In a recent speech, ATO Assistant Commissioner Dana Fleming outlined the 12 most common mistakes made by SMSF trustees.
Ms Fleming acknowledged that most SMSF trustees do the right thing and “operate within the rules and regulations”. She stated that individuals who choose to set up an SMSF must understand the risks, time and resources necessary to run the fund and meet compliance obligations. Ms Fleming said trustees should not cut corners, and one of the key messages is “that trustees need to understand they are ultimately responsible for the operation of the fund and it is an important roles that carries certain duties and responsibilities.”
The ATO (Australian Tax Office), as a result of ATO casework, education and support, and risk assessments, has identified 12 areas where trustees commonly make mistakes. The 12 areas are:
- New registration of an SMSF
- Sole purpose test
- In-house assets
- Separation of assets
- New trust deeds and trust deed updates
- Maintenance and updates of investment strategy
- ATO lodgement obligations
- Unique bank account
- Valid Electronic Service Address
- Management of annual audit process
1. New registration of SMSFs
According to the ATO, potential SMSF trustees must ensure the SMSF is set up properly before applying for an Australian Business Number for the fund, and potential SMSF trustees must also ensure the SMSF is a regulated fund.
Ms Fleming said the 2 most common errors at SMSF registration stage are failure to properly set up the SMSF (such as the SMSF not yet holding assets) before applying for the ABN, and not providing correct and full details of the fund members or fund trustees.
The ATO conducts pre-registration checks on new SMSFs (or new members to existing SMSFs) to ensure the parties involved are starting an SMSF for the sole purpose of retirement, and to vet those individuals who have a poor income tax lodgement and debt compliance history outside of super.
For more information on starting an SMSF, see SuperGuide section Setting up an SMSF.
2. Sole purpose test
According to Ms Fleming, all investment decisions must be for the sole purpose of “growing and providing retirement benefits”. She said that investments that provide ‘current day’ benefits to fund members or related parties, either directly or indirectly, will breach the sole purpose test.
Lending SMSF money or assets to fund members, or relatives of fund members is the most common breach of the super rules encountered by the ATO, said Ms Fleming who explained that such loans are payments to members that have not met a condition of release. She said, “This behaviour is usually associated with a life event such as marriage breakdown, financial pressures or family illness where the trustee uses the SMSF funds to meet an immediate need with little regard for the consequences of accessing super illegally”.
4. In-house assets
SMSF trustees can invest no more than 5% of total fund assets in lending to, investing in, or leasing to a related party. According to the ATO, an in-house asset is any of the following assets:
- a loan to, or investment in, a related party of the SMSF
- an investment in a related trust of the SMSF
- a lease over a fund asset, and that lease is with a related party.
According to Ms Fleming, a breach of the in-house asset rules “is usually associated with a failing business and the immediate need to inject cash to keep it afloat. The ease of withdrawing money from the SMSF’s bank account may motivate some trustees with cash-flow problems in their business to use the money in their SMSF to boost their business with the intention of paying back the money, but often they don’t.”
Ms Fleming suggested that SMSF trustees should list all related parties when an SMSF is established, to minimise the risk of breaching this rule.
5. Separation of assets
SMSF trustees often fail to ensure fund assets are held in the name of the SMSF. For example, a common error is setting up the SMSF bank account in the name of individual/s rather than in the name of SMSF trustees. SMSF trustees can often make this mistake when investing in shares too.
SMSFs are banned from borrowing money except in specific and limited circumstances, such as when using a Limited Recourse Borrowing Arrangements (LRBAs).Ms Fleming said trustees borrowing money is a problem area, and reminded SMSF trustees that an LRBA can only be used to purchase an asset that an SMSF is permitted to purchase under the super laws.
Although Limited Recourse Borrowing Arrangements (LRBAs) are within the super rules, the ATO strongly advises obtaining good advice on the set up and structure of the LRBA, to minimise the risk of breaking the rules.
7. Trust deeds
The ATO actively encourages SMSF trustees to regularly review a fund’s trust deed and update when needed. Ms Fleming suggested that “an obvious time to update the deed is where there has been a law change or a significant court case that impacts the way the law applies. For example, the law might change to allow a new condition of release but the SMSF’s deed might not have been updated to allow for benefits to be paid out under those conditions”. For more information on the process for updating an SMSF trust deed, see SuperGuide article SMSF basics: Updating SMSF trust deeds.
8. Investment strategy
Ms Fleming noted that managing and updating an SMSF investment strategy is also an area where problems arise, and throughout the lifecycle of the SMSF, trustees must consider the individual circumstances of each fund member and the general condition of the fund. She said “You need to continually reassess whether an SMSF is still the appropriate option for your retirement savings… as a result, it’s important to review your investment strategy regularly to ensure it continues to reflect the purpose and circumstances of your fund, taking into account the retirement goals of the members, liquidity or growth needs reflecting the accumulation or retirement phase make-up if the fund and current economic and market factors.”
9. Lodgement obligations
According to the ATO, 86% of SMSFs lodge on time, while 14% of SMSFs fail to lodge on time. In March 2017, the ATO targeted 49,000 SMSFs with 2 or more years of outstanding SMSF returns. As at July 2018, the ATO had managed to cut that number by more than 22,000 SMSFs by re-engaging the SMSFs, or encouraging the SMSFs to exit the system and wind up.
The ATO will also focus on SMSFs that have never operated, or are no longer operating, and ensure those SMSFs are wound up and exit from the super system.
10. Valid bank account details
The ATO has found that some SMSFs run bank accounts that are not uniquely set up for super payments. An SMSF must have its own bank account, and hold separate bank records.
11. Electronic Service Address
SMSFs need a valid Electronic Service Address to receive employer super contributions. The ATO is aware of 250,000 SMSFs receiving employer contributions, but over 145,000 (58%) of those SMSFs have not reported a valid ESA to the ATO. The ATO encourages SMSF trustees to update ATO records for their SMSFs. For more information on ESAs, see SuperGuide article SMSF contributions: Your employer and fund must use SuperStream.
12. Annual audits.
Failure to lodge SMSF returns on time and failure to conduct an independent annual audit are often linked, according to the ATO. An SMSF must appoint an SMSF auditor each year. According to Ms Fleming, a common breach is when trustees fail to provide requested documents to the SMSF auditor within 14 days of the request. For more information on SMSF audits, see SuperGuide article SMSF audit: you must appoint an approved SMSF auditor.
For more information…
For more information on SMSF compliance and administration, common breaches and what happens if you break the super rules, see the following SuperGuide articles:
- How to evaluate whether an SMSF is right for you
- SMSF compliance for super beginners
- SMSF trustee declaration: a quick guide
- SMSFs: Driving your super C-A-R-T obligations
- SMSF compliance: Is your fund due for a super service?
- SMSF advice: Is your accountant still allowed to help your fund?
- SMSF providers: What should I look for when setting up my DIY super fund?
- SMSF compliance: Administrative penalties hit hard for misbehaving trustees
- SMSF trustees face big penalties: 2018/2019 guide