In this guide
- Regulatory framework
- Rights and responsibilities
- Residency requirements
- Passing the sole purpose test
- Developing an investment strategy and rules
- Considering member insurance needs
- Accepting contributions and making payments
- Monitoring total super balance and transfer balance caps
- Administration
- Appointing a registered auditor
- Lodging an annual return and paying tax
- Common mistakes made by SMSF trustees
- Current areas of SMSF compliance focus
- The bottom line
Self-managed super funds (SMSFs) offer their members more control and flexibility than they could otherwise achieve with a public fund, but freedom has its limits.
SMSFs are privately run superannuation trust structures. All members of an SMSF must be either an individual trustee of their fund, or a director of the corporate trustee of the fund (if the SMSF has been set up with a corporate trustee structure). All SMSF trustees are responsible for ensuring their fund complies with Australian superannuation legislation.
Regulatory framework
SMSFs are regulated by the Australian Taxation Office (ATO), which can impose harsh penalties on SMSF trustees for non-compliance with the rules.
Complying super funds in Australia (including both SMSFs and public funds) are eligible for tax concessions under Australian super legislation. Member contributions and fund earnings for compliant super funds are taxed at the concessional super rate of 15% (up to certain contribution limits).
Transcript
How can SMSF trustees know what areas the ATO is particularly concerned about?
Fortunately technology is our friend when it comes to what the tax office is looking for, because we can go onto the ATO website and of course most of us get regular updates either on a daily, weekly, monthly basis. So usually we’ve got a pretty good idea what the tax office red button issues are.
There’s a variety like we’ll go through a period where the tax office is concerned about say, limited recourse borrowing arrangements or areas that have caused enormous concern in recent times are the NALI and the NALE rules. So they’re the known knowns, they’re the areas that are of real concern to us. Some of them are likely to be things like pulling money out of a fund when we shouldn’t or alternatively making inappropriate investments. So the range of issues is actually very large.
What should trustees do if they are concerned they may have broken the rules?
I break the process in dealing with the ATO into two steps. One is, should we do something if we’re a little bit anxious, a little bit concerned, should we do something before we get a tap on the shoulder from the tax man? And that’s what I’ll call early engagement. And there’s actually a lot of limbs, if you like, to the concept of early engagement. And what I would say is engage early, engage early, engage early.
Then if we do find that we’ve got a problem with the tax office then we can go down what I’ll call the traditional dispute resolution procedures. And we almost know at the outset it’s going to be timely or very time consuming, and it’s going to be expensive, and there’s going to be a lot of anxiety and angst along the way.
So that really says to us, if we have a fair sense that that’s going to happen, whether we ultimately win or lose, then maybe we should think about some alternate dispute resolution options. And that’s where it gets interesting.
In some situations it might be we seek a private binding ruling. There are public rulings, there are private rulings, there are oral rulings. There are other situations though where we can’t seek a ruling because the legislation isn’t all encompassing. It doesn’t cover all of the situations where we’d like a ruling. But fortunately there’s a thing called administratively binding advice.
Very often the contact with the tax office will be through the tax agent. Now it could be they’ll engage a specialist like me and I’ll be behind the screen, I might draft something and the tax agent might then lodge it under the tax agent’s name because it’s easier that way. The tax agent is known, it’s on the ATO system.
In another situation it might be that the client provides a release, if you like, to the tax office to deal with me not being the tax agent. So therefore I can assist. And the same happens with other advisers, other specialist advisers. And then from there it might be, we lodge a ruling request. It might be we use the early engagement request email address for the tax office, which kind of opens up a door for not a private ruling, but for early engagement advice, if the tax office will deal with us.
And there’s a question there because there’s a bit of a gap as to when early engagement might work, that is early engagement, that isn’t a private ruling. There are some gaps there as to when there’s a tax office gateway if you like.
What are some of the penalties that the ATO can impose?
The penalties are kind of scary because if the fund becomes non-complying, people will generally be aware that we could lose 47% of the assets of the fund. Penalties might be less than that. But perhaps one of the really unsettling things is if the tax agent has been, if you’re like, playing outside the bounds, then when we look at the penalties that could be imposed, for individuals they could be more than a million dollars, or for an incorporated body, that could be over $5 million. And of course, our meal ticket is at risk as well.
So the penalties are absolutely daunting. So if ever there was a space to get this right, the superannuation space is where we’ve really got to get this right.
Any tips for trustees when dealing with a dispute with the ATO?
Back to my earlier comment, if you’re at all unsure, do two things. First of all, be or become an expert, a subject matter expert. Or if that’s not feasible, or even if you are, but you’d value a second opinion, get a second opinion from an expert. So make sure what the technical position is as best you possibly can.
Then from there, engage early. So early engagement, early engagement, that’s what it’s all about. I would much rather deal with someone from the tax office where I’m on the front foot and I’m saying, ‘Hey I want to work collaboratively with you to resolve this issue. We want to attend to our tax obligations’, than have a similar discussion on technical issues with a tax auditor who’s got out of bed in the morning wanting to make adjustments because after all, that’s his or her day job. I’d much rather engage early.
The only other thing I’d say is if the wheels fall off the cart and we have a dispute, it’s going to be expensive. So think about alternate dispute resolution options. And one of those might be what’s called in-house facilitation. And what that means is someone from the tax office who is not connected with the audit or the review. Someone from the ATO who’s trained as a facilitator. So they’re not really independent, but they’re kind of held out as being independent.
But someone else from the tax office gets involved. It brings the parties together, let’s say the tax office auditors and me as the advisor might have my client with me. Bring the parties together to determine what the issues are, make sure we’re focused on the same issues, see where the differences are, see where the common ground is and see whether we can come to some sort of agreement. That’s kind of how in house facilitation works.
Can it work? Yes, it can. Is it the answer to a maiden’s prayers, as they say? Not always. Have I had success down that path? Yes, I have. So I’d say give some thought to that. Because the alternative is tax disputes always take a lot of time and they’re always costly. And the only one who wins is the adviser from charging all of the fees. Not the poor client, the poor taxpayer.
Rights and responsibilities
Complying super funds in Australia (including both SMSFs and public funds) are eligible for tax concessions under Australian super legislation. Contributions by and on behalf of members (up to certain contribution limits) and fund earnings for compliant super funds are taxed at concessional rates. But these incentives to lock away your retirement savings in super come with responsibilities.
Your responsibilities as an SMSF trustee are outlined in your fund’s trustee declaration. Each trustee of an SMSF must sign and return this declaration to the ATO within 21 days of their appointment to indicate they understand all their legal compliance obligations.
Corporate trustees should be aware that they must also comply with the general provisions of the Corporations Act.
Residency requirements
To be compliant, an Australian SMSF must satisfy the following three residency conditions:
- The fund must have either been established in Australia (i.e. the initial contribution to set it up was made and accepted in Australia), or have at least one Australian-based asset.
- The central management and control of the fund is ordinarily in Australia. However, trustees are permitted to manage their fund temporarily outside Australia for up to two years without breaching this residency requirement.
- The fund’s active members (that is, members making fund contributions or having contributions made on their behalf) must be Australian residents and they must hold at least 50% of fund assets (or at least 50% of the amounts payable to members). Alternatively, a fund with no active members that meets residency rules 1 and 2 can still be classified as an Australian super fund.
Passing the sole purpose test
Any super fund (including an SMSF) needs to pass the sole purpose test to be compliant and eligible for tax concessions. This means the fund must operate for the sole purpose of providing retirement benefits to its members (or to their dependants if the member dies).
An SMSF will fail the sole purpose test if:
- Any trustee (or related party) directly or indirectly benefits outside of the fund from any SMSF investment decisions made. SMSF trustees must also ensure that all the fund’s investment transactions are done at ‘arm’s length’ at current market values. This includes any transactions involving relatives or business associates of fund members.
- Any trustee has the use of (or access to) SMSF assets or benefits prior to reaching preservation age and meeting a superannuation condition of release. A major requirement of the sole purpose test is to keep members’ SMSF assets separate from their personal assets. The fund must be the owner of all SMSF assets; they can’t be held in the name of members or trustees.
Developing an investment strategy and rules
It’s a legal requirement for SMSF trustees to prepare a documented investment strategy during the fund’s set-up process. This strategy must be reviewed regularly by fund trustees to ensure that it continues to reflect members’ changing needs and circumstances.
Rules that allow the trustees to implement the fund’s investment strategy should be included in the fund’s trust deed. These rules should outline the specific types of investments the trustees can make.
Considering member insurance needs
SMSF trustees must consider whether to take out appropriate insurance cover for each member of their fund as part of preparing their investment strategy. Important considerations for each member include:
- Their current level of debt
- Whether they have any dependants and, if so, how those dependants would be provided for if the member died or became unable to work for any reason
- Their current insurance cover held outside super or in another super fund.
SMSFs can provide life, total and permanent disability (TPD) and income protection insurance for their members. However, they cannot provide trauma or health insurance.
Accepting contributions and making payments
Trustees of SMSFs are responsible for ensuring they only accept contributions from members (or from employers on behalf of members). They must also ensure that member benefits are not paid as lump sums or income streams unless a member:
- Has reached their preservation age and met a condition of release, or
- Has special circumstances and is entitled to access their super early (for example, if they are permanently or temporarily incapacitated, if they’re suffering from severe financial hardship, if they have a terminal medical condition or on specific compassionate grounds).
Monitoring total super balance and transfer balance caps
SMSF trustees must monitor the total super balance of their members and be aware of the transfer balance cap. These measures were introduced in July 2017.
If any SMSF members have a combined total super balance of more than $1.7 million in their accumulation and retirement accounts, it affects their eligibility to make non-concessional (after-tax contributions), to use the bring-forward rule and to make co-contributions.
The transfer balance cap places a limit on the amount that can be transferred into a super fund member’s retirement account. To confuse matters, this cap is also currently $1.7 million. If a member exceeds this cap, they are liable for excess transfer balance tax. This cap will increase over time by $100,000 multiples, in line with consumer price index (CPI) movements.
Administration
SMSF trustees also have administrative, reporting and record-keeping obligations to ensure their fund’s compliance with super legislation. These responsibilities include:
- Appointing an SMSF auditor
- Valuing fund assets at market value
- Paying the ATO levy
- Event-based reporting
- Reporting member or trustee changes
- Maintaining records.
Appointing a registered auditor
The trustees of an SMSF must appoint an approved auditor at least 45 days before their fund’s annual return to the ATO is due. This auditor must be independent (that is, have no financial interest in the SMSF, or any personal or business relationships with fund members or trustees).
Approved auditors are registered with the Australian Securities and Investments Commission (ASIC). An SMSF auditor is responsible for analysing a fund’s financial statements and assessing its compliance with super law. They must report any non-compliance issues to all fund trustees and the ATO.
Lodging an annual return and paying tax
SMSF trustees are responsible for submitting their fund’s audited annual return to the ATO and for ensuring any associated tax obligations are paid in full.
In addition to providing income tax information, the SMSF annual return is also used to report member contributions and superannuation regulatory information.
Event-based reporting
Event-based reporting is an ATO framework that started on 1 July 2018 to enable administration of the transfer balance cap.
SMSF trustees need to start reporting under the event-based reporting framework as soon as one of their members begins a retirement phase income stream.
From 1 July 2023, all SMSFs with members in retirement phase must report transfer balance account events by lodging a transfer balance account report (TBAR) quarterly.
SuperStream requirements
The trustees of an SMSF must ensure that employer superannuation guarantee contributions made to their fund on behalf of fund members are paid via the ATO’s electronic SuperStream system.
Paying the ATO supervisory levy
All SMSFs must pay an annual supervisory levy to the ATO. The annual levy is currently $259. It must be paid in advance, meaning that SMSFs pay double this annual levy in the first year of their operation.
Common mistakes made by SMSF trustees
The table below provides the most common compliance mistakes made by SMSF trustees, from 2004 when contravention reporting began to June 2021. These mistakes are known as ‘contraventions’ and are reported to the ATO as part of the independent annual auditing process.
Distribution of SMSF contraventions by type, to 30 June 2021
| Contravention type | % of total contraventions | % of value of contraventions |
|---|---|---|
| Acquisition of assets from related parties | 1.1% | 2.0% |
| Administrative type contraventions | 11.7% | 8.0% |
| Borrowings | 7.7% | 8.2% |
| In-house assets | 17.3% | 27.1% |
| Investments at arm’s length | 7.4% | 9.4% |
| Loan to member/financial assistance | 20.0% | 13.6% |
| Operating standard type contraventions | 8.2% | 6.0% |
| Other | 4.1% | 0.9% |
| Separation of assets | 12.7% | 21.9% |
| Sole purpose | 9.9% | 3.0% |
| Total | 100% | 100% |
Source: ATO SMSFs: A statistical overview 2019–20
Providing loans or financial assistance to SMSF members or their relatives are the most common contraventions, followed by in-house assets and the separation of assets.
In the 2020–21 financial year, auditors lodged contravention reports for 13,900 SMSFs representing 40,200 contraventions. Just under half (45%) were reported as rectified.
In addition, the ATO has revealed the top 5 errors with SMSF annual returns are:
- Bank account not unique to the SMSF
- Providing an incorrect electronic service address (ESA)
- Not valuing SMSF assets at market value
- Trying to lodge with zero assets
- Lodging a SMSF annual return with incorrect or no auditor details.
Current areas of SMSF compliance focus
Besides focusing on the common contraventions outlined above, another current area of SMSF compliance focus for the ATO is the illegal early release of super.
In May 2022, the ATO reported significant growth in the number of SMSFs failing to lodge their first annual return, which it said was often an indication that someone had set up an SMSF to gain illegal early access to their super.
As a result, the ATO is also focusing on non-lodgement of SMSF annual returns. It reported that 34,000 SMSFs had never lodged their first return, while 60,000 lapsed lodgers had one or more outstanding returns.
The bottom line
SMSF trustees are legally obliged to ensure their fund’s compliance with superannuation legislation in Australia. The ATO imposes a range of penalties for non-compliance, depending on the seriousness of the breach.
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