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Limited Recourse Borrowing Arrangements
27/08/2014 by Heath Griffiths
Current trends show that more and more SMSF's are investing in property through the use of limited recourse borrowing arrangements. Therefore it is of ever greater importance that this process is completed in-line with ATO requirements.
For trustees thinking of undertaking a limited recourse borrowing arrangement please find a useful checklist below:
Ensure your SMSF's deed allows you to borrow, grant security and allow assets to be held by a bare trust.
Amend your SMSF's investment strategy to permit the acquisition of the asset (property or shares) and allow borrowing for that purpose.
Who is the bare trust? Arrange for the bare trust deed to be prepared and the bare trustee company to be registered.
Prepare a minute, for the bare trust, showing a resolution that the trustee will act as custodian of the asset for the SMSF trustee.
Negotiate for the purchase of the asset in the name of the bare trustee.
Complete loan agreements between the SMSF Trustee/s and the lender. Make sure it is clear that the loan agreement states 'limited recourse borrowing loan'.
Purchase the asset using only the SMSF's money and the loan.
Ensure that upon repayment of the loan the asset is transferred from the bare trust to the SMSF.
When sourcing the finance for the purchase of the asset you can lend from either private sources (including members) or traditional lenders.
This article is general in nature and it is recommended you obtain specific advice from a qualified SMSF specialist to assess your individual requirements.
The new SPAA Committee for the Townsville Sub-Chapter
21/08/2014 by Melanie Griffiths
The New Townsville SPAA Board Members HG is on the right.
Announced in August the new SPAA Sub Chapter in Townsville provides a forum for SMSF related discussion. The next meeting is on the 11.09.14 at 12.15pm at Maclean Partners Office Aitkenvale, Townsville. We will be discussing:
• SPAA Borrowing Guidelines
• Retirement Income Products – The Government Discussion Paper
• Dividend Washing and Home Loan Unit Trusts on the ATO Radar
• McIntosh v McIntosh and what it means for SMSFs.
For more information please visit: Townsville SPAA Discussion Group
What Constitutes Auditor Independence?
Whilst working at the Australian Tax Office the issue of Self-Managed Superannuation Fund (SMSF) Auditor independence was often raised. Since leaving there I have noted that there has been additional debate in the accounting community as to exactly what constitutes independence for an SMSF Auditor in relation to small and medium sized accounting firms. Guidance Statement GS 009 - Auditing Self-Managed Superannuation Funds states that the auditor must comply with the requirements of APES 110. On February 2013 the fourth edition an Independence Guide (The Guide) was prepared by the three major accounting bodies in Australia which addressed APES 110 directly.
SMSF Auditor Independence Principles
The guide identifies five cases where independence could be breached:
An auditor cannot audit their own SMSF;
An auditor cannot audit an SMSF where staff reporting directly to them have prepared the accounts;
An auditor cannot audit an SMSF where the individual auditor has significantly prepared the accounts for the SMSF;
An auditor cannot audit the SMSF where a partner within their own firm is a member/trustee of that SMSF; and
An auditor cannot audit the SMSF where a relative or a related party of the auditor is a member/trustee of that SMSF or where the auditor has a close personal relationship or business relationship with a member/trustee of the SMSF. Reference to Section 10 and 71 of the Superannuation Industry (Supervision) Act 1993 should be consulted where related parties are to be considered.
In summary the following are fully accepted as breaching independence standards and necessitate SMSF audits to be outsourced:
An auditor cannot audit their own SMSF
An auditor cannot audit an SMSF when a partner within their own firm is a member
Where the books are 'prepared' by the auditor - "if the auditor undertakes tax calculations or provides advice to the trustee on how to prepare the accounts, then it is not likely that the independence requirements can be met." (The Guide, February 2013).
SMSF Auditor Independence for small and medium sized firms
Many small accounting firms are still stating that they have addressed their SMSF independence issues through the use of "Chinese Walls". The Independence Guide specifically addresses some common situations seen in practice and points to the difficultly of remaining compliant with independence requirements:
Sole practitioners "As discussed above, a sole practitioner would not be able to audit an SMSF for whom they have undertaken the accounts preparation."
One partner prepares accounts and tax returns and another partner audits the fund - the guide notes this will generally only be acceptable where a firm has separate divisions (eg SMSF Administration/SMSF Audit) with staff reporting to divisional partners. It also notes "Smaller firms with two or three partners would find it difficult to put appropriate safeguards in place". Additionally the guide states that this is "Often referred to as 'Chinese walls', it is possible for a firm to carry out both the accounting/tax work and audit work for an SMSF client, but only with appropriate safeguards in place to ensure audit independence. If the safeguards cannot be put in place, the firm will need to decline the audit engagement and outsource the audit function."
Sole practice with member of staff responsible for preparing the accounts & tax returns - This scenario would not satisfy the standards required for independence and therefore the practitioner would not be permitted to undertake the audit. The Guide notes that sole practitioners would not be able to put appropriate "safeguards in place as all of their staff are essentially reporting to them, and there is no opportunity within the practice to segregate ultimate responsibility for the audit engagement from the non-assurance services. It is not relevant that different staff are carrying out each separate function or that a staff member prepares the accounts that are then audited by the partner. It does not matter if the partner had no role in the preparation of the accounts. The issue is that the reporting mechanisms within the firm are such that all staff ultimately report to the sole practitioner (auditor). Similarly, it would not suffice for the sole practitioner to prepare the accounts which were then audited by a staff member."
Firms that provide financial planning advice - The Guide also concludes that independence is unlikely to be possible where a firm has recommended specific products or structures to a client. "If an auditor is assessing the compliance or validity of a particular product or investment arrangement that has been recommended or implemented by the firm, it may be perceived that the auditor would not be independent in undertaking their role. Despite the fact that they may be extremely knowledgeable about such arrangements, a reasonable person may not perceive them as being independent in making that assessment. It is the absence of independence (or perception of independence) that would require the auditor to decline the audit engagement in this circumstance."
SMSF Audit Outsourcing
Many firms have found the increased focus on SMSF Auditor independence as confusing and poorly explained. This has provided the opportunity for specialist firms to establish themselves as experts in the field as they are truly independent and help mitigate any unnecessary risks. As a matter of best practice the issue of independence should always be considered.
Heath is a registered SMSF Auditor and director of HG's Super Audits. If you require further information please see www.hgssuperaudits.com.au for contact details.
Keeping Self Managed Superannuation Fund assets separate from your own assets
Although this requirement is covered in the covenants, subparagraph 52(2)(g) of the Superannuation Industry (Supervision) Act 1993 (SISA), from August 2012 this has now moved to an operating standard allowing the ATO to take firmer action with trustees who fail to follow this requirement.
The assets of a Self Managed Superannuation Fund (SMSF) must be registered with the legal owners being the trustee/s of the fund for the SMSF. An example of this would be Mr A Jones and Mrs B Jones as trustee for the Jones Superannuation Fund or Jones Pty Ltd as trustee for the Jones Superannuation Fund. This is to protect the assets of the fund in event of insolvency or bankruptcy.
It is noted that in some Australian States land and buildings, known as real property, cannot be held in the name of the SMSF. In this instance the minimum that you should do is prepare a declaration of trust stating that the property is held by the trustees on behalf of the fund.
Failure to follow this requirement can now result in the being fined up $17,000 and/or making the fund 'non-complying' which means that that the fund no longer has a right to its concessional tax treatment. When this occurs the fund will be taxed at the top marginal tax rate rather than the concessional rate of 15%.
New ATO Compliance Regime Rundown
Royal assent was given on the 18th March 2014 to the Tax and Superannuation Laws Amendment (2014 Measures No 1) Bill 2014. This means the ATO now has powers to impose administrative penalties for contraventions within SMSF's. This regime will commence from 1 July 2014 and subjects trustees to monetary penalties (see Table 1), mandatory education and rectification directives if found in breach of the SIS Act. This means trustees can be personally liable to pay significant fines which cannot be paid using the resources of the fund.
Rectification Directives
Trustees may be required to undertake a specified action to rectify a contravention within a specified time frame and provide the ATO with evidence of the person's compliance with the direction.
Mandatory Education
Trustees may be required to undertake a specified course of education within a specified time frame and provide the ATO with evidence of completion of the course. This is to gain a better understanding of their obligations and responsibilities to prevent future breaches of the law. The cost of this education is at the expense of the trustees.
Monetary Penalties
An administrative penalty can be imposed whereby the trustee is personally liable, the table below outlines the penalty units and corresponding monetary values.
Table 1: Contraventions and Corresponding Penalties
Provision in SISA Contravention Administrative Penalty Penalty ($)
s34(1) Failure to comply with prescribed standards 20 3400
S35B Failure to prepare financial statements 10 1700
s65(1) Prohibition on lending or providing financial assistance to members and their relatives 60 10200
s67(1) Prohibition on super fund borrowing, except as permitted. 60 10200
s84(1) Breach of in-house asset rules 60 10200
s103(1) Failure to keep trustee minutes for at least 10 years 10 1700
s103(2A) Failure to maintain a section 71E election in relation to a fund with an investment in a pre-99 (11/8/99) related unit trust. 10 1700
s104(1) Failure to keep record of change of trustees for at least 10 years. 10 1700
s104A(2) Failure to sign a trustee declaration within 21 days of appointment and keeping for at least 10 years. 10 1700
s105(1) Failure to keep member reports for at least 10 years. 10 1700
s106(1) Failure to notify the ATO of an event that has significant adverse effect of the fund's financial position. 60 10200
s106A(1) Failing to notify ATO of change of status of SMSF (e.g. fund ceasing to be an SMSF). 20 3400
s124(1) Failure to make appointment of an investment manager in writing. 5 850
s160(4) Failing to comply with the ATO education directive 5 850
s254(1) Failure to give ATO information in the approved form, within the prescribed time upon establishment of fund. 5 850
s347A(5) Failure to complete a form which is part of the ATO's Statistical Program 5 850
What can SMSF Trustees do to prevent any issues?
It is imperative that trustees who are currently in breach of the Act ensure their SMSF is compliant from 1 July 2014 and any breaches rectified before this date to ensure they do not become liable for penalties. Contraventions made prior to 1 July 2014 and which continue after that date will still fall under this new regime. Whilst the ATO will consider the circumstances if trustees are making progress in rectifying a contravention this is by no means a guarantee that penalties will be remitted. It is advisable that all trustees and their advisors/accountants rectify any contraventions prior to this date to ensure unnecessary penalties, rectifications or associated ramifications are avoided.
Please contact us if you have any questions that we may be able to assist you with.
Trustee Covenants
Although the deed does set out the responsibilities of the trustees of a Self-Managed Superannuation Fund (SMSF) the Superannuation Industry (Supervision) Act 1993 (SISA) also has an additional set of defined obligations which must be followed.
The covenants are:
To act honestly in all matters concerning the entity;
To exercise, in relation to all matters affecting the entity, the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with property of another for whom the person felt morally bound to provide;
To ensure that the trustee's duties and powers are performed and exercised in the best interests of the beneficiaries;
To keep the money and other assets of the entity separate from any money and assets, respectively:
(i) that are held by the trustee personally; or
(ii) that are money or assets, as the case may be, of a standard employer-sponsor, or an associate of a standard employer-sponsor, of the entity;
Not to enter into any contract, or do anything else, that would prevent the trustee from, or hinder the trustee in, properly performing or exercising the trustee's functions and powers;
To formulate and give effect to an investment strategy that has regard to the whole of the circumstances of the entity including, but not limited to, the following:
(i) the risk involved in making, holding and realising, and the likely return from, the entity's investments having regard to its objectives and its expected cash flow requirements;
(ii) the composition of the entity's investments as a whole including the extent to which the investments are diverse or involve the entity in being exposed to risks from inadequate diversification;
(iii) the liquidity of the entity's investments having regard to its expected cash flow requirements;
(iv) the ability of the entity to discharge its existing and prospective liabilities;
if there are any reserves of the entity-to formulate and to give effect to a strategy for their prudential management, consistent with the entity's investment strategy and its capacity to discharge its liabilities (whether actual or contingent) as and when they fall due;
to allow a beneficiary access to any prescribed information or any prescribed documents.
Even though many trustees engage experts to perform various duties the ultimate responsibility and accountability for running the SMSF lies with the trustees.
Should your SMSF have a corporate trustee?
Statistics provided by the ATO indicate that 73% of all SMSFs in Australia have individual trustees and 90% of newly established SMSFs are established with individual trustees.
However, the benefits of appointing a company as trustee of an SMSF easily justify the initial cost of acquiring the corporate trustee and the annual ASIC fee.
Appointing a corporation to act as trustee of your SMSF has advantages in the following areas:
-Succession planning;
-Ease with which additional members/directors can be appointed and removed;
-The SMSF is often in a better position to borrow money for the acquisition of investment assets (limited recourse borrowing arrangement);
-Greater privacy and greater convenience; and
-Reduction in personal risk that comes with being a trustee who is a legal natural person.
Are there personal risks from being an individual trustee?
While being a corporate trustee does not make you risk immune it is something you need to consider when making the decision for or against.
In the case of Shail Superannuation Fund v Commissioner of Taxation [2011] the individual trustees, Mr and Mrs Shail, held assets exceeding $3.46 million within their SMSF. Mr and Mrs Shail were both individual trustees and members of this fund. After encounter some relationship difficulties Mr Shail withdrew the whole $3.46 million of SMSF assets and left the country.
As Mr and Mrs Shail had not yet satisfied a condition of release for the fund assets, the Australian Taxation Office issued a notice of non-compliance and assessed the trustees of the fund for $1.58 million in tax payable, plus penalties of $1.47 million. As a co-trustee, Mrs Shail was now liable for the liabilities incurred in this process.
Mrs Shail was now left with a debt in excess of $3 million for which she was personally liable to pay and is likely to face bankruptcy proceedings in the future, resulting in the loss of any property and assets that she owns in Australia, including any family home.
Personal liability arising from the liabilities of an SMSF
This case above clearly shows the principle that co-trustees are jointly and severally personally liable for the liabilities of an SMSF.
This can be potentially disastrous to individual trustees, particularly where:
-They own valuable assets outside their SMSF, in their personal names, including the family home;
-The SMSF owns 'real' property and an accident occurs on that property where legal action follows; and
-The regulatory body fines or assesses other taxes or liabilities.
Whilst the use of a corporate trustee cannot extinguish all possible liability situations the appointment of a corporate trustee can go a long way towards protecting the personal assets of a trustee.
Should all SMSF's have a corporate trustee?
For any one of the reasons above the cost of registering a company far outweighs the savings which might be made from being an individual trustee. Additionally the convenience by which changes in membership can be achieved and the personal liability protection which results by using a corporate trustee seems to weigh in its favour.
Appointing a corporate trustee ensures that in the event of a liability arising, the corporate trustee bears that liability instead of the individual trustees. This is something members should consider when weighing up their options. When establishing an SMSF and before making any decisions it is extremely important that you make an appointment and get advice from a professional so that you get it right the first time. I am happy to answer any queries you may have and can be contacted on the supplied details.
Sole Purpose Test
The sole purpose test is defined in Section 17A of the Superannuation Industry (Supervision) Act 1993 (SISA). Briefly the sole purpose test is a test that ensures a superannuation fund is maintained for the purpose of providing benefits to its members upon their retirement (or attainment of a certain age), or for beneficiaries if a member dies.
If a super fund trustee, a super fund member or relative enjoys a direct or indirect benefit before retirement from a super fund's investment, that is, more than an incidental or insignificant benefit, then it is probable that the super fund has breached the sole purpose test.
A great ATO publication to read is SMSFR 2008/2: The application of the sole purpose test this outlines the ATO's view and gives examples of specific scenario's where there has been a breach of the sole purpose test.
Setting up a Self-Managed Superannuation Fund
There are legislative and trust law requirements that must be considered when setting up a Self-Managed Superannuation Fund (SMSF). We would suggest that you consult a professional advisor for assistance in the set-up of your SMSF and to ascertain whether it is the right choice for your situation.
Below is a simple list of the steps required to set up an SMSF:
Decide if your SMSF will have a corporate trustee or individual trustees; for further information on this decision please see our post on "Should your SMSF have a corporate trustee?"
Execute a trust deed for your SMSF, stat sets out the rules for your SMSF. In summary your deed may include the following:
a. The name of the SMSF;
b. The trustees of the SMSF;
c. Membership eligibility; and
d. Conditions relating to the acceptance and payment of benefits.
Have the deed registered at your state revenue office;
Elect for your SMSF to received tax concessions and obtain a tax file number. Electing to be regulated under the Superannuation Industry (Supervision) Act 1993 (SISA) needs to be done within 60 days of your SMSF being established. You will need to read the instructions and complete the form "ABN Registration for Superannuation Entities".
Open a bank account in the name of all trustees on behalf of the fund. Please note that the structure must be strictly adhered to as a requirement of the SISA is that all assets of the fund must be held separately from those of the trustees.
Draw up an investment strategy for the fund. This strategy should consider life insurance for all members and clearly state the SMSF's objectives and how these will be achieved. Often benchmarks are used to show the ratio of the assets to be held by the fund.
Administer the fund. I.e. accept contributions, make investments, enter into contracts to buy and sell assets of the fund and make payments to members as required by the deed.
Have financial reports prepared and audited annually as required by the SISA.
Comply with other administrative obligations such as record keeping and lodgement of superannuation annual returns.
Further information can be found by downloading the ATO publication "Setting up a Self Managed Super Fund".
Definition of an SMSF
There are 3 kinds of SMSF those consisting of individuals, single member and those known as corporate whereby a company is trustee.
Individual Trustees
Consists of 4 members or less
No member is an employer of another (unless related).
Each member is a trustee
Trustees are not paid for being trustees
Who Cannot Act as a Trustee of a SMSF- section 120 (1) SISA:
Anyone who is disqualified meaning:
Convicted;
Has a civil penalty order against them;
Is an undischarged bankrupt; and/or
Is disqualified by a regulator
Corporate Trustees
Each member is a director of the company.
No director receives remuneration for services to the fund
A Company Cannot Act as a Trustee under subsection 120 (2) SISA if:
A responsible officer is disqualified
A receiver and or manager or provisional liquidator has been appointed to the company
The company is winding up
Must have 2 individuals as trustees as long as:
The member must be a trustee
The other trustee must be related or any other person provided they are not an employee
No payments to be received for services to the fund
Corporate Trustee Single Member
Only 1 member and trustee required ie 1 individual
Member must be the director or one of two directors of the company the second director being either related or any other person provided they are not an employee.
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