The use of reserves by SMSFs is subject to stricter scrutiny by the Australian Taxation Office (ATO) than it is for other types of super funds that are regulated by the Australian Prudential Regulation Authority (APRA).
SMSF trustees therefore need to be very 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 amounts held within super funds that haven’t yet been allocated to a specific member of members. 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 a reserve is subsequently allocated to SMSF member/s, it is classed as a concessional (i.e. before tax) contribution if both of the following apply:
- it is not allocated on a fair and reasonable basis to all fund members.
- it is greater than 5% of a member’s account balance.
Concessional contributions are taxed at 15% within the superannuation environment, which is lower than Australia’s lowest marginal tax rate.
Example: Wayne, Carolyn and Darren are the three members and trustees of their own SMSF. They have all been members of the fund for the same length of time. They have accumulated $20,000 worth of fund reserves and decide to transfer it to Wayne, who is approaching retirement. Wayne currently has a an SMSF account balance of $300,000.
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 on the other hand 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 potential concern of ATO’s is that reserves could be misused by SMSFs for the purposes of avoiding tax payable on fund income (i.e. 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 in excess of $1.6 million cannot make any non-concessional contributions. Non-concessional contributions aren’t taxed within the super environment.
- 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 $1.6 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.
The information contained in this article is general in nature.