WEBINAR: SMSF Quarterly Wrap

Keep up-to-date with the latest technical and regulatory issues impacting self-managed super funds with the “SMSF Quarterly Wrap”.

The last three months has seen a range of important information or changes impacting SMSFs including:

  • The ATO releasing their compliance program and key target areas for SMSFs;
  • new requirements for SMSF trustees from 1 July 2012 with the Stronger Super reforms, including some important delays;
  • the latest ATO interpretative decisions impacting reserves, fund tax deductions and much more…
  • recent case-law, including non-arms’ length income and an excess contribution win for the taxpayer over the ATO! and
  • ATO NTLG technical issues, including 0% interest rates with SMSF limited recourse borrowing arrangements

Find out more about this session and how you can register.

PS.  Don’t forgot about joining me for the Top10 SMSF strategies FREE webinar this Thursday!!

New valuation guidelines for SMSF assets

The past week has seen legislation finalised regarding SMSFs requiring assets to be valued to their “market value” each income year, plus the release of valuation guidelines for SMSFs by the Australian Taxation Office.  The Stronger Super reforms originally recommended these changes to value assets to their “net market value” to better reflect the member’s balance within a fund.  The final amendment to the regulations has seen a logical approach taken by Treasury to remove “net” and simply include the market value.  Market value is already defined within section 10 of the SIS Act and is used as a measurement tool for areas such in-house asset requirements.

Following on from this change to value all fund assets to their market value for the 2012-13 income year and future years, the ATO has also provided valuation guidelines designed to help trustees when preparing financial statements, for acquisition purposes and other SIS requirements .  Importantly, this guidance from the ATO replaces the previous Superannuation Circular, 2003/1, which focused on market valuing assets in determining the purchase price of a pension (pre 1/7/2007).

The valuation methodology required will vary depending upon the event occurring within the fund.  For example:

  • Where the SMSF prepares financial accounts & statements, it is a requirement to value all assets at their market value.  Any valuation should be based on subjective and supportable data
  • Collectables and personal use assets acquired after 1 July 2011 (or where transferred/sold to related party) must be made a market price as determined by a qualified valuer.  Any pre 1/7/2011 collectable acquired or sold until 1 July 2016 can be simply be done on an “arm’s length” price, without the need for formal valuation by a qualified valuer
  • Related party acquisitions must be made at market value, with disposals on an arm’s length basis

In situations where a pension commences, the fund will be required to value assets at the commencement date of the income stream, with ongoing pensions requiring the member’s account balance to be determined at 1 July each year.  The ATO has stated within the guide that an annual valuation is not required unless there has been an event that significantly affects the value of the asset.  The same approach would also apply to testing the market value of SMSF in-house assets and whether they exceed 5% of the total fund assets.  Interestingly, where SC 2003/1 (para 20) stated that a most recent valuation within the last 12 months for the commencement of the pension or in-house asset purpose could be used, this doesn’t appear to be the case under these new guidelines.

What is a significant event?

The ATO considers any of the following would prospectively affect the value of an asset:

  • a natural disaster
  • macro-economic events
  • market volatility
  • changes to the character of the asset

When valuing fund assets, the trustees must be able to demonstrate that the valuation has been arrived at using a ‘fair and reasonable’ process.  Generally, a valuation is considered fair and reasonable where it meets all the following:

  • It takes into account all relevant factors and considerations likely to affect the value of the asset.
  • It has been undertaken in good faith.
  • It uses a rational and reasoned process.
  • It is capable of explanation to a third-party.

Certain assets and events require different ways in which to value assets.  The ATO has provided a checklist for such obtaining valuations to assist trustees and practitioners.

It is important to understand the methodology required for valuing assets for acquisition and/or reporting purposes and that appropriate methodology is applied for superannuation law requirements.  Further changes are anticipated from 1 July 2013, with the removal of related party acquisitions of listed shares where an underlying market exists, along with requirements to have a sworn valuation for any business real property acquisitions.

View the ATO valuation guidelines for self managed super funds

Stronger Super reforms for SMSFs delayed to 1 July 2013

Well… it’s finally official.  The ability to undertake off market transfers of listed shares into SMSFs can continue until 1 July 2013.  This Stronger Super recommendation amongst several others has not commenced at 1 July 2012 as expected, with Treasury still working through some significant roadblocks around market manipulation rules contained within the Corporations Act and other areas that may provided a range of unintended consequences.

The Stronger Super website has recently provided further information of the deferred commencement date for several of the measures announced under these reforms to 1 July 2013.  These include:

  • the banning of off-market share transfers – where an underlying market exists, all acquisitions and disposal of assets between SMSFs and related parties must be conducted through that market;
  • a requirement to use a suitably qualified valuer for acquisitions and disposals where an underlying market does not exist, i.e. transfer of business real property;
  • providing ATO powers to:
    • issue administrative penalties against SMSF trustees,
    • issue relevant persons with a direction to rectify specified contraventions within a specified reasonable time,
    • enforce mandatory education to trustees where superannuation law legislation has been breached
  • having illegally early amounts that have been released to be taxed at the superannuation non‑complying tax rate of 46.5% (currently taxed at taxpayer’s marginal tax rate)

Can the delay be a permanent one for off-market share transfers?

The ongoing drafting issues being experienced by Treasury can hopefully lead to a sensible outcome rather than applying a ‘sledgehammer’ approach to off-market transfers for SMSF trustees.  With the proposed changes only affecting SMSFs, not APRA regulated funds, surely there is a better solution suitable for all funds?  I have been pushing this barrow for some time (see original blog post), that a better solution would be to introduce measures to limit valuation manipulation for capital gains tax and contribution cap purposes.  This could be achieved through an operating standard, which would prescribe acceptable time lines and pricing  which the auditor would need to sign off on each year as part of the compliance audit.  This approach was taken with collectables and personal use assets, originally recommended to be banned, but after intense lobbying a suitable solution was found.

It is important for the industry to continue pressure on Government to find a more practical solution…

Details of the delayed measures can be found on the Stronger Super website.

Net Market Value to provide problems for SMSFs

The recent draft regulations issued by Treasury to require SMSF trustees to value assets each year at their net market value (NMV) seems a logical step to ensure members have current and accurate information about their account balances, along with providing more useful and reliable data for comparisons across the superannuation sector.

This recommendation, whilst good in theory, has created a range of practical issues as valuing to net market value is a concept not really considered within superannuation law.  Market Value is already defined within the SIS Act, so requiring net market value is only going to add additional costs, in particular when dealing with real property, collectables and other assets where an underlying market does not exist.

The timing of when this NMV methodology should be used has also come into the debate, as the draft regulations only consider the use of net market value for the preparation of the financial statements each year (subsection 35B(1)).  Is this same valuation required needed for a pension that commences during a financial year?

One of the key highlighted reasons for change has been the ability to more accurately compare information for SMSF members against APRA-regulated data.  SMSFs are not required to adhere to Australian Accounting Standards (AAS), however many funds (via their accountant or administrator) adopt certain accounting standards, in particular, AAS25, Financial Reporting by Superannuation Plans.  This standard was referenced within the explanatory memorandum (EM) to provide comparable data of all funds across the superannuation sector.

The use of this standard has created a problem though…  AAS25 is currently in the processed being replaced and reliance on this will only created further inconsistencies between SMSFs and APRA regulated funds.  The latest exposure draft of the replacement standard, ED 223, requires ‘fair value’ to be used as the valuation measure for all assets and liabilities of a superannuation entity.  As a result, the principles and requirements in AASB13, Fair Value Measurement, will be used to determine fair value for the super fund.

Where the objective of these reforms was to provide more useful and reliable data, a change in this format could have the opposite effect.  It’s impact has the chance to effect a range of current and proposed reforms including for example, valuation methodology for the $500,000 account balance for members over 50 to make additional contributions from 1 July 2014.

It sounds like a rethink may be required to ensure we get to a ‘fair’ outcome to achieve policy objectives.

Exposure draft released on consideration of Insurance, Separation of Assets and Valuation of Assets at Net Market Value for SMSFs

The Super System Review submitted to Government back on 30 June 2010 made several recommendations to improve the operation and regulation of the self managed super fund sector. Many of these recommendations were accepted by Government and formed part of the Stronger Super reforms to take effect from 1 July 2012.  We have now seen the issue in of the draft regulations in respect to some of the recommendations around consideration of:

  • insurance within an SMSF investment strategy;
  • the inclusion as an operating standard the requirement to have fund assets held separately from personal or employer assets; and
  • fund assets to be valued at net market value for reporting purposes

Trustee requirement to consider insurance for SMSF members as part of their investment strategy

The proposed regulations are to insert a new paragraph into sub-regulation 4.09 (2) to ensure that trustees consider whether they should hold a contract of insurance that provides insurance cover for one or more members of the fund.  With less than 13% of SMSF’s holding insurance for members, this recommendation aims to ensure that trustees appropriately consider the holding of insurance for fund members.

There will be a requirement for trustees to consider whether to hold insurance for their members such as life insurance when they formulate, regularly review and give effect to the fund’s investment strategy. It is expected that trustees will evidence this requirement by documenting decisions in the funds investment strategy or minutes of trustee meetings that are held during an income year.

In addition to the consideration of insurance within a fund’s investment strategy, this regulation would also amend subsection 4.09 (2) to require trustees to regularly review the funds investment strategy.  This will require trustees to evidence this review by documenting decisions in the minutes of trustee meetings are held during the income year.

The separation of fund assets from personal or employer assets

These regulations would insert into sub regulation 4.09A to require that a fund trustee keep money and other assets of the fund separate from money or assets held by the trustee personally or by a standard employer sponsor.  Currently this requirement forms part of a covenant (section 52(2)(d) of SIS Act) that is deemed to be incorporated into the governing rules of the fund (i.e. trust deed).  The ATO is currently unable to enforce compliance with covenants and relies on voluntary compliance by trustees.

It is not uncommon within SMSFs that breaches occur within this existing covenant where investments are incorrectly held by the fund.  This may include the fund bank account or other investments that maybe incorrectly recorded in a member’s own name rather than in the capacity as trustee of the SMSF.  Contraventions of this existing covenant are one of the most commonly reported contraventions sent by auditors to the ATO.

With this regulation becoming a prescribed standard applicable to the operation of a SMSF, the Regulator will have powers to enforce fines of up to $11,000 for a person who intentionally or recklessly contravenes the standard.

Valuing fund assets at net market value

A SMSF is required under section 35B of the SIS Act to prepare a Statement of Financial Position and Operating Statement each income year.  From the 2012/13 financial year, all SMSF’s will be required to value an asset at its net market value when preparing accounts and statements.

Sub-regulation 8.02A(2) will define net market value as the amount that could be expected to be received from the disposal of an asset, in an orderly market, after deducting costs expected to be incurred in realising the proceeds of such a disposal.  Currently, SMSFs are generally able to choose either historical cost or market valuation methods to determine the value of fund assets when preparing financial statements.  There are however requirements for a fund in pension phase (see TD 2009/29) or for in-house asset purposes (see s.82, SIS Act) that assets should be valued at market value each year.

The lack of consistency in valuation methodology has not only lead to an impact on a member to not be able to ascertain the current value of their super benefits, but it also affects the reliability and usefulness of superannuation data to make accurate comparisons across the entire superannuation sector (where APRA regulated funds are required as reporting entities to value their assets at net market value as required by Australian Accounting Standard, AAS 25).

The requirement to value assets to their net market value will ensure that members are provided with current and accurate information about the financial position of their fund and entitlements, along with an ability to better compare and understand the financial information across all sectors of the superannuation system.  Failure to comply with this reporting requirement will carry penalties of $11,000 and is also a strict liability offence and carries a penalty of $5,500.

My views

It will be interesting to watch over the coming years as to the influence of the inclusion within the fund’s investment strategy to consider insurance.  I would argue that many SMSF trustees (not all) lack a solid written investment strategy, with a large number of funds only having something in existence to ensure compliance with the auditor’s sign off under the compliance audit.  Far too often it is not actually used as a tool to set objectives consider risk, diversification, liquidity and from 1 July, insurance.  With a large proportion SMSF members at or nearing retirement, the need for insurance traditionally diminishes over time.  I do however believe this to be a positive step with the number of younger SMSF members entering the market, in particular where individuals are now undertaking borrowing within superannuation to acquire assets.

You can access information about these draft regulations and explanatory memorandum on the Stronger Super website.

(C) The SMSF Academy 2012
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