later without exceeding your cap.

Timing can be important in the context of managing caps, particularly those relating to contributions. As a simple example, assume that a 66 year old person has an existing superannuation balance of $1.58 Million and has just sold a small business and wishes to contribute; $25,000 concessional contribution, $100,000 non-concessional and $1.445 Million CGT contribution. If the timing of these contributions is not handled correctly, it could result in the person not being able to contribute the $100,000 non-concessional amount.

Most of the superannuation caps are subject to some form of indexing. Therefore, over time we will expect to see the monetary amounts of the caps increase

What software should I use for my SMSF?

Self-Managed Superannuation Funds (“SMSF”) have a number of unique aspects which mean that standard business software is not suitable for maintaining the relevant accounting records and tracking the various compliance aspects. For example, it is necessary to track individual member balances including allocation of a proportionate share of income and taxes. There are also annual contribution limits and minimum pension withdrawal amounts that need to be tracked and reported. What should I look for when trying to assess a software application to help manage my SMSF?

 There are a number of software solutions available that have been designed specifically for SMSF’s, however most have been designed to be used by professionals for delivering compliance services to their SMSF clients and are generally not suited to fund trustees who wish to take a more active role in maintaining the financial records and managing the operations of their fund.

For these trustees, Practical Systems have developed a specialized and easy to use solution Practical Systems Super. The Company has been successfully developing and supporting software solutions for farmers and small business for more than 25 years.

Practical Systems Super has been developed using the latest cloud based technology making it ideal for collaborating between all members of the SMSF “team” including; auditor, tax agent, financial adviser and fund members. The system is operated from any web browser and does not require any installation of software or set up.

The software is backed by a support network of professionals who understand self-managed superannuation and have significant industry experience. All software development, help desk & professional support and all administration is conducted from the Company offices in Armidale in regional NSW and they do not use any overseas outsourcing. All data is stored on secure servers within Australia.

Some of the features of the Practical Systems Super application include:

  • Simple financial transaction entry including automated bank data feeds and a “transaction wizard” for those who may struggle with accounting jargon and double entry bookkeeping concepts
  • Complete investment tracking including real-time valuation of portfolios
  • Easy viewing of real time member balances, investment listings, etc. with extensive use of graphs and simplified presentations
  • Free set up of all initial fund information and opening balances – simply provide the information to Practical Systems on the standard forms supplied and your fund will be fully set up and ready to use from your first log in.
  • Automated year-end close off including automatic tax calculations and allocation of income and tax between members
  • Extensive range of reports for all management and compliance purposes
  • Additional users can easily be added and access rights to various parts of the software customized for each user. These additional users might include; auditor, accountant, financial planner, etc.
  • Access is available via other devices such as mobile phones and tablets
  • Future capability to create and store all relevant fund documents such as minutes, trust deeds, trustee declarations etc. integrated with electronic signing

Another unique aspect of Practical Systems Super is that all of the data within the system remains under the ownership and control of the fund trustees. This means that if the trustees at any stage wish to change a professional adviser such as auditor, tax agent or financial adviser, they can make the change instantly without any delays waiting for records to be transferred. All of the fund records are instantly available to the newly authorised user.

The software is also suitable for professional accountants and has specific provision for efficiently managing multiple funds within a single “group” of fund clients.

The software is provided on the basis of an annual subscription and will be constantly updated to reflect the latest tax rates and superannuation laws. These changes will be automatically available to all users without the need to download or install upgrades.

The people behind the software have a keen interest in self-managed superannuation and are passionate about helping individuals secure their financial futures using the SMSF concept. The professional and personalised support provided is a key element of the Practical Systems Super solution.

Deferred farm income – The sleeping giant?

USING SUPERANNUATION TO SLAY THE SLEEPING GIANT OF DEFERRED FARM INCOME

Farm businesses can often accumulate “deferred income”: income that would usually be taxed in the year it is earned or generated, but is deferred or delayed to a future year through various mechanisms available to primary producers.

Over time, these deferred amounts can become substantial, with the potential for unexpected tax consequences arising from an unplanned event.

Even with good planning, “deferred income” could build up significantly over time – and reducing it could be expensive, due to tax paid at higher rates.

Superannuation could be the slingshot to bring down this Goliath.

Types of deferral

Deferrals can be either deliberate (for example, depositing funds into a Farm Management Deposit), or simply occur in the normal course of events (such as when market values for livestock rise above their current book value).

Deferred income can be generated through:

Farm Management Deposits (“FMDs”).
Using this scheme, primary producers can reduce their taxable incomes in “good” years by depositing cash in special types of bank deposits. These deposits can be redeemed in “bad” years; they are included with taxable income in those years, but are often offset by additional expenditure, such as fodder. In this way, FMDs can be a very effective tool as part of a drought management strategy. However, they can also become a risk if they build up to a level beyond reasonable requirements. Farming families can accumulate significant amounts in these facilities: up to $800,000 per person.

Deferral of livestock profits arising as a result of loss or destruction of pastures – often referred to as “Drought Forced Sales”.
This popular technique is used in drought periods or dry spells when farmers have to sell livestock because of poor pasture conditions. This strategy effectively reduces taxable income in this situation, and does not involve the outlay of any cash. One risk is that deferrals can only be made for up to five years; sometimes farmers use the cash from the proceeds of the “forced sales” for other purposes, and a build-up of deferred sales can create problems if a run of “good” years follows dry spells.

Unrealised profit in livestock inventory.
Many farmers will use the “average cost” method for valuing year end livestock inventories for taxation purposes. This means – particularly for those who breed (rather than trade) livestock – the taxation value of inventories over time can be considerably lower than market value. If the farm or other assets are sold, that difference between average cost and market value is realised, and can significantly increase taxable income.

Excess depreciation claims.
The depreciation provisions are generally fairly generous, enabling farmers to claim large proportions of plant and equipment capital expenses against taxable income. (For instance, the 100% write off option for assets costing less than $30,000.) Over time, the total “written-down value” of farm plant can be much lower than the value that would be realised at a clearing sale. Any excess received on the sale of plant (over taxation written-down value) will be taxable income, and not subject to the CGT exemptions – unlike the sale of farm property, which is a capital gain event, but often exempt from any tax due to the Small Business Tax Concessions.

These examples are not exhaustive, and other provisions can defer farm income.

Consequences of deferred income

An unplanned tax event can have unexpected – and expensive – tax consequences.

For example, when a person dies, any FMDs or drought deferred sales related to them automatically becomes taxable income in the year of their death. Depending on their circumstances, this can create a significant tax bill.

The same is true if the taxpayer ceases to be a primary producer – for example, if they retire or exit the family business to allow a family member to take over. If the farm is sold, deferred income can be realised from livestock dispersal (at market value) and the sale of plant and equipment at the farm clearing sale.

The key here is (a) to be constantly aware of the accumulated amount of “deferred income” you are carrying forward; and (b) to ensure that you include this aspect in your succession and retirement planning.

A superannuation contribution strategy can “chip away” at deferred income by moving the deferred income into a retirement savings vehicle, using the applicable tax concessions to improve the result.

Example

A farming family of two parents and their son and daughter have accumulated $1M in “deferred income”, mainly in FMD’s. After a run of “good” years, they now feel the amounts in FMD’s are excessive to their needs. They also need to return drought deferred sales as income over the next couple of years.

They could make concessional superannuation contributions to the allowable cap of $25,000 per person (i.e. a total of $100,000 pa), funded either in part or in full by redemptions from the FMD’s.

Each year, they could reduce deferred income by $100,000 at an effective tax rate cost of 15% (the rate the superannuation fund must pay on the contributions received).

Depending on the family’s other incomes, this rate may be considerably less than they would pay if they simply returned the income with no offset and tax paid at that personal marginal or average rates.

Over time, they could save tens of thousands and possibly more, particularly in the case of an unplanned event or death situation.

Another advantage of this strategy is that the family starts to accumulate a significant off-farm asset in a tax-effective environment, which could be a future source of tax-free retirement income.

Should they wish to maintain “control” over their investment assets, they could use a Self-Managed Superannuation Fund structure.

Why Choose a Self-Managed Superannuation Fund (SMSF)?

Roughly one-third of all superannuation monies in Australia are contained in self-managed funds and these have continued to increase in popularity with consistent growth over the past 10 years. There are currently around 600,000 SMSF’s in Australia. This fact sheet discusses some of the reasons you might choose to manage your own superannuation fund.

For an employee in the private sector or a business person, the options for superannuation can include:

  1. Industry Funds – these are so called “profit for members” funds usually designed for people in a particular industry – for example, cbus in the building industry and HESTA for the health and community services sector
  2. Retail Funds – open to the public and run by financial institutions such as banks and insurance companies
  3. Corporate Funds – established by a particular employer and only open to their employees
  4. Self-Managed Superannuation Funds (“SMSF”) – “do-it-yourself” funds controlled by the members

The reasons for choosing the self-managed route are varied but can include:

A. Control. The members of the fund are also the trustees of the fund and therefore have ultimate control over all aspects of the operation of the fund including investment policy and administration.

B. Flexibility. SMSFs can be far more flexible and personalised in their operations. For example, SMSFs have the ability to:

  • Transfer business real property and listed securities owned by members to the fund
  • Invest in projects in conjunction with business associates or in other non- traditional asset types
  • Take advantage of the of the provisions that effectively allow the “bring forward” of next year’s concessional contribution cap and enabling the member to claim 2 years contributions for tax purposes
  • Customise life insurance arrangements to the precise requirements of individual members
  • Loan (up to 5% of assets) to related business entities

Note however, that SMSFs cannot generally run a business as that could be taken as not meeting the “sole purpose test”.

C. Convenience. As members are the decision makers and administrators (including controlling the fund bank account) they can effect transactions instantly – such as short notice changes to pension payments, contributions, commence a transition to retirement income stream, implement contribution splitting, etc.

D. Administration Costs. Generally, industry and retail funds can charge between 1.0% and 2.0% of account balance in administration type fees and often there are other fees “hidden” within investment returns. The administration costs for an average SMSF would be typically less than 5%.

E. Effective succession planningA self-managed fund provides more options for leaving account balances in the fund for the benefit of surviving dependents and members can effectively create a strategic estate plan outside the member’s will. This can include using the fund as a so called “family superannuation fund” involving other family members (subject to the limitation of the number of members).

F. Ability to utilise borrowings for investment “gearing”. This can be for the purchase of property and shares and unit trust investments via a “Limited Recourse Borrowing Arrangement”. Note that these arrangements can be complex and appropriate professional advice should be sought before considering this.

Note that there are a range of responsibilities associated with running an SMSF. For some people, being more engaged with their retirement fund can be very rewarding while others may find it a burden. It is therefore important that individuals get appropriate professional advice and fully consider all aspects before deciding on the self-managed option.

BOB LOCKE – CHARTERED ACCOUNTANT & SMSF SPECIALIST

Bob’s career spans more than 40 years in accounting, taxation and financial services. His specialty is self- managed superannuation funds and the development and management of financial accounting software.

Bob has experience as a partner in a large accounting firm, as administrator of a large corporate superannuation fund with more than 1000 members and as owner/founder of Practical Systems.

 

The information provided in this article is general in nature and does not take into account your personal circumstances, needs, objectives or financial situation. This information does not constitute financial advice. Before acting on any information in this article, you should consider its appropriateness in relation to your personal situation and seek advice from an appropriately qualified and licensed professional