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The use of reserves by self-managed super funds (SMSFs) is subject to stricter scrutiny by the Australian Taxation Office (ATO) than it is for other types of super funds. This is because funds other than SMSFs are are regulated by the Australian Prudential Regulation Authority (APRA), not the Tax Office.
That means SMSF trustees need to be extra careful when using and allocating funds as reserves. They must clearly articulate the purpose for holding reserves and manage them in accordance with their fund’s investment strategy.
What are ‘reserves’?
Reserves are simply assets or money held in a super fund that haven’t yet been allocated to a member or members. SMSF reserves are not counted towards any member’s balance until they are credited or allocated to them.
SMSFs are allowed to maintain reserves under the super rules, provided it is permitted in their Trust Deed.
If any reserves are held in an SMSF, trustees must:
- clearly articulate the purpose for holding them, and
- manage them in accordance with the fund’s investment strategy.
When allocating reserves, trustees should ensure:
- It is allocated in a fair and reasonable manner.
- The amount of annual allocation is less than 5% of the member’s total account balance or recorded as a concessional (pre-tax) contribution for that member.
- Allocations are not made to an account-based pension.
Concessional contributions are taxed at 15% inside super, which is lower than Australia’s lowest marginal tax rate.
The $20,000 of reserves transferred to Wayne’s account will be classed as a concessional contribution and count towards his concessional contributions cap (which is currently $25,000 per year), because it is not being allocated to all fund members and the amount is greater than 5% of his account balance.
What is the ATO’s view?
The ATO’s view is that SMSFs should only use reserves in limited circumstances, whereas they believe APRA-regulated funds have a greater need to use them. This is because APRA- regulated funds have much large member bases than SMSFs. Using reserves helps them to spread their costs and returns among these members more accurately.
The ATO’s potential concern is that reserves could be misused by SMSFs for the purposes of avoiding tax on fund income, that is, member contributions and fund earnings.
Examples of SMSF reserve use that will attract ATO scrutiny
- Using reserves to reduce a fund member’s total superannuation balance to enable them to make non-concessional (after-tax) contributions. Currently, any person with a total super balance over $1.7 million cannot make any non-concessional contributions. Non-concessional contributions aren’t taxed inside super.
- Using reserves to reduce a fund member’s total superannuation balance below $500,000 so they can make catch-up concessional contributions of up to $125,000 under the carry-forward rule.
- Using reserves to reduce a fund member’s transfer balance so it is below the transfer balance cap. The transfer balance cap is the maximum amount that can be transferred from a super accumulation account into a tax-exempt super retirement account. This cap is currently $1.7 million.
SMSF trustees need to be very careful when using and allocating funds as reserves, because the ATO pays close attention to how this is done and is on the lookout for any attempt to use reserves to avoid tax.
The information contained in this article is general in nature.